Have you done well enough that you are thinking of making a substantial gift to charity? For those seeking philanthropic flexibility and high impact, the vehicle of choice has almost always been to create a private foundation. Because it provides financial control, tax advantages and the ability to perpetuate a family legacy, philanthropic individuals and families usually consider it an excellent charitable giving vehicle. A donor-advised fund in a community foundation is the alternative to this.
The old rule of thumb was that a private foundation did not make sense unless the initial funding was $2 million. This was due to the complicated nature of setting up the foundation and the ongoing expenses to keep it running. This “rule” has basically gone away, but we still believe that below $500,000.00, a donor-advised fund may be a better alternative and should be considered.
Donor Advised Fund
At the most basic level, a donor-advised fund is an account in a public charity. A private foundation is an actual charitable organization. The differences mainly revolve around control and flexibility. Contributions to a donor-advised fund make irrevocable contributions to the public charity that administers that fund and makes decisions regarding its investments. Contributors recommend eligible charities as grant recipients, but the donor-advised fund’s governing body is “technically free” to accept or reject any grant recommendation. Contributions to a public charity with a donor-advised fund are often limited to a high percentage of adjusted gross income (“AGI”) (50%), than with many private foundations (30%).
With a private foundation, the donor retains control over charitable donations and other disbursements. With a foundation, the donor can hire staff, reimburse expenses, set up scholarship and award programs, and make grants directly to individuals in times of need. Donors can also contribute a much wider variety of assets to fund the foundation, such as “Section 144” restricted stock, while retaining control over how the assets are invested.
Technically, a private foundation is a not-for-pro t entity that is controlled by, and receives most of its funding from, a single individual, family or business. This distinguishes it from public charity and generally gets at least one-third of its support from the public. It is organized exclusively for charitable, educational, religious, scientific or literary purposes under Section 501(c)(3) of the Internal Revenue Code. A foundation must apply to the IRS to obtain of official recognition of its tax-exempt status.
The benefits of a private foundation are as follows:
- Family legacy: A private foundation establishes a tradition of giving that can carry on your family name, fund causes that are important to you, and support your favorite charitable activities into the future.
- Control: Private foundations provide the greatest control of any charitable giving vehicle. You decide which charities to support, who sits on the board and how your donated funds are invested. You also have great latitude as to the types of assets you can put in the foundation.
- Family involvement: A private foundation enables you to involve your spouse, children and other relatives in philanthropy and pass values on to future generations.
- Current tax deduction for future grants: You can take an immediate tax deduction for contributed assets, even if the foundation does not make charitable grants until a later date. You are also able to remove taxable assets from your estate, without incurring capital gains taxes. Consult with your tax advisor about your specific tax situation.
Typically, donations to a private foundation are tax deductible up to 30% of AGI for cash, and up to 20% of AGI for appreciated securities, with a five-year carry forward. There are exceptions that move the limit up to 50% for most operating foundations. It is important to consult with your tax advisor bout the deductibility of contributions. Other types of assets, including real estate, can be donated to the foundation, but are subject to limitations. To avoid self-dealing penalties, care should be taken to ensure that property that is subject to a liability is not donated to a foundation by a disqualified person (donor, donor family, director offered, etc.).
There is a minimum but no maximum on giving for private foundations. The IRS requires that private foundations pay out at least 5% of the previous year’s average net assets for charitable purposes. This can include certain administrative expenses.
If you are interested in a private foundation there is lots more to learn. We can also help you weigh the pros and cons of same versus a Donor Advised Fund in a Community Foundation.