Frequently Asked Questions

Here are some of the most frequently asked questions relating to foundations

Setting Up

What is a non-operating foundation?

Private non-operating foundations are organizations typically established by an individual, family, or corporation to distribute funds to charitable causes.Unlike operating foundations, they don't directly engage in charitable activities but rather provide grants to other charitable organizations.

They're governed by specific rules to maintain their tax-exempt status and ensure that their funds are used for charitable purposes. Below, you'll find some of those rules and regulations.

What are the initial legal requirements to establish a private foundation?

To establish a private foundation, you need to create a legal entity, often by incorporating as a non-profit corporation or setting up a trust. This process involves:

  1. Legal Filing: Filing articles of incorporation with the state if forming a corporation, or drafting a trust agreement if forming a trust.

  2. Tax ID: Applying for an Employer Identification Number (EIN) from the IRS.

  3. Tax-Exemption: Applying for tax-exempt status by submitting IRS Form 1023 for charitable organizations. This form details your foundation's structure, governance policies, and planned activities. It's important to ensure that the mission statement and activities are crafted strategically to ensure the foundation not only qualifies for tax-exemption, but also allows the board to invest in a manner that does not create conflicts, fines, or UBI.

  4. Governance: Establishing bylaws or trust agreements that outline the governance of the foundation, including the responsibilities of directors or trustees.

  5. Compliance: Ensuring compliance with state and local regulations, which may involve additional registrations or filings depending on the foundation's location and activities.

What are the minimum financial requirements to start a private foundation?

The minimum financial requirements to start a private foundation can vary significantly depending on the goals of the foundation, the geographical location, and the legal structure chosen. Here's a general overview:

  1. Initial Funding: There is no legal minimum amount required by federal law in the United States to start a private foundation. However, practical considerations often dictate starting with a substantial amount to cover administrative expenses and to make meaningful grants. Many experts suggest a starting amount of anywhere from $100,000 to $500,000 to ensure sustainability and impact, but it is possible to start with less.

  2. Costs of Establishment: Setting up a foundation involves legal fees for drafting articles of incorporation or trust documents, filing fees, and possibly the cost of hiring an attorney or consultant to navigate the setup process. These costs can range from a few thousand dollars to much more, depending on the complexity of the foundation's structure and the professional fees involved.

  3. Ongoing Operational Costs: Foundations have ongoing costs, including administrative expenses like accounting, auditing, legal compliance, grant management, and possibly staffing. These costs should be considered when determining how much money is needed to effectively operate the foundation.

Regulatory Framework

What sections of the federal tax code (IRS) relates to private foundations?

Here are the specific sections of the Internal Revenue Code (IRC) that relate to private foundations:

  1. 501(c)(3): This section provides the basic framework for organizations to qualify for tax-exempt status as charitable organizations. To qualify under 501(c)(3), an organization must be organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals. Private foundations typically fall under this category, but they are subject to additional regulations compared to public charities.

  1. 4940: Minimum Distribution Requirement: Section 4940 establishes the minimum distribution requirement for private foundations. It requires that private foundations annually distribute an amount equal to at least 5% of the fair market value of their non-charitable use assets. This requirement ensures that private foundations actively support charitable purposes and prevent the accumulation of assets for private benefit.

  1. 4941: Self-Dealing: Section 4941 prohibits private foundations from engaging in self-dealing transactions, which are transactions between the foundation and disqualified persons (such as founders, substantial contributors, and their family members) that result in the direct or indirect financial benefit to the disqualified person. Examples of self-dealing transactions include selling, exchanging, or leasing property, as well as providing compensation or loans to disqualified persons.

  1. 4945: Prohibited Transactions: Section 4945 outlines various prohibited transactions for private foundations, including jeopardizing investments, excess business holdings, and taxable expenditures. Jeopardizing investments refer to investments that jeopardize the carrying out of the foundation's exempt purposes. Excess business holdings refer to ownership interests in business enterprises that exceed certain thresholds. Taxable expenditures include lobbying activities, political campaign intervention, and certain grants to individuals.

  1. 4942: Expenditure Responsibility: Section 4942 requires private foundations to exercise expenditure responsibility when making grants to organizations that are not public charities. This involves exercising due diligence to ensure that the funds are used for charitable purposes and reporting on the use of those funds. Expenditure responsibility helps prevent abuse and ensures that grants further the foundation's charitable mission.

