When heirs swap foundation bonds for crypto tokens, the IRS does not see innovation. It may see a punishable violation. Under federal law, a private foundation can face excise taxes for jeopardizing investments, and the managers who approved the trade may face personal liability.
Founders who want to protect charitable assets need more than a standard trust. They need clear investment rules, shared approval, and practical controls that limit what successors can do with foundation funds.
Wealth transfers are vulnerable when family priorities change. A founder may spend decades building a tax-exempt foundation for charitable grants, then hand control to heirs who want to pursue new investment strategies. Written intentions and fiduciary duties may not be enough if the people with account access can move funds without review.
The Modern Wealth Trap: Good Intentions, Poor Execution
Consider Marcus, a first-generation industrialist who endowed a $15 million family foundation to support clean-water projects. After his unexpected death, control passed to his 26-year-old grandson, Julian. The foundation had a basic paper trust with no clear limits on asset classes. Unhappy with the 4% return from the foundation’s municipal bond ladder, Julian sold $4 million of conservative holdings.
One Tuesday evening, Julian wired the money to a major cryptocurrency exchange. He converted the funds into a DeFi liquidity pool that promised an 18% annual return. Ten weeks later, a smart-contract exploit drained the pool, and the $4 million was gone.
Sixteen months later, the Internal Revenue Service reviewed the foundation’s Form 990-PF. Because Julian had failed to use reasonable care and prudence, the IRS treated the transaction as a jeopardizing investment. The foundation and the managers who approved it faced separate excise taxes.
Understanding IRC Section 4944: The Penalty for Jeopardizing Investments
Internal Revenue Code (IRC) Section 4944 imposes excise taxes when a private foundation makes an investment that jeopardizes its charitable purposes. The key question is whether the managers used ordinary business care and prudence when they made the investment.
Risk alone does not decide the issue. The IRS considers the investment in the context of the foundation’s full portfolio, its charitable needs, and the information available at the time. Concentrating a large share of an endowment in volatile, speculative tokens without suitable analysis can create significant risk.
The Two-Tier Tax Structure
Section 4944 can impose an initial tax on the foundation and participating managers. If the foundation does not correct the investment, an additional tax may apply.
| Tax Trigger Level | Entity Penalty (Foundation) | Personal Penalty (Manager) |
|---|---|---|
| Tier 1 (Initial Tax) | 10% of the jeopardizing investment amount | 10% of the investment amount, capped at $10,000 per investment for each manager |
| Tier 2 (Uncorrected Penalty) | 25% of the jeopardizing investment amount | 5% of the investment amount, capped at $20,000 per investment for each manager who refuses to correct it |
| Possible Combined Impact | Up to 35% of the investment amount if the violation is not corrected | The manager caps apply separately to each responsible manager and investment; they do not create a blanket $30,000 total cap |
A manager’s tax is personal. A foundation generally cannot pay that individual liability from its assets. A manager who knowingly and willfully participates without reasonable cause may have to pay from personal funds.
The Phantom Tax and Forced Asset Liquidation
Section 4944 taxes are based on the amount invested, not necessarily the asset’s current value. If Julian invested $4 million and the crypto later fell to zero, the foundation could still owe an initial 10% tax based on that investment amount—$400,000 under the example rates above.
The foundation must pay the tax in cash. If the failed crypto position cannot provide that cash, the foundation may have to sell real estate or long-term stock holdings. That forced asset liquidation can reduce funds available for charitable grants and weaken the founder’s plan.
The Fiduciary Sibling Dynamic: Why Paper Rules Fail
Family boards can struggle to challenge one another. Personal relationships, grief, and a desire to preserve peace may replace careful investment review.
One year after Marcus’s death, Julian, his older sister Sarah, and their cousin Mark meet by video. Julian proposes using 30% of the portfolio for Web3 investments. Sarah is tired of handling compliance work. Mark knows little about digital assets and does not want an argument. Both sign a resolution allowing Julian to manage the allocation in DeFi applications.
After the investment fails, the CPA explains that family harmony does not excuse a lack of care. If the managers knowingly participated without reasonable cause, each may face a separate personal tax. Their exposure depends on the applicable cap and the facts of each investment; it is not automatically a shared $30,000 liability.
Common Mistakes in Digital Succession Planning
- Assuming trust documents enforce themselves: A document cannot stop an heir with banking access from wiring money to a risky exchange.
