As a charitable donor, or philanthropist, you have a number of structures and vehicles available to use. In addition to a donor-advised fund, which I have previously written about, you can also set up a private foundation. Not all foundations are the size of The Bill and Melinda Gates Foundation, which currently has $40 billion in assets. Most are more modest in scale and are grant-making foundations, which is the type covered in this article. Here is some basic information about private foundations -- their requirements and use.
A private foundation is a tax-exempt nonprofit organization that is managed by its own trustees and directors. Irrevocable, tax-deductible donations are usually given from a single source, such as a family or corporation, to create a foundation's fund or endowment. Donations made to the foundation as part of a will or estate are also not subject to estate taxes. Family foundations tend to have ongoing family involvement from their donors, who can serve as volunteer trustees or directors. Foundations support social and environmental causes, and must benefit the public, primarily by making grants to other nonprofit organizations.
Private foundations are legal IRS-designated organizations and are required to file a 990-PF form with the IRS annually. Each foundation is also required to pay out at least 5% of its assets each year. Although IRS rules are subject to congressional legislation, they have historically been subject to a 1% or 2% excise tax on net investment income. A foundation may not be used to enrich the donor, their family, or their friends -- this is called self-dealing.
Advantages and flexibility
A private foundation is more appropriate for charitable givers who want more control and engagement than are available with other vehicles. The investments of a private foundation are managed by the foundation, though these investments and assets are somewhat limited by IRS rules. Grants are also directly controlled by the foundation itself. In addition, foundations have some unique flexibility, including the ability to make grants to individuals in cases of emergency or hardship, and even foreign charities that are not recognized by the IRS. Foundations can also create and run scholarship programs.
In fact, when they are made for charitable purposes, private foundations can also provide loans, loan guarantees, and equity investments. These program-related investments, or PRIs, allow foundations to recoup their investments, which can then be reallocated to new charitable purposes. A private foundation can direct some of its own charitable programs for those who want to do hands-on implementation.
Limitations and disadvantages
Individual income-tax deductions for gifts to private foundations are lower than those to public charities; foundation gifts are limited to 30% of the donor's adjusted gross income, or AGI, for gifts of cash, and 20% of AGI for gifts of property. Donors to private foundations also face valuation limitations that donors to public charities don't. With gifts of long-term appreciated property, such as real estate, closely held business interests, and tangible personal property, donors are limited to the tax basis amount. However, with gifts of long-term appreciated publicly traded stock or mutual funds, donors to private foundations can deduct the full market value.
Depending on the financial scale of the effort and capacity to run them, private foundations can be more expensive to establish and maintain than other charitable-giving vehicles. In addition, private foundation boards -- which, in family foundations, often include family members -- have the potential for personal liability and are subject to penalties for distributions or expenses not allowed by law. As you may have already noticed, private foundations have complex rules and can be challenging to run without staff support. For this reason, some have the impression that private foundations only make sense if you have significant resources for philanthropy -- at least in the millions.
However, in 2010, according to the IRS, of the 86,245 private foundations, 80,064 had assets under $10 million, and 56,186 of them had assets under $1 million. At least a few hundred thousand dollars in assets is recommended for it to be worth the time and expense of setting up and running a private foundation.
Private foundation resources
Although you may have to pay for legal and accounting support to set up and maintain a private foundation, there are resources to help you along and keep your time commitment and operating costs down.
- Foundation Source is the largest provider of support services to private foundations, doing virtually everything you might need, primarily through the Web.
- Some community foundations and private banks offer management services to private foundations.
- The Council on Foundations can help educate you and keep you informed about running a foundation.
- Exponent Philanthropy (formerly The Association of Small Foundations) is a membership organization geared specifically for foundations that choose to keep their operations small, regardless of the scale of their resources.
Setting up a private foundation is an enduring commitment to philanthropy. If it seems like it would suit your charitable aims, talk to a philanthropy specialist, your family, and legal or tax advisors.