  1. 6033: Annual Reporting Requirements: Section 6033 mandates that tax-exempt organizathings tions, including private foundations, file annual informational tax returns (Form 990-PF) with the IRS. These returns provide detailed information about the foundation's financial activities, governance structure, grantmaking activities, and other relevant details. Compliance with annual reporting requirements is essential for maintaining tax-exempt status and ensuring transparency and accountability.

What are the specific tax advantages of creating a private foundation?

Creating a private foundation offers several specific tax advantages that can be beneficial for donors. These advantages not only help in maximizing the impact of charitable giving but also provide financial incentives for the donor. Here are the key tax benefits:

  1. Income Tax Deductions: Donors can receive an immediate tax deduction for cash or property donated to a private foundation. The deduction for cash donations can be up to 30% of the donor's adjusted gross income (AGI). For appreciated assets like stocks, the deduction is limited to 20% of AGI. These deductions can be carried forward for up to five additional years if they exceed these limits in a single year.

  1. Estate Tax Reduction: Assets transferred to a private foundation are removed from the donor's estate, potentially reducing estate taxes. This can be particularly advantageous for donors with large estates, as it helps to minimize the estate tax burden upon their death.

  1. Avoidance of Capital Gains Tax: Donating appreciated assets such as stocks, real estate, or other appreciated property to a foundation allows the donor to avoid capital gains taxes that would be due if the asset were sold. The foundation can then sell these assets without paying capital gains tax, thus preserving more of the asset’s value for charitable use.

  1. Excise Tax Benefits: Although private foundations are subject to a 1.39% excise tax on net investment income, this rate is generally lower than personal or corporate income tax rates that might apply to investment gains if the assets were not in a foundation.

  1. Tax-Free Growth: Once assets are within a foundation, they can grow tax-free, as long as the income and gains are used for charitable purposes. This allows foundations to increase their philanthropic impact over time.

  1. Charitable Consolidation: For donors who support multiple charitable causes, a private foundation can serve as a single entity through which all charitable giving is channeled, simplifying the management and tracking of charitable activities and potentially reducing administrative overhead.

These tax advantages make private foundations an attractive option for many donors, enabling them to increase the effectiveness of their philanthropy while also gaining significant financial benefits.

Investments

Is the foundation a fund to invest?

Let's be clear: We are talking about a non-operating foundation - which is essentially an investment and grant-making tax-exempt incorporation.

The answer is: Maybe.

A foundation can manage funds and invest them to generate income that can be used to support charitable activities. Many foundations have endowments, which are funds invested to provide ongoing financial support for the foundation's mission.The investment strategy of a foundation can vary depending on its goals, risk tolerance, and time horizon - there is no one-size-fits-all answer.

Some foundations may focus on generating income through conservative investments, while others may pursue more aggressive investment strategies to maximize returns over the long term. And, some foundations may be setup for strictly donation and grant-making purposes only, without an extensive investment portfolio.

The answer is - it depends on your goals. The flexibility offered by this entity allows you and your family to try alternative strategies till you figure out the right one, provided you're playing by the rules of the game.

What are some examples of investments that are typically invested from a foundation?

Foundations typically invest their funds in a diversified portfolio that may include various asset classes. Some common examples of investments that foundations may hold include:

  1. Stocks: Foundation may invest in publicly traded stocks of companies to benefit from potential capital appreciation and dividends.

  2. Bonds: Foundation may invest in bonds issued by governments, municipalities, or corporations to generate income through interest payments.

  3. Real Estate: Foundation may invest in real estate properties or real estate investment trusts (REITs) to benefit from rental income and potential appreciation in property values.

  4. Mutual Funds: Foundation may invest in mutual funds that provide exposure to a diversified portfolio of stocks, bonds, or other assets managed by professional investment managers.

  5. Hedge Funds: Some foundations may allocate a portion of their assets to hedge funds, which employ alternative investment strategies to generate returns that are uncorrelated with traditional markets.

  6. Private Equity: Foundation may invest in private equity funds or directly in private companies to benefit from potential growth and capital appreciation over the long term. It's important to ensure the private equity fund is well-vetted, and their investment spread can advance your foundation's mission, to ensure you will not be subject to UBI.

  7. Impact Investments: Increasingly, foundations are also considering impact investments, which aim to generate social or environmental benefits alongside financial returns. These can include investing in patent-pending technology, mission-related startups or benefit corporations, and other companies that can be tied to the advancement of your charitable mission.

