For many individuals with accumulated wealth, occasional gifts to a favorite charity may satisfy their charitable inclinations. The added incentive of an often-substantial tax deduction, coupled with various estate planning benefits, can be the driving force behind such charitable gifts. However, for some individuals, philanthropy is a far more serious endeavor, often involving a succession of substantial gifts of at least $5 to $10 million, which may necessitate an amount of control and general oversight. In these situations, a private foundation can be an ideal venue for managing a large, ongoing charitable giving program.
In its simplest form, a private foundation is a charitable, grant-making organization that is privately funded and controlled. When properly arranged and operated, a private foundation can be an entity that is exempt from income taxes and which thereby permits tax deductions for those who donate to the foundation.
Contributions to a private foundation are deductible for gift and estate tax purposes. However, the income tax deduction for gifts to a private foundation is a bit more complex. Generally, the deduction is based on the fair market value of the gift (at the time it was given), and it is limited by the donor’s adjusted gross income (AGI). The charitable deduction is also limited (to 20%, 30%, or 50% of AGI) by the type of charitable organization that is ultimately receiving the gift from the private foundation and the type of gift being made. Gifts that are not cash or publicly traded securities, and that are valued at more than $5,000, need to adhere to specific rules to ensure that they are tax deductible.
In addition to offering the advantages of a tax deduction (which is usually not exclusive to private foundations), private foundations may also offer an array of other benefits. Because a private foundation is typically established to manage a long-term charitable gifting program, it may highlight the philanthropic presence and identity of the donor within the community or associate the donor with a particular charitable cause. It can also serve to create a family charitable legacy while at the same time protecting individual family members from the pressures of other charitable appeals. Finally, a private foundation can serve as an appropriate mechanism for controlling distributions to charities, and it can determine which charities it will benefit.
When a private foundation is established, two important questions need to be asked. First, what type of private foundation should the donor establish? And second, how should the private foundation be structured? There are generally three types of private foundations: nonoperating, operating, and company-sponsored. Each type of foundation has specific characteristics that make it appropriate for a particular situation. Also, each type of foundation must adhere to a set of strict requirements and guidelines.
The most common type of foundation is the nonoperating. Essentially, a donor or group of donors make contributions to the foundation, which in turn makes grants to a charity. In this case, the donor does not participate directly in any charitable work. There are several variations on this type of foundation.
An operating foundation may have direct involvement in charitable causes (e.g., an inner-city youth center) while retaining the tax benefits of a “private” foundation (in some respects, operating as a “public” charity does). To qualify as an operating foundation, several requirements need to be met.
A company-sponsored foundation is useful when the majority of contributions are from a for-profit corporate donor. Typically, the operation of this type of foundation is similar to that of a nonoperating foundation. It is usually managed by corporate officers, and it has the added benefit of allowing some contributions to accumulate over time. This can help the foundation make continual grants when corporate profits are low.
After careful thought is given to the type of foundation to be established, a decision about structure must be made. A foundation can be structured three ways; it can be a nonprofit corporation, a trust, or an unincorporated association.
A number of factors need to be considered to determine which structure is best. Generally, if the donor intends to keep the foundation in existence permanently, a nonprofit corporation or a trust may be the better choice. But it is important to consider a number of factors, including state and local laws governing private foundations, the type of foundation, the type of donor, the need or desire to make future changes or delegate responsibilities, and personal liability issues.
Creating and maintaining a private foundation is much more involved than using more traditional charitable-giving vehicles (e.g., a charitable remainder trust). Therefore, legal and accounting professionals who have experience with private foundations must play a significant role in such an endeavor. And it is important to know that expenses are likely to be substantial because of the complexity of foundations, the need for highly specialized legal and tax expertise, and the costs associated with design, set-up, management, and grant administration. Typically, a private foundation is only viable for individuals who intend to make periodic gifts in excess of $5 million.
Certainly, the private foundation allows today’s philanthropist the opportunity to manage substantial charitable gifts and to actually become involved in charitable work if he or she so chooses. It also affords the donor the opportunity to be recognized for charitable giving, while solidifying his or her philanthropic legacy. As with all advanced estate and tax planning, consult with your team of qualified legal, estate, and tax professionals to help ensure that you meet the goals and objectives of all involved parties.