Using a Family Foundation for Your Family’s Charitable Giving
By Caleb A. Williams
Many of our clients have discovered the benefits of using a private foundation to achieve their charitable giving goals. Private foundations are no longer limited to the Ford or Murdock families. However, often the complexities and formalities of forming and operating a private foundation are not fully understood. This article will provide some information on private foundations, including benefits, tax consequences and formation.
BENEFITS OF PRIVATE FOUNDATION
Foundation Source, an outsourced support services company for private foundations, recently stated that more than two-thirds of all private foundations have assets under $1 million. Just a small percentage of private foundations have assets over $10 million.
The first benefit of a private foundation is that donors to the foundation receive an immediate tax deduction for donations made to the foundation. The private foundation will then make future donations to selected charities. With a foundation, individuals can make contributions to a number of charities over many years, allowing the individual to carefully plan his or her giving, while receiving the tax deduction immediately. The deduction is limited to 20% – 30% of the donor’s adjusted gross income. The exact percentage is based upon the type of asset contributed to the foundation.
Many people are interested in forming a private foundation because it is a planned giving vehicle that fosters family involvement. The family that created the foundation may be involved in decisions such as what type of organizations to support with foundation assets. Private foundations also establish a legacy of giving that can carry the family name and support causes that the donor is passionate about through future generations. Often families will hold annual meetings to discuss general business of the foundation and to determine donation recipients.
Another significant benefit is that private foundations provide the greatest control of any planned giving vehicle. Donors decide which charities to support and how assets are to be invested. And there is no maximum limit on how much a foundation can give away in any year.
TAX RULES CONCERNING PRIVATE FOUNDATION
Due to the amount of control a donor may have over a private foundation, Congress has enacted a number of complex regulations and laws concerning private foundations, some of which are aimed at preventing a donor from using the foundation for the family members’ private benefit. These limitations include the following:
A private foundation must pay out at least 5% of the previous year’s average net assets for charitable purposes, which may include administrative expenses of the foundation.
Private foundations typically may only give grants or make donations to public charities qualifying under Section 501(c)(3) of the Internal Revenue Code. Donations made to organizations that are not tax-exempt are subject to a tax. Foundations may also establish a scholarship or grant-making program, but the program must be approved in advance by the Internal Revenue Service.
Family involvement with the foundation is strictly regulated. Although family members may be involved in decision making on behalf of the foundation, family members typically cannot be paid by the foundation. Family members are also restricted from entering into transactions with their foundation, except under limited circumstances.
Private foundations may face an excise tax of 1% – 2% on income of the foundation.
FORMATION OF A FOUNDATION
The vast majority of private foundations are non-profit corporations, which are formed under state law and which must abide by the statutory requirements imposed on all non-profit corporations. These requirements are substantially similar to those you would find in for-profit corporations, except there are no shareholders or owners of the corporation, as it is formed for the benefit of the public or of certain members.
A private foundation is a public benefit corporation under Oregon law, as it is organized for a public or charitable purpose (i.e., making donations to other charitable organizations). Public benefit corporations must register with the Attorney General’s office and provide annual reports to that office. The Attorney General’s office has authority over non-profit organizations and at times must approve actions by non-profit organizations.
Public benefit corporations in Oregon must have at least three people on their board of directors, appoint officer positions such as president and secretary, hold annual meetings, maintain accurate corporate records, and file annual forms with the state and federal government. As will be discussed below, in order to maintain tax-exempt status under Section 501(c)(3) of the Internal Revenue Code, operating your private foundation in accordance with state law governing public benefit corporations is mandatory.
In order for contributions to a private foundation to be tax deductible to the donor, the IRS must approve the foundation as a tax-exempt organization under Section 501(c)(3). Section 501(c)(3) organizations are divided into two broad groups: private foundations and public charities. Most of us have given to a public charity in the past. A public charity is primarily differentiated from a private foundation in that the public charity must receive at least one-third of its funding from government grants, small donations or small non-governmental grants. Donors who want the benefit of 501(c)(3) tax-exempt status for private foundations are typically using funds from only their family, which prevents them from being regulated as a public charity.
Due to the strict regulation of private foundations, the complexity of forming a foundation under state law, and receiving tax exempt status from the IRS, it is necessary for families who wish to use a private foundation to work closely with their accountants, lawyers and financial advisors through the formation process. Failure to follow the rules imposed by both state and federal governments can result in the loss of this tax-exempt status and a resulting loss in any tax deduction for a donation made to the foundation. A private foundation is not for every family, but a foundation provides a level of donor control not available with other planned giving vehicles, and provides a donor the opportunity to involve their family in building a legacy of charitable giving that can span generations.
ALTERNATE CHARITABLE GIVING VEHICLES
There are other alternatives to private foundations that are much less complex, but still provide some involvement by the donor. For instance, community foundations and donor advised funds are public charities that will allow donors to participate in the direction of donations made by the community foundation or donor advised fund. The Oregon Community Foundation is an example of a community foundation. These are “public charities,” and therefore, are subject to less regulation than a private foundation. These organizations pool the contributions of a large number of donors, and use those funds to provide donations to other tax-exempt public charities. As the donor does not set up the charity or participate in the management or control of the charity, the cost of formation and ongoing maintenance to a donor is less than those costs to form a private foundation.
This method of philanthropy is involved and complex. If you would like to discuss private foundations or other charitable giving vehicles, please do not hesitate to contact a member of our Business Planning Group or our Estate Planning Group.