    It is extremely important to ensure your investments stay within the foundation's mission to ensure the revenue generated will not be subject to Unrelated Business Income (UBI) and potentially face corporate tax rates.

An example: What makes an investment of real estate considered as charitable purpose?

For a foundation investing in real estate, using real estate investments to directly further its charitable purposes (that's the key test) means that the property must be used in ways that actively support or are integral to achieving the foundation's stated mission.

If a private foundation uses real estate in a manner that is unrelated to its exempt purposes, the income generated could be subject to taxes under rules governing unrelated business income (UBI).

Factors to Consider:

  1. Direct Use in Charitable Activities: The real estate must be used directly in the foundation's charitable activities. Simply earning income from property does not qualify unless the income itself is used for charitable activities.

  1. Related Use Test: The IRS applies a "related use" test to determine if the use of the property is directly related to the foundation’s charitable purpose. If the real estate is sold, the proceeds must be used to support the foundation's mission to maintain its tax-exempt status.

Examples of Charitable Use of Real Estate:

  1. Affordable Housing: A foundation could own and manage a building used to provide affordable housing to low-income families. This directly supports charitable goals if the foundation's mission is to alleviate homelessness or provide affordable housing solutions.

  1. Educational Facilities: Real estate owned by a foundation and used as a school, training center, or educational workshop directly serves an educational purpose. For example, a foundation focused on promoting education for underprivileged children could use a building to host classes and educational activities.

  1. Conservation Efforts: A foundation with a mission centered on environmental conservation might own a piece of land used for wildlife conservation, public parks, or as a nature reserve. The direct use of this land for conservation efforts qualifies as a charitable use.

  1. Community Centers: A foundation may operate a community center or a recreational facility that serves the local community, especially if it provides social services, health services, or other community-oriented activities aligned with the foundation’s goals.

  1. Research Facilities: Foundations focused on medical or scientific research may use real estate to house research facilities that contribute directly to their charitable mission of advancing knowledge in a specific field.

Compliance and Considerations

  1. Documentation and Policies: The foundation should have clear policies and documentation showing how the real estate is used in a manner that directly furthers its exempt purposes. This involves the strategic and tactical formulation of a mission statement and bylaws that would allow board members to invest in real estate that directly furthers their mission.

  1. Avoiding Jeopardizing Investments: Foundations must also be careful that owning and managing real estate does not constitute a "jeopardizing investment" or distract from their charitable purposes.

  1. UBI Considerations: If a foundation generates income from real estate that is not used directly for its exempt purposes, such as renting out a property for standard commercial purposes, this could be subject to unrelated business income tax (UBIT).

Can private foundations invest in private equity funds?

This is a question that we get asked quite a lot. The answer is:

Yes, private foundations can invest in private equity funds, but there are several important considerations and regulations they must adhere to when engaging in such investments. Here’s a breakdown of the key aspects:

1. Understanding Private Equity Investments

Private equity involves investing in companies that are not publicly traded on a stock exchange. These investments typically aim for higher returns compared to public equities but come with higher risks and longer investment horizons.

2. Compliance with IRS Regulations

Private foundations need to be cautious about the following IRS regulations when investing in private equity. Here are a few of those regulations:

a. Excess Business Holdings: The IRS imposes rules limiting the percentage of business holdings a private foundation can control. These rules are intended to prevent foundations from having too much influence over an enterprise. Private equity investments might count toward these limits, particularly if the fund gives the foundation a significant stake in any business.

b. Jeopardizing Investments: Foundations must avoid investments that could jeopardize their ability to carry out their exempt purposes. Investments that are considered too risky could be classified as jeopardizing investments, which could lead to penalties.

c. Unrelated Business Taxable Income (UBTI): If a private equity fund uses leverage (debt), the income passed on to the foundation could be subject to UBTI. Foundations need to manage UBTI carefully because income subject to this tax can reduce the overall resources available for charitable activities.

3. Mission-Related Investments

Foundations can also consider mission-related investments (MRIs) when evaluating private equity opportunities. MRIs are investments made with the intention of furthering the foundation’s mission while also achieving financial returns. This approach aligns the foundation's investment portfolio with its philanthropic goals.

4. Program-Related Investments (PRIs)

Another option for foundations is to make program-related investments. PRIs are usually made in the form of loans, guarantees, or equity investments that directly further the charitable mission of the foundation and for which the production of income or appreciation of property is not a significant purpose. PRIs count towards the foundation’s mandatory annual payout requirement.

