Benefits of Private Foundations and Charitable Giving

By Kris Maksimovich, AIF®, CRPC®:

One of the first things people think when they hear a charity’s call to action is, “How can I help?” The natural inclination of people is to help others. That’s because they have an innate desire to create positive change. This is one reason clients have questions about private foundations and charitable giving when discussing estate planning with their financial advisor.

Foundation or Charity

The key difference between foundations and charities is that foundations are private and receive their financial support from one source such as a family, individual or corporation. Charities receive their source of funding from the public. A foundation operates as a service fund managed by its own donors, or as a separate legal entity that carries out the donor family’s charitable wishes. It offers a vehicle for charitable giving through grantmaking and disciplined investment decisions. According to Charity Navigator, foundation giving is up six percent over the past year and represents 16 percent of all donations in 2017. Of those who benefitted from donations, foundations hold a fourth-place position just below churches, education and human services.

How it works

Step One: Legal Structure – Determine how you wish to set up your foundation, either as a corporation or a trust. A corporation offers more flexibility with the ability to amend their articles, bylaws and governance. They can also change the charitable purpose. Organizing as an irrevocable trust offers less flexibility but can help ensure that a specific charitable purpose is not changed by future generations. Consider the lifespan of the foundation. Will it exist in perpetuity, requiring a succession plan? Or will it have a sunset clause, designating a specific end date? You should discuss the multiple reasons behind these strategies with your trusted financial advisor.

Step Two: Mission Statement – Create a clear mission statement which outlines the specific vision and guiding principles for donors, board members or trustees, staff and the public. This statement should establish the goals and values and suggest what can be expected of the foundation.

Step Three: Organize Board of Directors or Trustees – Only include those trusted and qualified to oversee activities and carry-out the mission. Choices can consist of donors, their family members or other qualified independent parties depending upon the scope of the foundation. For instance, a foundation that provides grants for medical research needs members with a different skill set than one that provides educational scholarships. You’ll also want to establish a variety of controlling roles that cover purpose, financial and legal aspects as well as investments, grants and transactions.

Step Four: Select Professional Advisors – Advisors you’ll work with include attorneys, tax advisors and financial advisors. Your financial advisor can assist with planning and executing the foundation and coordinate with legal and tax advisors. They can also help with the foundation’s charitable assets and investment strategy.

Step Five: Apply for Employment Identification Number (EIN) – The IRS requires you to apply for an EIN, even if you do not anticipate hiring people. This number serves as your tax identification number for the foundation, much like a social security number for individuals.

Flexibility and Control

Donors of private foundations can take on the role of trustee and control the timing of donated funds and disposition of gifts. For instance, donors can monitor public charities and support them during selective causes rather than offering them gifts for which you have no control over.

Assets eligible for donation to private foundations include:

  • Artwork
  • Jewelry
  • Cash
  • Closely-held business stock
  • Non-publicly traded stock
  • Publicly traded securities
  • Mutual funds
  • LLC or LP interest
  • Real estate
  • Life insurance policies
  • Other unique assets

The IRS has rules against excessive business holdings, so it’s important to seek the advice of your trusted advisor.

Grant-Making

You’ll need to establish grant-making guidelines along with administrative support for charitable inquiries. A grant officer must manage grantmaking by reviewing applications, handling correspondence, suggesting grants and conducting site-visits to ensure funds have been used appropriately. Grant recipients might include:

  • Churches
  • Colleges and universities
  • Hospitals
  • Medical research organizations
  • Museums
  • Schools
  • Social service organizations

Though foundations often make grants to nonprofits, they can create their own program. Such a program must meet the IRS’s charity definition for tax purposes. Grants made to individuals for scholarships, hardship, emergency assistance and medical assistance must also meet certain IRS criteria.

Additionally, grants made to non-charities such as a for-profit organization that employs homeless for example, must be used solely for charitable purposes and meet IRS criteria. Your financial advisor can help you sort through these grant-making options.

