Private foundations don't typically get a lot of attention, as most of them quietly do their charitable work for the good of the audiences they're formed to serve. But lately, private foundations have gotten thrust into the spotlight as a result of allegations against President Donald Trump's private foundation.
For those wealthy individuals who want to get the benefits of a charitable private foundation without running afoul of any of the rules that govern one, the experience of the Donald J. Trump Foundation can serve as a valuable lesson on how to manage a foundation's affairs, and potential pitfalls to avoid.
What is a private foundation?
Private foundations are charitable organizations that qualify for tax-exempt status under Section 501(c)(3) of the Internal Revenue Code. To qualify, a foundation must generally be organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes. Some additional specific categories, including public safety testing, fostering amateur sports competitions, or the prevention of cruelty to animals or children, are also included within the definition of a private foundation.
The primary appeal of a private foundation is that it allows donors to exercise continuing control over the funds that they contribute to the foundation. Although the funds must eventually be used for charitable purposes, as defined by federal law and the foundation's own organizational documents, the foundation can retain money for an extended period of time rather than distributing it immediately. Donors also can generally claim a charitable deduction for the donations they make, with fairly generous limitations of up to 30% of adjusted taxable income available.
What rules govern private foundations?
In order to get the benefits of tax-exempt status, private foundations have to follow a number of rules. They include the following:
- The foundation must not be organized or operated for the benefit of any private interest.
- No part of the foundation's earnings may be used to benefit any private shareholder or individual.
- If a person with substantial influence over the foundation gets an excess benefit from the foundation, that person may have to pay an excise tax, and those managers of the foundation who agreed to the transaction can also be liable.
- No substantial part of the foundation's activities can be to influence legislation through lobbying, propaganda, or other means.
- The foundation cannot participate in or intervene in any political campaign on behalf of, or in opposition to, any candidate for public office.
In addition, there are a number of further restrictions. No self-dealing is allowed between private foundations and their founders, substantial contributors, or other disqualified persons, which typically includes family members. The foundation must make annual distributions of income for charitable purposes, and limits apply to their holdings in private businesses. A foundation's investments must not jeopardize its exempt purposes, and its expenditures must further those purposes.
Allegations against the Trump Foundation
In a civil suit against the Trump Foundation, New York Attorney General Barbara Underwood alleged several violations of these rules. As the attorney general's office explained in a press release accompanying the lawsuit, the allegations include:
- "Repeated and willful self-dealing transactions to benefit Mr. Trump's personal and business interests."
- "Extensive unlawful political coordination with the Trump presidential campaign."
- "Us[ing] the Trump Foundation's charitable assets to pay off his legal obligations, to promote Trump hotels and other businesses, and to purchase personal items."
In conclusion, Underwood asserted: "The Trump Foundation was little more than a checkbook for payments from Mr. Trump or his businesses to nonprofits, regardless of their purpose or legality." The lawsuit sought restitution of $2.8 million, dissolution of the foundation, bans from serving as directors of charitable organizations in New York for President Trump and his three oldest children, and potential further financial penalties.
The right way to handle private foundations
There's nothing inherently improper about private foundations, but in order to get the charitable and financial benefits they provide, you have to follow the rules. Specifically, it's essential to acknowledge the separate identity of the private foundation. Observing formalities like holding regular meetings, maintaining separate financial statements and accounts, and documenting income and expenses are necessary to give the IRS and state tax authorities the reassurances they need that your foundation is being run correctly.
In particular, once you donate money to the private foundation, it's no longer yours to direct as you so choose. The terms of the foundation might give its board of directors some discretion over exactly how to achieve its charitable purpose, such as offering grant awards or directing foundation funds to particular charities that share the foundation's mission. However, if you get even an indirect benefit personally from a payment that your foundation makes, it can be problematic.
Private foundations do important work, and they can produce immense tax savings when used correctly. But to get those benefits, you can't afford to ignore the responsibilities that federal and state authorities put on private foundations and their operations.