Dan Hall & Associates Solid Plans for Peace of Mind

Private Foundations

Private Non-Operating Foundation vs. Private Operating Foundation

A private foundation is a charitable organization that is distinct from a public charity.  A private foundation generally has a single funding source, such as an individual, family, or corporation, whereas a public charity usually solicits funds from the public in general.  Both private foundations and public charities have the intent to provide some type of charitable program, service, or activity.

There are two kinds of private foundations.  Most private foundations in the US are non-operating foundations which generally just disburse funds to other charitable organizations.  Conversely, operating foundations generally use their investment income to run charitable activities and work toward achieve their own charitable purposes.

Minimum Payout rate

A private foundation is required each year to make qualifying distributions for charitable purposes equal to or exceeding 5% of the fair market value of its net investment assets. If the foundation exceeds the 5% payout, the excess reduces the required distributions over the next 5 years. Qualifying distributions include grants and expenses related to pursuing the foundation’s mission, but not investment-related expenses.

Excise Tax

Private foundations are subject to a two percent (2%) excise tax on their net investment income. The tax is one percent (1%) in any year in which the foundation’s percentage of distributions for charitable purposes exceeds the average percentage of its distributions over the five preceding taxable years.  The government imposes the excise tax so that there is little or no out-of-pocket cost to the government to handle the logistics of approving and handling the reporting for these entities.

Self-dealing and Excess benefit

Certain acts between the foundation and an insider, known as a “disqualified person,” are prohibited, such as the sale or lease of property. A disqualified person includes a foundation’s officers, directors, trustees, substantial contributors, family members, and certain entities (e.g., trusts, corporations, partnerships, estates) in which these persons have significant interests. A substantial contributor is one who has contributed more than 2% of all historical contributions made to the foundation since its formation and, in most case, has contributed at least $5,000.

 

Benefits of private foundations vs. Donor Advised Funds and other Philanthropic Vehicles:

Control

The donors, through a Board of Directors of their choosing, maintain control over their charitable giving and their investment strategy.

Grant making flexibility

Private foundations have several options for making gifts. In addition to gifts to US-based charities, private foundations may make international grants, grants for scholarships and awards and other forms of assistance directly to individuals and families, and grants to non-charitable exempt organizations (e.g., civic associations, business leagues), governmental units (federal, state, county, town), and even for-profit companies provided that the funds are used for a charitable purpose. Foundations may manage direct charitable programs, such as providing books to a school or hiring contractors to conduct research, and they may make charitably motivated loans and equity investments know as Program Related Investments. All of the foregoing are subject to the fulfillment of IRS requirements.

Continuity

By establishing a foundation, the donors’ charitable goals continue beyond his or her lifetime. The donors’ name is associated with the foundation’s charitable purposes in perpetuity.

Investment Strategy

Private foundations can own nearly any type of asset (partnerships, real estate, jewelry, closely held stock, options) and follow any investment strategy provided that they follow the prudent investor rules and avoid what the IRS defines as jeopardizing investments.

Mission Related Investing

A private foundation may invest its endowment in a way that’s aligned with its mission. For example, a foundation that focuses on environmental issues may invest its assets in a company that’s involved in alternative energy.

Expenses

Foundation members can pay for reasonable (non-lavish) and necessary administrative expenses associated with running the foundation, such as for conferences, office supplies, subscriptions, and site visits to charities. As long as these expenses help achieve the foundation’s charitable purpose and are well-documented, they count towards satisfying the foundation’s minimum payout requirement.

Compensation

Foundation may employ staff to run the foundation including family members. Foundation are allowed to pay compensation to family members provided that the individual is qualified for the position and that the compensation is reasonable in relation to what other foundations of a like size would pay a person with like skills, experience, and duties.

Tax Advantages

Private foundations receive favorable tax treatment. Donors receive an income tax deduction for contributions and an unlimited estate tax deduction for bequests at death. In addition, foundation earnings grow virtually tax free (1-2% excise tax).

Reasons Not to Establish a Private Foundation

There are many reasons why a private foundation may not be the best charitable vehicle for some individuals.  Some of the main reasons are as follows:

  1. The cost to establish a foundation is significant
  2. The annual cost to administer a foundation can also be significant
  3. The amount that should be contributed in order for a foundation to make sense is usually in the range of $1 million and up, with plans for additional contributions in the future

The private foundation requires a succession plan or a plan for termination on the passing of the original creators.

By John K. Bishop  2/19/11

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