Tax Benefits

To qualify for tax exemption, a foundation’s purpose must serve one of the following:

  • Charitable
  • Religious
  • Educational
  • Scientific
  • Literary
  • Testing for public safety
  • Assist national or international amateur sports
  • Prevent cruelty to children or animals

Since private foundations fall under charitable, section 501(c)(3) organizations, they are exempt from federal income tax, offering a one-two punch for donors. Donors can deduct their contribution to the foundation and further reduce their taxable income by donating appreciated property at fair market value because no capital gain is realized. Property must have been held more than one year prior to the contribution or it is subject to the donor’s cost basis.

Deductions are based upon the donor’s adjusted gross income, limiting them to 30 percent for cash contributions and 20 percent for capital gain property. Contributions over those limits can be carried forward up to five years to help offset future taxable income.

Private foundations also offer the ability for donors to gain a tax timing advantage. Donors can lock-in their deduction in the current-year or donate during a year in which they have sizable personal income, they can also direct how the foundation invests the donation and time the execution of disbursement to charities across multiple years.

Compliance

Distributions – Private foundations must make an annual qualifying distribution of five percent of fair market value of non-charitable use assets. The use of foundation assets may cover charitable grants and administration such as administrative expenses, equipment that assists in achieving the foundation’s charitable purpose, directly related charitable activities and program-related expenses.  Some funds used for administration, however, do not count toward the IRS’s minimum required annual distribution such as investment management, salaries and custodial fees, or for a board member’s expenses involved in overseeing investments.

Taxes – Depending upon the value of a private foundation’s assets and amounts distributed to charities annually, they must pay a 1-2 percent excise tax on net investment income. Additionally, the IRS considers certain types of assets as excess business holdings and may have limitations on how long the foundation can hold that asset without incurring an excise tax.

Tax Forms – Private foundations must file Form 990-PF annually with the IRS and in the state where their main office is maintained. This report supplies details of the foundation’s operations, contributions, disbursements, expenses, sales of assets and capital gains. What’s more, if there is greater than $1,000 in unrelated business income during the year, the IRS requires the foundation to also file a Form 990-T. Each state has their own rules, and some states require private foundations to register and file annual reports with the state’s attorney general. Your professional advisors can assist you with the required forms.

The Caveats

Penalties – While private foundations can offer advantages that charitable contributions do not, there are strict IRS rules which can result in severe penalties for tax code violations if abused. Penalties can be levied on both the board members and foundation and are meant to thwart the risk of abuse when interested parties control the foundation instead of an independent board. Not to mention, public scrutiny and online commentary that could also damage a foundation’s reputation.

Self-Dealing – Private foundations are prohibited from self-dealing transactions like lending or borrowing money from the foundation. Disqualified persons may not transact with the foundation other than making donations. Disqualified persons include the foundation’s officers, directors, trustees, substantial contributors or those who own a substantial stake in a company that is a substantial contributor. Family members, spouses and descendants of these are also disqualified along with businesses partially or wholly owned by them. Specific examples of prohibited self-dealing include:

  • Providing goods and services to or from the foundation
  • Borrowing funds from the foundation
  • Personal use of foundation assets or income
  • Leasing space to or from the foundation
  • Retaining foundation assets on private property, such as artwork

Private foundations must avoid making grants to individuals and organizations that are not public charities unless they follow strict guidelines. They must also avoid making expenditures to influence elections or legislation, as well as making grants to private operating foundations and certain foreign organizations.

Leaving a Legacy

Private foundations are no longer tools used solely by the affluent and corporate philanthropists. Many moderate-income families are taking part in charitable giving as well. Foundations can offer the benefit of multiple generations working side-by-side on a shared vision. Values can be passed down to younger members who are taught about charitable giving and engagement with the community. Our clients often find that the most appealing aspect of creating a private foundation is that they offer the family an opportunity to leave a legacy long after members are gone.

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Kris Maksimovich is a financial advisor located at Global Wealth Advisors 18170 Dallas Parkway, Suite 103, Dallas, TX 75287. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at (972) 931-3818 or at info@gwadvisors.net.

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