By: Rob Gordon, MBA, CFP®, AIFA®
Private foundations are a staple of our country’s philanthropic history and its future. For years, they have provided a mechanism for successful individuals, families and companies to develop focused programs of charitable giving over long periods of time. They also represent the glamorous, high profile image of philanthropy. Names such as the Bill & Melinda Gates Foundation and the Ford Foundation are well-recognized around the world. However, did you know that the vast majority of private foundations have assets under $1 million?1 Access to the advantages of a family foundation are within reach of many individuals, families and companies.
How a Private Foundation works:
Generally speaking, private foundations are funded with assets that originate from a single family, individual or company. Members of the family or entity usually serve in the governance of the private foundation as well. A family or private foundation is any charity that does not have an inherently public nature (e.g., a hospital, church or college), does not receive most of its donations and support from the general public (e.g., a museum), and/or is not an organization that is operated, supervised or controlled by or in connection with a public charity (something of a subsidiary of a public charity). In fact, every U.S. and foreign charity that qualifies under section 501(c)(3) of the Internal Revenue code as tax-exempt is a “private foundation” unless it demonstrates to the IRS that it falls into another category.2 The graphic below illustrates the basic structure and the flow of financial benefits related to a private foundation:
Forming a private foundation is relatively simple. A trust or a charitable corporation is formed and an application is submitted to the Internal Revenue Service for exempt status using IRS Form 1023. The private foundation can exist forever depending on the wishes of the donor and the board of the foundation. It is also relatively easy to terminate a private foundation. The board can simply decide to distribute all of the foundation’s assets to charity.
Taxes and Administrative Considerations:
A private foundation offers donors the opportunity to exercise a high degree of control over their financial support for their causes. That increased control requires an increased level of responsibility on the part of the donor and the individuals chosen to oversee the foundation. A few key items to be aware of:
- Donations to a private foundation are tax deductible up to 30% of adjusted gross income (AGI). This contrasts with the 50% deductibility limit for “public” charities and foundations.
- Private foundations pay a 1-2% excise tax on investment income and realized capital gains. This tax may be reduced provided the private foundation meets certain distribution requirements.
- In most cases, private foundations must make aggregate distributions to qualified entities of at least 5% of their assets.
- There are also limits on business holdings designed to limit the ability of a private foundation to maintain an ownership interest in a corporation or other business enterprise.
- Investments which jeopardize the carrying out of the charity’s exempt purpose, known as “jeopardizing investments”, may also become liable for taxes.
- The penalties for mismanagement or neglecting important requirements can be steep.
Self-dealing is a sensitive area for private foundations. Because they are so frequently staffed with family members or individuals associated with the founding entity, there is the risk that the family or entity derives some benefit, perceived or real, from their contributions. It is a very sticky area and one that is closely monitored by the IRS. Acts of self-dealing may include:
- Sales or exchanges of property, leases, loans, goods, services, or facilities,
- The payment of compensation,
- The transfer or use of the income or assets of a private foundation to the donor or other disqualified person.
The general definition of a disqualified person generally includes the foundation’s officers, directors, trustees, key employees, substantial contributors, their family members, corporations, partnerships, trusts or estates in which any of the foregoing has more than 35 percent of the voting power, profits or beneficial interest, and any owner of more than 20 percent of a corporation, partnership or trust that is a substantial contributor.3 For more specifics on this important topic, please consult www.irs.gov and type in “Disqualified Persons”.
Yes, the rules are complex but they are meant to protect the efficacy of private foundations so that they are not abused as they have been in the past. The greatest benefits afforded by private foundations are:
- The foundation can hold a wide variety of assets and can receive a wide variety of assets as donations.
- Private foundations can employ their own investment managers or manage their assets on their own which can save on expenses and allow them to hold assets which might have to be liquidated at a significant loss if held in another charitable entity.
- They don’t have to impose a minimum grant size.
- They can give grants directly to individuals in situations like natural disasters.
- Donors can be actively involved in the decision-making process for grant-making and foundation management. This helps develop important organizational leadership skills in future generations, managers, or family members.
- The structure encourages a focused giving strategy which increases the influence of the donor and potentially increases chances of success for the receiving organization in addressing the specified need.4
Private foundations are required to file a Form 990-PF and those are available for public review at websites such as www.charitynavigator.com and others.
Establishing a Private Foundation:
If you are interested in establishing a Private Foundation, call Investor Solutions, Inc. at 800-508-8500. We have experience assisting our clients in establishing and maintaining their private foundations so that they derive the greatest benefit without the administrative headaches.