5. Risk and Return Considerations

Investing in private equity can offer substantial returns, which might appeal to foundations looking to grow their endowments. However, the illiquid nature of private equity and its potential for high volatility must be carefully balanced against the foundation's risk tolerance and payout requirements.

6. Due Diligence and Monitoring

Foundations should conduct thorough due diligence before committing capital to private equity. This includes reviewing the fund’s management

Can we explore excess business holdings in more depth?

First, it's important to understand that these rules are designed to prevent private foundations from having too much control or financial interest in for-profit businesses, which could conflict with their charitable purposes.

  1. Generally, a private foundation is allowed to hold up to 20% of the voting stock of a corporation, minus any ownership held by disqualified persons (such as substantial contributors to the foundation, foundation managers, and their family members).

  1. If disqualified persons own more than 20% of the voting stock, the foundation's permissible holdings drop to no more than 2% of the voting stock, plus any stock that disqualified persons do not own.

Exceptions and Modifications:

  1. There is an exception if the combined total of the stock owned by the foundation and the stock owned by disqualified persons does not exceed 35% of the voting stock of the corporation, provided that an unrelated party effectively controls the corporation.

What are the best practices for managing and overseeing foundation investments?

Best practices for managing and overseeing foundation investments focus on sustainability, risk management, and alignment with the foundation’s mission:

  1. Diversification: Just like any investment portfolio, foundations should diversify their investments to manage risk effectively.

  1. Mission-related investing: Aligning investments with the foundation’s charitable goals can enhance its overall impact.

  1. Regular reviews and audits: Frequent evaluation of investment performance and compliance with investment policies is crucial.

  1. Professional management: Many foundations engage professional investment managers to handle their portfolios, ensuring expertise in decision-making.

  1. Transparency: Keeping clear, accessible records and reporting on investment activities and performance helps maintain trust with stakeholders and the public.

Implementing these practices ensures that a foundation's investments are not only prudent but also contribute to its charitable objectives.

Management and Compliance

What about penalties for non-compliance, abuse of foundation funds, etc.?

Foundations are no different from any other legal entity - the rules of the game must be followed in order to keep the entity in compliance. Here are some of the rules, regulations, and penalties associated with the abuse of foundation rules.

Self-Dealing (IRC Section 4941): Self-dealing involves prohibited transactions between a private foundation and its disqualified persons.

  1. Initial Tax (IRC §4941(a)): Imposes a tax of 10% of the amount involved in the self-dealing transaction on each disqualified person who participates in the transaction.

  2. Additional Tax (IRC §4941(b)): If the self-dealing is not corrected within the taxable period, an additional tax of 200% of the amount involved is charged to the disqualified person.

  3. Tax on Foundation Managers (IRC §4941(a)): Foundation managers who participate knowingly and willfully in the self-dealing transaction are taxed 5% of the amount involved, up to $20,000. If not corrected, an additional tax of 50% of the amount involved, up to $20,000, may be imposed.

Non-Charitable Expenditures (IRC Section 4945): Non-charitable expenditures are those not in furtherance of the foundation's exempt purposes.

  1. Initial Tax (IRC §4945(a)): A tax of 10% of the non-charitable expenditure is imposed on the foundation.

  2. Additional Tax (IRC §4945(b)): If the expenditure is not corrected within the taxable period, an additional tax of 100% of the expenditure is charged to the foundation.

  3. Tax on Foundation Managers (IRC §4945(a)): A tax of 2.5% of the non-charitable expenditure, up to $5,000 per expenditure, is imposed on foundation managers who agree to the expenditure knowing it should not be made.

Jeopardizing Investments (IRC Section 4944): Jeopardizing investments are those that put the foundation’s ability to carry out its exempt purposes at risk.

  1. Initial Tax (IRC §4944(a)): A tax of 5% of the amount invested is imposed on the foundation annually for jeopardizing investments.

  2. Additional Tax (IRC §4944(b)): If the jeopardizing investment is not corrected, an additional tax of 25% of the amount involved is imposed on the foundation.

  3. Tax on Foundation Managers (IRC §4944(a)): A tax of 5% of the amount, up to $10,000 per investment, is imposed on any foundation manager who knowingly participates in making the investment.

Excess Business Holdings (IRC Section 4943): Excess business holdings involve a foundation holding more business interests than permitted.

