Are You Thinking About Forming a Private Foundation?

What is a private foundation?

A private foundation is a nonprofit corporation or trust which is exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code and does not qualify as a "public charity." Unlike a 501(c)(3) "public charity," it receives all or most of its support from members of a single family, or from a small number of sources. Certain types of 501(c)(3) organizations automatically qualify as public charities. These include schools, churches and hospitals.

Usually (but not always), a private foundation does not operate programs directly, but rather makes grants to other organizations to be used for charitable, educational, religious, and other 501(c)(3) purposes. The donor or donors have the ability to direct the grantmaking, but the foundation is subject to a more stringent set of rules than those applicable to a public charity.

Advantages to creating a private foundation

  • The donor receives a federal income (or estate) tax deduction for contributions, up to the contribution limits.
  • The donor maintains control over giving.
  • Family philanthropy. The founder can use a private foundation to develop a family philosophy toward philanthropy, and to instill younger generations with philanthropic habits.

Disadvantages to creating a private foundation

  • Contribution limits. The deductible limits on contributions to private foundations, for federal income tax purposes, are more limited than are contributions to public charities.
  • Tax on investment income. Private foundations are subject to a tax on 1% or 2% of their investment income.
  • Limitations on self-dealing. Very stringent rules, and onerous penalties, apply to transactions between a private foundation and its creators, family members, substantial contributors and other "insiders." These rules are much more restrictive than those applicable to public charities.
  • Tax on taxable expenditures. Private foundations are subject to a tax on grants made for lobbying or political purposes. Grants made to organizations other than public charities may also be subject to tax if the foundation does not comply with certain administrative requirements to ensure that the funds are used for permissible purposes.
  • Taxes on excess business holdings and jeopardizing investments. Private foundations may also be subject to tax on their ownership of business interests in excess of certain thresholds (generally 20% or 35%, taking into account interests held by certain insiders). They are also subject to a tax on certain speculative investments.

Alternatives to creating a private foundation

  • Donor advised fund. A number of large investment banks and community foundations maintain charitable funds, allowing a donor to make up-front contributions and later recommend grants to public charities. These qualify as public charities, allowing the donor to take advantage of higher deduction thresholds than those applicable to private foundations. However, the donor relinquishes some control as the fund is not legally bound by the donor's recommendations.
  • Pooled fund foundation. Some community foundations operate pooled income funds, which are also treated as public charities for purposes of the deduction thresholds. These funds allow the donor to designate the public charity to receive funds, but a donor's contributions may not accumulate indefinitely. The fund is required to distribute all income annually within 2 ½ months after the end of the year, and a donor's contributions must be distributed within one year after the donor's death.
  • Field of interest fund. Also frequently managed by community foundations, these are public charities that receive tax-deductible contributions and make contributions to public charities within a designated category (such as community health care or education).
  • Supporting organization. A founder may create an organization with public charity status, without attracting wide public support, by structuring the organization as one that supports, and is closely involved with, one or more public charities. In this way, the donor takes advantage of the higher deduction thresholds, and avoids the onerous restrictions on private foundations, but must relinquish control over the organization.

How much money is needed to start a private foundation?

This is a very personal decision. There is no legal minimum. However, it is important to keep in mind that the foundation must generate enough income, after administrative expenses, to support its grant program. In some instances, it may be appropriate to start a foundation with a small contribution, for example where the founder wishes to establish, or test, a pattern of grantmaking while planning to fully fund the foundation upon death.

For more information on creating a private foundation, see the Council on Foundations website.

For more information on private foundation alternatives, see the Seattle Foundation website.

 

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