- Misunderstanding program-related investments: A nonprofit label or DAO structure does not make an investment a PRI. The primary purpose must further the foundation’s exempt purpose, rather than mainly seek investment returns.
- Giving immediate seed-phrase access: Immediate control removes time for training, review, and a careful assessment of the successor’s readiness.
- Relying only on conventional legal counsel: Legal documents set duties and limits, but families may also need operational controls that restrict account access and approval rights.
Traditional Trusts vs. Programmable Legacy Controls
Written rules are important, but they usually work after a dispute or unauthorized transaction. Technical controls can add protection before funds move.
The Limits of a Traditional Trust
A trust may prohibit risky investments through written clauses and affidavits. If an heir breaks those rules, another trustee may need to seek a court order or pursue damages. By then, the foundation may already have lost money and incurred tax exposure.
Digital Access Controls
A programmable access system can require more than one approval before a significant transfer. It can also keep sensitive credentials encrypted until defined conditions are met, such as an independent review, training, or a required waiting period. These controls do not replace legal advice, but they can reduce the chance that one heir moves foundation assets alone.
Connecting Succession Rules to Programmable Legacy Tools
The risk is clear: poor succession controls can expose a foundation to investment losses and excise taxes. Families that want stronger protection can combine legal documents with systems that control when and how successors receive access.
Cipherwill's programmable legacy protocols help families organize that process. Instead of handing an heir a bank login and a hardware wallet, a founder can preserve instructions, approval requirements, and staged access in an encrypted environment.
With Cipherwill's Dead Man's Switch and Time Capsule Encryption, a founder can set conditions for release. For example, an heir might receive access to operating funds after death while core endowment controls remain protected until an independent review, training, or other documented milestone is complete. These tools can support a succession plan, but they should be designed with qualified legal and tax professionals.
The Fiduciary Failsafe Checklist
- Set investment limits: State in the foundation’s governing documents which digital assets and strategies are prohibited or require special approval.
- Use multisignature access: Require several authorized people to approve significant transfers so one heir cannot move funds alone.
- Protect sensitive credentials: Use a system such as Cipherwill's Shard Switch to divide access among trusted parties, advisers, and heirs.
- Document reasonable cause: Before making a novel investment, obtain and retain advice from a qualified tax professional and record the foundation’s risk analysis.
Frequently Asked Questions
Question: What constitutes a jeopardizing investment under IRS rules?
Answer: It is an investment made without the ordinary care and prudence needed to protect the foundation’s charitable purpose. The IRS considers the investment, the full portfolio, and the facts known when the decision was made.
Question: Does the IRS automatically flag cryptocurrency as a jeopardizing investment?
Answer: No. Crypto is reviewed case by case. A large, concentrated position in speculative tokens without adequate analysis is more likely to raise concerns than a carefully managed, diversified allocation.
Question: Can a foundation manager be held personally liable for a bad investment?
Answer: Yes, if the manager knowingly participates, acts willfully, and lacks reasonable cause. The manager’s tax is personal and generally cannot be paid from foundation assets; the applicable initial cap is $10,000 per investment for each manager.
Question: How does the IRS calculate the excise tax under IRC Section 4944?
Answer: The tax is generally based on the amount invested, not the asset’s later value. A position that falls to zero may still produce a tax based on the original investment amount.
Question: What is the correction period for a jeopardizing investment?
Answer: The foundation must correct the jeopardizing investment within the period allowed by the tax rules and IRS process. Failure to correct it can trigger an additional foundation tax of up to 25% of the investment amount.
Question: Can program-related investments (PRIs) be penalized under these rules?
Answer: A qualifying PRI is generally excluded from the jeopardizing-investment rules. It must primarily further the foundation’s charitable purpose and not be designed mainly to produce investment returns.
Question: How can founders prevent heirs from making risky charity investments?
Answer: Combine clear governing documents with practical access controls, such as multisignature approvals, staged credential release, and independent review. Tools such as Cipherwill can support those controls but do not replace legal or tax advice.
Question: Can external personal assets be seized if the foundation manager cannot pay?
Answer: A personal excise-tax liability is collected from the manager, not the foundation. If it remains unpaid, normal federal collection tools may include liens or levies against personal property, subject to applicable law and procedure.
By Cipherwill Editorial Team, Reviewed by Cipherwill Review Board, Trust & Security Review Team
Editorial contributor: Iraan Qureshi
Review contributor: Nivaan Khattar
