A private foundation allows you to make gifts to an unlimited number of charities over time and to involve family members in the decision-making process.

Private foundations may be organized as non-profit corporations or as wholly charitable trusts, but the key requirement for either structure is that all of the assets be dedicated to charitable purposes. Assets contributed to a foundation cannot be withdrawn.

Mechanics

  • Most private foundations are grant-making foundations that make financial contributions to public charities selected by their trustees, board, or grant-making committee.
  • Some private foundations are operating foundations that directly fulfill a charitable function by providing some service to the public, e.g., operating a museum or soup kitchen.
  • Private foundations are exempt from income tax, but must pay a 2% excise tax on net investment income, including capital gains; excise tax may be reduced to 1% under certain circumstances.
  • Typically, donations to a private foundation are tax deductible up to 30% of adjusted gross income for cash and up to 20% of AGI for appreciated securities held more than one year with a five-year carryover. Gifts of appreciated publicly traded stock are generally deductible at fair market value, but gifts of non-marketable property are limited to tax cost. An unlimited estate tax charitable deduction may be available for transfers made at death.
  • Private foundations are required to pay out at least 5% of the prior year’s net asset value, based on a monthly average. Distributions in excess of the minimum carry over to satisfy the minimum distribution requirement in future years.

Corporation vs. Trust

  • For private foundations organized as non-profit corporations, family members may serve on the board as directors of the foundation.
  • A private foundation organized as a trust may have an individual and/or corporate trustee, often with an advisory committee (family members) that selects charities to which grants are made.

Advantages

  • One major attraction of a private foundation is the control it offers. If the foundation is formed during your lifetime, the donor may serve as sole trustee, may control a board of trustees or directors through veto power, or may appoint family members, friends, and associates to a board with full removal power.
  • Many donors conclude that a private foundation is the ideal vehicle to promote family philanthropy. Hands-on involvement by donor and/or family members is common. And by being actively involved in the grant-making process, a donor’s children learn not only about philanthropy, but are introduced to portfolio management and the importance of budgeting and cash flow management.
  • A private foundation also offers income and estate tax savings: an income tax deduction is available for all lifetime gifts made by you or others; and contributions of publicly-traded stock, for example, can significantly reduce estate tax liability.
  • A private foundation may be used with other charitable giving vehicles, such as charitable trusts. For example:
    1. A charitable remainder trust (CRT) can first make payments to you or a family member for life, with the remainder funding a private foundation.
    2. A charitable lead trust (CLT) could first fund a private foundation via annual payments over a term of years, with the remainder going to children or grandchildren.

Caution

  • A private foundation can be administratively very complex. In addition to minimum distribution requirements and excise taxes, the IRS also imposes rules on self-dealing, excess business holdings, jeopardizing investments and excess expenditures, all with associated penalty taxes.
  • A private foundation must file detailed and public tax returns on grants, investment fees, and trustee/director and staff names and salary. This may pose a problem if maintaining the donors’ privacy is a concern.

Example

Hal and Martha are the parents of three school-aged children – Kendra, Jason and Holly. Their estate has a current value of $10 million. They feel strongly about giving back to the community and want to pass this passion on to their children.

After evaluating their options, Hal and Martha decide to establish a $1 million grant-making family foundation, the mission of which is to broaden educational alternatives in the local community. Hal and Martha will serve as board members, with Kendra, Jason and Holly as junior board members.

Hal and Martha will receive an income tax deduction of $1 million or up to 30% of their AGI in the year of contribution, with a five-year charitable contribution carryover. The assets held in the private foundation grow income tax free, subject only to a 1-2% excise tax on net investment income.