High net worth individuals and families may be attracted to the idea of founding a private foundation. There are many advantages to so doing. The founder is able to make tax-deductible charitable contributions but retain significant control over the foundation’s charitable giving program. Additionally, a successful mission-driven foundation provides opportunity to involve family members in philanthropic projects, flexibility in charitable giving, and create name recognition and a legacy of goodwill for the founder.
Unfortunately, many founders find that the administrative burden and cost of running a private foundation ultimately outweighs the benefit. Setting up the foundation, while expensive, is relatively easy. Operating a compliant foundation is not. Running a private foundation requires steadfast vision, comprehension of complex tax laws, strong leadership, a good deal of time, and hard work. The day-to-day details, like overseeing investments, complying with federal and state law, monitoring income and expenditures, and making the required distribution of at least 5% of the entity’s assets each year is often overwhelming. The Internal Revenue Code regulates everything from the types of investments and grants a private foundation can make to transactions with officers, directors, trustees, and substantial contributors. Stiff penalties may be charged for noncompliance, even if the violation was unintended.
In an era of increased scrutiny of charities and private foundations to prevent abuse, any client considering founding a private foundation would be well served to consider carefully the nature of this long-term investment of time, energy and resources. To learn more about the types of compliance issues managers of private foundations face, review the Compliance Checklist for Private Foundations prepared by the Council on Foundations in 2010.
Alternative to the private foundation
As an alternative to a private foundation, consider the option of establishing a Donor Advised Fund (DAF) with the Benton Community Foundation. A DAF has many of the benefits of a private foundation without the administrative burdens: BCF handles all compliance issues including annual audit and tax filings. Donors name their fund, recommend grants from their fund, and—if they desire—partner with BCF to build a philanthropic plan to achieve maximum impact on the causes that matter most to the donor. For larger accounts, the donor may able be to nominate an independent advisor to manage the investment portfolio.
With the ability to name successor advisors, donors can use the DAF to train children and grandchildren in philanthropy. By naming one or two advisors on the account while involving other family members in the process of recommending grants, the donor can ensure a lasting legacy. Some donors, mindful of avoiding sibling rivalry, elect to establish multiple accounts, each with one family member as advisor.
Unlike private foundations, there is no required minimum 5% of asset value pay out for charitable purposes for a DAF. Also unlike private foundations, a DAF can be established at BCF with as little as $15,000 (there is no maximum investment). The minimum initial investment recommended for a private foundation is $250,000 and there is a substantial wait time (many months) involved in receiving a letter of determination of private foundation status from the IRS. A DAF, alternatively, can be established within days at BCF.
Low administrative fees
BCF charges no set-up fees for a DAF, and the annual operating cost is only 1.25% of the annual fund balance; a mere fraction of the annual operating costs of a private foundation and often less than the current percentage of excise tax on investments of a private foundation.
Additionally, tax benefits to donors are greater for contributions to the DAF than to a private foundation. Because BCF is a 501(c)(3) public charity, the donor may deduct 50% of adjusted gross income for cash contributions and 30% of adjusted gross income for gifts of stock or real property. The same contribution to a private foundation would enable the donor to deduct only 30% of adjusted gross income for cash contributions and 20% of adjusted gross income for gifts of stock or real property. Furthermore, the donor may claim the fair market value of contributions to a DAF of closely held stock and real property. With a private foundation, the deduction is generally limited to cost basis.
For donors who wish to remain anonymous, a DAF is preferable to a private foundation. BCF will keep in strict confidence the identities of its donors who so desire. Such anonymity is not possible for a donor who is founder and trustee of a private foundation. The foundation’s yearly tax filing, IRS Form 990-PF, is a public record that shows assets, gifts, grants, and the names and addresses of trustees, directors, and officers.
Transitioning to a DAF
What if you or your client has an existing private foundation? Perhaps you or your client was highly motivated and active in grantmaking during the early years, but now struggle to meet the annual deadline for distributions. Or perhaps you or your client is a successive generation trustee of a family foundation. The successive generation trustee may not share his or her parents’ mission and/or he or she may be at odds with siblings in executing the foundation’s charitable goals.
A private foundation may terminate its status under IRC section 507(b)(1)(A) by distributing all its net assets to a public charity that has been in existence for a continuous period of at least 60 months before the distribution. Founded in 1953 and operating continuously throughout the six decades since, BCF certainly meets the 60 month criteria. Furthermore, pursuant to ruling 2003-13, there is no requirement to notify the IRS and no termination tax. Thus, it is neither difficult nor costly at the federal level to transfer the assets of and terminate the status of the private foundation. Care must be taken, however, to comply with any and all state requirements for transfer of assets and dissolution of entity and to avoid missing the annual distribution requirement during the termination process.
We would be happy to meet with you to discuss this issue in further detail. Simply call us at (541) 753-1603 or send us an e-mail.