  1. Initial Tax (IRC §4943(a)): An initial tax of 5% of the value of the excess business holdings is imposed on the foundation.

  2. Additional Tax (IRC §4943(b)): If the excess holdings are not disposed of within the period provided, an additional tax of 200% of the value of the excess business holdings is imposed.

What is the 1.39% excise tax that foundations face?

The excise tax on net investment income for private foundations is outlined in Section 4940 of the Internal Revenue Code. Private foundations are required to pay an annual tax on their net investment income, which includes interests, dividends, rents, royalties, and capital gains. The tax rate has historically been 2%, but recent changes in legislation have reduced this rate to 1.39%.

This tax is intended to support the enforcement of regulations governing private foundations and to ensure that these entities use their resources for charitable activities. By taxing the investment income of private foundations, the government aims to encourage the use of these funds for philanthropic purposes rather than accumulation of wealth.

Here's the section:

Tax on Net Investment Income (IRC Section 4940): Private foundations are subject to a tax on their net investment income. This includes income from dividends, interest, rents, royalties, and capital gains. The rate of this tax was traditionally 2%, but legislation has reduced it to 1.39%.

Can you give me some examples of how this works?

Example 1: Basic Calculation

A private foundation has the following investment income for the year:

Dividends: $10,000

Interest: $5,000

Capital Gains: $20,000

Total Expenses related to investments: $3,000

Calculation:

Total Income: $10,000 (Dividends) + $5,000 (Interest) + $20,000 (Capital Gains) = $35,000

Net Investment Income: $35,000 - $3,000 (Expenses) = $32,000

Excise Tax: $32,000 x 1.39% = $444.80

Example 2: Loss on Investments:

A private foundation reports the following:

Dividends: $8,000

Interest: $4,000

Capital Loss: -$12,000

Calculation:

Total Income: $8,000 + $4,000 - $12,000 = $0 (No taxable income due to the loss)

Excise Tax: $0 x 1.39% = $0

Example 3: No Income

A private foundation does not earn any investment income during the year.

Calculation:

Net Investment Income: $0

Excise Tax: $0

Example 4: High Capital Gains

A private foundation has significant capital gains:

Interest: $1,000

Capital Gains: $100,000

Calculation:

Total Income: $1,000 + $100,000 = $101,000

Assuming no related expenses for simplicity: Net Investment Income = $101,000

Excise Tax: $101,000 x 1.39% = $1,403.90

These examples illustrate how different scenarios of income can affect the excise tax calculations for a private foundation. The key factor is the net investment income after allowable deductions, which is then taxed at the rate of 1.39%.

How can a foundation ensure compliance with IRS reporting requirements?

To ensure compliance with IRS reporting requirements, foundations need to adhere to several key practices:

  1. Timely Filing of Form 990-PF: Private foundations must annually file Form 990-PF, which provides the IRS with detailed information on the foundation’s income, expenses, assets, and grants. Filing this form accurately and on time is crucial.

  1. Accurate Record-Keeping: Maintaining meticulous records of all financial transactions, grants, and administrative activities is essential. This documentation supports the information reported on the tax forms and can be crucial in case of an audit.

  1. Understanding Tax Obligations: Foundations must be aware of their specific tax obligations, including the payment of the 1.39% excise tax on net investment income and ensuring proper handling of unrelated business income (if applicable).

  1. Adherence to Distribution Requirements: Foundations are required to distribute at least 5% of the average market value of their net investment assets annually for charitable purposes. Monitoring these distributions and keeping detailed records is essential to meet this requirement.

  1. Regular Training and Education: Keeping board members and staff informed about regulatory changes and best practices in foundation management through regular training sessions can prevent compliance issues.

  1. Engaging Professional Help: Many foundations find it beneficial to hire professionals such as accountants, lawyers, or tax advisors who specialize in nonprofit law to help manage complex compliance issues and prepare tax filings.

By implementing these practices, foundations can ensure they meet IRS requirements and maintain their tax-exempt status, thereby focusing on their primary mission of philanthropy.

Donating and Distribution Requirements

Does the foundation still have to distribute 5% to charity, regardless of income?

Yes, private foundations in the United States are required by law to distribute at least 5% of the average market value of their net investment assets each year for charitable purposes. This requirement is known as the minimum distribution requirement and is intended to ensure that foundations actively contribute to charitable activities, rather than merely accumulating wealth.

