By: Susan Hagley, MST
Senior Wealth Strategist
There are many charitable giving vehicles available to help you carry out your philanthropic goals. In our previous e.Insight, we discussed one of the commonly used options to consider; a Donor Advised Fund. In this Part 2, we will discuss Private Foundations.
A Private Foundation is a distinct tax-exempt legal entity that is governed by its own set of bylaws to support charitable activities. Private Foundations have more required formalities and costs, but also allow for more flexibility and family control over grantmaking and investment decisions. Private Foundations can be a very powerful charitable tool to promote philanthropy through multiple generations.
Starting a Private Foundation is a more time-intensive process that includes filing an application with the state and IRS to obtain private foundation status. This involves legal and accounting costs to complete the application and filings prior to being approved.
Once established, Private Foundations typically hire staff or outside advisors to manage the administrative work and investment management for the Foundation. They can also appoint a board of directors (including family members) and are recommended to have regular board meetings, which include recording minutes.
In addition to the general laws that all charities must follow, Private Foundations are subject to complex technical rules. Failure to follow these rules, described below, may result in excise tax penalties:
- Self-dealing restrictions between Private Foundation and substantial contributors and disqualified persons
- Annual 5% minimum distribution requirement based on the previous year’s net average assets
- Limitations on private business holdings
- Investments must not jeopardize the carrying out of exempt purposes
- Expenditures must further exempt purposes
Private Foundations offer a wider array of choices in grantmaking compared to Donor Advised Funds (DAFs), which can only issue grants to 501(c)(3) charitable organizations. Private Foundations, for example, may also provide scholarships to individuals, grants to families or individuals for hardships and emergencies, and grants to international organizations. A Private Foundation can also make grants to a DAF or even be converted into a DAF, if specific rules are followed. On the contrary, a Donor Advised Fund can’t make grants to or be rolled into a Private Foundation. The Private Foundation is responsible for legal compliance and due diligence in the grantmaking process.
Private Foundations are required to file annual returns, which are available to the public. These returns list foundation assets, contributors and grantees. Therefore, it is not possible to make anonymous gifts.
Contributions and Asset Selection
A Private Foundation can be funded with many different types of assets. For example, donors may gift cash, publicly-traded securities, mutual funds, publicly-traded bonds, art, real property and private equity investments. Unlike a DAF, where the sponsoring organization may limit the type of assets gifted and also usually sells after receiving, a Private Foundation has less restrictions.
One of the most appealing qualities of Private Foundations is the degree of flexibility around investment decisions. This allows Private Foundations to grow their assets in a tax-efficient and dynamic way. A Private Foundation can include private equities in its portfolio, as long as the board follows all of the specific IRS rules and is cognizant of other issues, including liquidity needs and unrelated business income tax. In addition, Private Foundations can invest in Program Related Investments (PRIs). A PRI is a versatile investment that is designed to provide a below-market return back to the Private Foundation, which can then be used for charitable purposes.
Many donors start a Private Foundation with long-term family engagement in mind. Private Foundations are inherently collaborative because of the required board structure. The family can remain in control through generations by specifically drafting into the organizational documents that family members are to serve on the board of directors. A Private Foundation may hire and compensate family members to provide professional services to the Foundation, provided their compensation is reasonable. The high-level of formality and long-term platform provided by Private Foundations may be attractive to families that want to do something positive, together, for generations to come.
In addition to the board structure, donors may wish to create a Family Philanthropic Mission Statement to memorialize values, experiences and insights. A Family Philanthropic Mission Statement may provide guidelines for grantmaking such as specific causes and geographic areas. It will also ensure that your core vision will guide your family giving now and in the future.
Income Tax Deductions for Taxpayers Who Itemize Deductions
Private Foundations and DAFs are subject to different tax treatment. In Part 1, we compared the income tax deductions. Gifts to private foundations are subject to lower Adjusted Growth Income (AGI) limitations than gifts to a DAF. In addition, private foundations are subject to an annual excise tax of 1.39% on net investment income.
Donor Advised Funds and Private Foundations are commonly used charitable vehicles that may effectively help you reach your philanthropic goals. They offer very different levels of control, flexibility and legacy building. The choice between philanthropic vehicles also does not need to be an either/or decision. Donor Advised Funds can be a great complement to a Private Foundation. When used together, they can be an optimal solution for managing wealth and achieving philanthropic impact.
How do you decide what makes sense for your family? Here are some questions to discuss with your Oxford Advisors to help guide the decision:
- What is your giving style?
- Do you require more flexibility or control over investments or grantmaking?
- How much do you wish to donate?
- What level of family involvement do you desire?
- Do you want the vehicle to extend through multiple generations?
The information contained in this report is confidential and proprietary to Oxford and is provided solely for use by Oxford clients and prospective clients. The opinions expressed are those of Oxford Financial Group, Ltd. The opinions are as of date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. The information in this presentation is for educational and illustrative purposes only and does not constitute investment, tax or legal advice. Tax and legal counsel should be engaged before taking any action. OFG-2401-38