STARTING A PRIVATE FOUNDATION: ADVANTAGES AND DISADVANTAGES
Advantages of Starting a Private Foundation
- Effective Philanthropy. Starting a private foundation facilitates organized, systematic, and targeted giving.
- Expanded Giving Opportunities. Individuals may not claim charitable deductions for grants made to other individuals, foreign nonprofit organizations, or non-charitable organizations. An individual, however, may achieve these expanded giving objectives by first making tax-deductible donations to a family foundation which may then in turn, once certain IRS procedures are followed, make such grants.
- Deductibility Plus Control. Donors may make tax-deductible donations to their own family foundation and still, as foundation trustees, remain in control of the investment and management of the funds as well the final charitable disposition of the gifts.
- Sheltered Income Plus Control. Foundation investment income, held by the foundation's trustees, is exempt from taxation (with the exception of the 1-2% excise tax described below).
- Consistency in Giving. Under normal circumstances, foundations may accumulate and hold a portion of their funds. Foundations may also choose if and when to distribute such accumulated funds (or the income earned on accumulations). Thus, even though yearly contributions to the foundation may vary, giving levels are able to remain constant. Such consistency may be particularly helpful to grantees that rely on level funding from year to year.
- Payment of Reasonable Compensation. Under normal circumstances, family members and others may receive reasonable compensation from the foundation in return for services rendered.
- Reimbursement of Travel and Other Expenses. Reasonable and direct costs of site visits and board meetings may be paid by the foundation to family members, employees, and trustees.
- Double Capital Gains Tax Benefits. First, no capital gain is realized when appreciated property is donated to a foundation. Second, donors may claim a charitable deduction for the full market value of appreciated stock held in publicly traded companies.
- Estate Tax Reduction. Assets transferred to family foundations are generally not subject to estate taxes. This may provide triple tax savings when combined with the benefits above.
- Public and Community Relations. If desired, foundation grantmaking may bring recognition to family members.
- Privacy Concerns. On the other hand, individuals who are already subject to continuous fundraising appeals and interruptions at home and work may wish to increase their privacy by referring all such inquiries to the family foundation.
Disadvantages of Starting a Private Foundation
- Initial Time Commitment and Costs, including legal and accounting fees.
- Excise Tax. Private foundations are subject to a 1.39% annual excise tax on net investment income. The tax, ostensibly, defrays the costs incurred by the government in regulating private foundations.
- Recordkeeping Requirements. At a minimum, family foundations should properly document grants and keep regular meeting minutes, which for small foundations may require an investment of 2-6 hours per grantmaking cycle.
- Regulatory Requirements. There are two main classes of tax-exempt charitable organizations: public charities (funded by a variety of public sources) and private foundations (privately funded or endowed). Private foundations are required to distribute at least 5% of their net investment assets annually in the form of charitable grants (known as a minimum distribution requirement) and are subject to tighter scrutiny than public charities.
- Annual Reporting Requirements. Tax filings required by the IRS and most states typically require 4-8 hours to complete each year by an accountant or attorney. Learn more about annual reporting and compliance requirements.
- Lower Deductibility Caps. Individuals may receive tax deductions for donations to public charities to the extent of 60% of their adjusted gross income (AGI) for cash gifts and 30% of AGI for gifts of appreciated property. For gifts to private foundations, however, the limits are 30% of AGI for cash gifts and 20% of AGI for appreciated property.
- Less Favorable Treatment of Some Capital Gain Gifts. Gifts to public charities of appreciated property are deductible at fair market value. To private foundations, gifts of appreciated property are deductible on a cost basis only (with the exception of publicly traded stock which is deductible at fair market value).