If you donate to charities frequently or have charitable causes that you are particularly passionate about, you may want to consider establishing a private foundation to manage your charitable giving.
A private foundation is a charitable organization typically established by an individual or family to support public charities and other private foundations. While private foundations offer many benefits, they do require a more "hands-on" approach than other types of charitable giving vehicles. For that reason, a private foundation may be more appropriate for someone who wants to become immersed in the execution of their giving strategies, including managing the organization, its investments, and its grant-making decisions.
Below are some of the key variables to consider if you are thinking about establishing and managing a private foundation.
Establishment and administration
To create a private foundation, you must first establish a legal entity and apply for tax-exempt status from the Internal Revenue Service (IRS). Foundations are overseen by a board of directors or trustees that is responsible for determining, often with the help of professional advisors, the affairs of the foundation, including how foundation assets are invested, when grants are distributed, and the size of the grants.
Donors can appoint relatives to the board of directors, give them responsibility over the day-to-day activities of running the foundation, and, subject to certain limitations, provide compensation. Once established, a private foundation must file annual tax returns and ensure that it adheres to the tax-reporting rules that govern foundations.
To justify the expenses involved, most new private foundations are funded with initial endowments of at least $1 million. Assets that can be contributed include cash, publicly traded stock, certain restricted, control and privately held securities, real estate, and tangible personal property. If an initial donation of $1 million or more is beyond your means, you may want to consider other charitable giving vehicles.
Tax benefits and considerations
Generally, you can deduct up to 30% of your adjusted gross income (AGI) for cash donations to a private foundation, and up to 20% of AGI for donations of long-term publicly traded appreciated securities. Keep in mind that the AGI deduction limitations with other charitable giving vehicles may be higher, 60% and 30%, respectively.
Donations of non-publicly traded assets, such as privately held stock or real estate, may only be deductible at your cost basis, rather than fair market value (FMV). If your initial or subsequent donations exceed the annual limit on charitable donations, you can generally carry them forward for up to five years.
It's important to note that foundations must pay an excise tax of either a 1% or 2% on their net investment income, such as interest, dividends, and capital gains.
Donor's role in investment and grant-making decisions
At private foundations, the board of directors exercises complete control over the foundation's investments. The board can manage the investments itself or hire a professional investment manager.
Similarly, the board of directors also maintains full control over the foundation's grant-making decisions. Unlike with many donor-advised funds, private foundations can grant money to individuals, scholarship programs, and organizations that are organized under the laws of other countries.
Role of the donor's family
Private foundations are allowed to hire and pay family members as employees or have them serve as members of the governing board. That said, some foundations prefer to outsource staffing and administration to a professional third party administrator. These organizations manage the foundation's operations to ensure they do not violate IRS rules or other regulations. For example, a third party administrator can ensure that your private foundation meets its annual requirement to distribute at least 5% of its assets.
Contrary to its name, a private foundation is a fully public entity. A foundation's annual tax filing (IRS Form 990-PF, Return of Private Foundation) is a public record that lists assets, gifts, grants, and the names and addresses of donors, trustees, directors, and other officers. These documents are accessible through the Internet. Therefore, if privacy and the ability to donate anonymously are major concerns, you may want to explore other options.
Explore all of your options
Private foundations offer wealthy donors the ability to take a true "hands-on" approach to supporting their favorite charitable causes. While they offer additional flexibility in terms of investment management and grant making, they are also more costly and time consuming to manage. Therefore, you may want to explore other charitable giving vehicles as well.
There are many ways to support your favorite charities, each with its own benefits and drawbacks. View a charitable giving matrix for a handy side-by-side comparison on the Fidelity Charitable® web site.