Private Foundations vs. Community Foundations

Finance | Mark J. Ackerman | Sep 17, 2015

Pros and Cons to Private and Community Foundations

By: Mark Ackerman, CPA

For clients who have expressed the desire to use part of their wealth for philanthropic giving, the overwhelming vehicle used to accomplish this is to establish their own charitable foundation. The use of the foundation vehicle is for long term giving, estate planning, and family legacy. It is true that initially, to set up your own foundation, there is an initial time commitment by you as well as legal and accounting costs. These are one-time startup costs. Over the long term planning, this initial investment is not significant, looking at the long term advantages. Laws governing a private charitable foundation falls under state law and the IRS code section 501 (c) (3).

Advantages of starting a private foundation vs. using a community foundation

Effective philanthropy:

The foundation vehicle may facilitate 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 a grant.

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 as the final charitable disposition of the gifts.

Shelter 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).

Consistency of giving:

Under normal circumstances, foundations may accumulate and hold portions of their funds. Foundations may also choose if and when to distribute such accumulated funds (or the income 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.

Estate tax reduction:

Assets transferred to family foundations are generally not subject to estate taxes. This may provide triple tax savings when combined with 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.

Family legacy:

The family foundation can be a vehicle to remind the generations the importance of giving back to the community. The need for trustee meetings can foster family ties and family pride.

Avoid high community foundation fees:

Community foundations generally charge high fees for administration. Family foundation administrative fees are controlled directly by the trustees.

Disadvantages of a family foundation vs. using a community foundation

Initial time commitment and costs:

There is an initial time commitment, legal, and accounting fees to establish a family foundation. It will take approximately 6 months to get federal approval.

Excise tax:

Private foundations are subject to a 1-2% annual excise tax on net income depending on the level of grantmaking from year to year. 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 50% of their net investment assets annually in the form of charitable grants and are subject to tighter scrutiny than public charities.

Annual reporting requirements:

Tax filings required by the IRS and most states require the need for an accounting firm.

Lower deductibility caps:

Individuals may receive tax deductions for donations to public charities to the extent of 50% of their adjusted gross income (AGI) for cash 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% 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).

Overview of establishing a 501 (c) (3) nonprofit private foundation

Establish a nonprofit corporation:

This is a state level process that establishes a nonprofit, corporate entity.

Obtain 501 (c)(3) status:

This next step is a much more complex than incorporating. To obtain a 501 (c) (3) status, a nonprofit corporation must apply to the IRS for recognition of tax exemption by filing IRS for 1023. Form1023 is up to 28 pages long. With the required attachments, schedules and other materials that may be necessary, it is not uncommon for these submissions to the IRS to be more than 50 pages. It is a thorough examination of the organization’s governing structure, purpose and planned programs. The IRS is looking to make sure that the organization is formed to exclusively 501 (c) (3) purposes and that its programs are designed to fulfill these stated purposes. In addition, the IRS is looking closely for conflicts of interests and the potential for the benefit to insiders, both possible grounds for denial.

State compliance issues:

While obtaining 501 (c) (3) status grants your new nonprofit federal tax exemption, there are several other, critical issues that must also be addressed:

  • Charitable Solicitations Registration
  • State Corporate Tax Exemption
  • State Sales Tax Exemption

A private foundation is applicable for those families whose intent is to have continued charitable giving over a long term period of time. Once the foundation is set up and running, administrative costs are reasonable, the flexibility of charitable giving is a distinct advantage, family legacy (estate planning advantages), family ties, and family pride is fostered. As trustees, you have more control and flexibility as to the investments the foundation makes.