by Jon Austin
In 1936 Henry Ford’s son Edsel started and funded the Ford Foundation, now one of the most famous private foundations in the world, to promote philanthropic goals shared by the family. The Ford Foundation has been actively funding the family’s charitable goals for seventy-five years and at the end of 2009 had over $10 billion in assets. In the world of private foundations, the Ford Foundation is the exception; there are over 120,000 private foundations in the United States and approximately 75% of them have less than $10 million in assets. But the purposes and benefits of private foundations are uniform to all, from the smallest to the largest.
Private foundations have a number of useful purposes and you don’t have to be worth billions for it to be a valuable planning tool. One of the most common reasons people create private foundations is tax reduction. There are other significant benefits, including:
- Promoting and directing long-term charitable giving for certain specified purposes; and
- Creating a family purpose that will provide common ground and common goals to guide future giving efforts.
Private foundations are only one of many methods commonly used to fund charitable purposes and reduce taxes. However, private foundations generally have three distinctive characteristics:
- Most or all of the funding comes from a single source, usually a family or business, rather than from the general public;
- Distributions from the foundation are typically in the form of grants to public charities or government entities, rather than the foundation directly operating charitable programs; and
- Grants and administrative expenses come out of the foundation’s endowment or investment income of the endowment, rather than through a fundraising program.
Private foundations are not without their trade-offs. Like most other planning techniques with significant tax benefits, private foundations are subject to a number of complex and sometimes burdensome rules. These rules are intended to prevent “abuse” of the benefits and ensure a private foundation is managed consistently with the charitable purpose of its creation. There are rules associated with funding the foundation, including restrictions on how much stock or other ownership interest a foundation can hold in a business, and percentage caps on the amount deductible as a charitable contribution. There are also rules regarding the ongoing operation of a private foundation, such as the requirements the foundation generally distribute at least five percent of the foundation’s net investment assets each year, make annual filings with the IRS and pay a small tax on certain investment income. There are also substantial due diligence and conflict of interest requirements the board must adhere to. Particularly relevant to many business owners are the self-dealing rules that impose severe limitations on business transactions (e.g., selling, leasing, etc.) between a foundation and related parties.
The private foundation is not, however, the only way to reach many common charitable goals. Another option, the donor advised fund, operates in much the same manner but is generally easier and less expensive to set-up. The trade-off is less control over the assets and the long-term direction of the giving. And for many people, other more common gifting and estate planning techniques will accomplish their goals without the complexity often associated with a private foundation. But for people with a real philanthropic passion, or people with a potential estate tax concern, the private foundation is a worthwhile option to consider.
Our firm is routinely approached by persons with charitable intentions to assist them in evaluating the alternative means by which their charitable intentions might best be fulfilled, including the possibility of setting-up private foundations. We are honored to contribute in this important aspect of planning and gifting. Whether you are taking the first step of exploring the options or you are working to implement a complex charitable gifting plan, we would consider it a privilege to help.