For years private foundations have gained prominence in the media, and raised public awareness of their causes. Every private foundation must have a charitable “intent” which is managed by an appointed trustee or executive director (which can be you) that oversees the foundation’s investments and distributes the foundation’s assets.
Beyond the joy of philanthropy itself, Grantors often realize, establishing your own foundation can often make smart money sense, as well.
A Private Foundation meets four basic criteria:
- A private foundation is a charitable organization (trust or nonprofit corporation that has obtained 501(c)3 tax-exempt status) organized and operated exclusively for religious, charitable, scientific, literary or educational purposes or for the prevention of cruelty to children or animals. The term charitable is quite broad and encompasses the arts, youth and senior programs, health care, historic preservation, and of course endless multiple social causes.
- A private foundation is formed and funded by one source which is an individual, a family, or corporation*. Funding can come in the form of dollars, a large equity position in a publicly traded company, a family ranch or any other highly appreciated asset. This is how they differ significantly from a public charity which receives all of its funding from the general public.
- A private foundation receives funding from investment income on an ongoing basis. Let’s say that Fred and Mary Jones contribute $1 million (in cash or investment real estate, stocks etc.) to the Fred and Mary Jones Foundation during 2016. The foundation invests this contribution – the endowment – and receives investment income on an annual basis. They, or other members of the Jones family may or may not make additional contributions to the foundation during their lives or at death.
- A private foundation either makes grants to others for charitable purposes or conducts its own charitable programs. Most private foundations are established as grant-making organizations and are often referred to as private nonoperating foundations. Private nonoperating foundations make grants to others for charitable purposes. Private foundations that conduct their own programs are private operating foundations. In addition to making grants, you must see that your foundation’s endowment remains secure and intact, and earns enough investment income to cover the legally required annual 5% payout plus any administrative expenses.
*If your family owned-business is a C corporation, its charitable income tax deduction for contributions to the company foundation cannot exceed 10 percent of the company’s adjusted taxable income. Although the company foundation is a separate entity, it is closely tied to the family business because the business provides the funding. One advantage of a company foundation is that it can build an endowment that will enable it to continue its charitable giving in years when company profits are low. The company builds the company foundation with significant funding in profitable years to build an endowment so it can support charitable causes regardless of the future profitability of the company.
Primary Advantages of Private Foundations:
- To return to society some measure of the successful accomplishments of the donor.
- To promote and pass on to children and future generations a family tradition of giving.
- To maintain family unity (may include creating jobs for family members along with initiating new and exciting family dynamics because you’re all working together to see and enjoy the benefits of your gifts).
- To provide a lasting memorial to a family member(s).
- Builds a family legacy and provides family members with considerable influence in the community.
- Control and flexibility. You have control over who is on the board, how the money is granted, how it is managed.
- To establish an organized, systematic vehicle for charitable giving that avoids last minute, ad hoc and unfocused charitable check writing.
- To serve as a buffer for on-the-spot solicitations (those seeking funds will need to follow the established application procedures).
- To reduce current income tax obligations (because they are considered a “charitable organization”) any earnings on foundation assets are tax-exempt. However, net investment income of private foundations is generally taxed at 2 percent, but often is pared to 1 percent through various tax strategies hence why you’ll need an experienced tax pro on your team!
- To remove highly-appreciated assets (and avoid/delay capital gains taxes) from your estate thus reducing future estate tax liabilities.
- If approaching retirement, a foundation offers an opportunity to stay active, use (or gain) knowledge, skills, creativity and energy in new ways. By taking responsibility for reviewing grants and performing other foundation duties, you can play an important role in the welfare of the community and the world at large
- To make use of tax deductions for payments that are otherwise not deductible. Tax deductible contributions to a private foundation can be used for:
√ Making grants to individuals (such as scholarships).
√ Paying staff salaries and other necessary and reasonable expenses to run a grantmaking program.
√ Making grants to non-U.S. charities.
√ Making grants to non-charitable organizations for a charitable purpose.
Starting a private foundation is a good option for some, but before making a decision there is a lot to consider (cost to establish, taxation and compliance, disclosure requirements, investment options, restrictions on self-dealing, management responsibilities, operating guidelines, required documentation, awarding grants, etc.). Plus there are several other attractive alternatives available for charitable planning, one of which is a donor-advised fund through your local community foundation.
Here are two great resources should you want to learn more:
Exponent Philanthropy http://www.exponentphilanthropy.org/
Council on Foundations www.cof.org