Key Points Regarding the 5% Distribution Requirement:

  1. Asset Valuation: The 5% distribution rate is calculated based on the average market value of the foundation's net investment assets, which is typically assessed over the course of the year.

  1. Types of Qualifying Distributions: Qualifying distributions can include grants made to other charitable organizations, direct charitable activities undertaken by the foundation, and certain administrative expenses directly related to the operation of the foundation and its charitable activities.

  1. Timing: Foundations must meet this distribution requirement annually. If a foundation fails to meet the 5% requirement in any given year, it must make up the difference in subsequent years.

  1. Regardless of Income: The distribution requirement applies regardless of the foundation's actual income from investments or other sources in a given year. This ensures that foundations contribute consistently to charitable causes, even in years when returns on investments may be low.

  1. Penalties for Non-compliance: Failure to meet the minimum distribution requirement can result in penalties for the foundation. The IRS may impose an excise tax on the undistributed amount.

How does the tax deduction work when you donate to a private foundation.

Eligibility: Donations to qualified private foundations are generally tax-deductible. The foundation must be recognized by the IRS as a 501(c)(3) organization. Below, we'll examine donations made to a private "non-operating" foundation (which is what we've been discussing thus far).

Deduction Limits:

  1. Cash: For cash donations to private foundations, the deduction is limited to 30% of the donor's adjusted gross income (AGI) in the year of the donation.

This is lower than the 60% AGI limit for public charities.

  1. Assets: For donations of appreciated securities and other assets, the deduction limit is generally 20% of AGI.

  1. Carryover: If your donations exceed the AGI limits, you can carry over the excess "credit" for up to five (5) subsequent tax years. This does not stop you from making more donations the subsequent years and growing the fund, but your deduction is capped at 20% for donation of assets and 30% for donations of cash.

  1. Valuation: The deduction amount is generally the fair market value of the donated assets at the time of the donation for publicly held stock. All other assets generally get the adjusted cost basis of the donor.

Can we go through a simple example of how the cash donations and the associated tax deduction looks like?

Let's say you donate $50,000 in cash to a private foundation in 2023.

Assume your adjusted gross income (AGI) for the year is $120,000.

Step-by-Step Calculation:

  1. Determine Deduction Limit: 30% of your AGI because it's a cash donation to a private foundation. 30% of $120,000 = $36,000.

  2. Calculate Deductible Amount: Since you donated $50,000, and the limit is $36,000, you can deduct $36,000 on your 2023 tax return.

  3. Carryover: The remaining $14,000 can be carried forward for up to five years. You can use this carryover amount to potentially reduce your taxable income in future years, subject to the same AGI limitation applicable in those years.

Can we go through a simple example of: donating an asset vs donating the proceeds would play out?

Original purchase price of the asset (cost basis): $100,000

Improvements: $20,000

Sale price of the asset: $300,000

Capital gains tax rate (for simplification): 20%

AGI: $350,000

Deduction Limit for Cash Donations to a Private Foundation: 30% of AGI

Deduction Limit for Donations of Appreciated Assets to a Private Foundation: 20% of AGI

Donation Deduction Limit: According to IRC Section 170(e)(1)(B)(ii), when donating appreciated property to a private non-operating foundation, the deduction is limited to the donor's adjusted basis in the property.

Scenario 1: Selling the Asset and Paying Capital Gains Tax

Sale Price of the Property: $300,000

Adjusted Basis: $120,000 (purchase price + improvements)

Capital Gain: $300,000 (sale price) - $120,000 (adjusted basis) = $180,000

Capital Gains Tax: 20% of $180,000 = $36,000

Scenario 2: Donating the Asset to a Foundation, Which Then Sells It

Donation of Asset to Foundation:

The foundation sells the asset for $300,000: Foundations typically don't pay capital gains tax.

Net Proceeds to Foundation: $300,000 (taxed at a flat excise tax rate of 1.39%)

Deductible Amount: $120,000 (adjusted basis, not the $300,000 FMV)

Deduction Limit for Appreciated Assets to a Private Foundation: 20% of AGI

Calculation: 20% of $350,000 AGI = $70,000

Deductible Amount Used: Since the maximum deduction limit for donating appreciated assets to a private foundation is 20% of AGI, and the adjusted basis of $120,000 exceeds this limit, you can only claim up to $70,000 of the $120,000 adjusted basis in the year of the donation.

Excess Deduction: $120,000 - $70,000 = $50,000: This excess amount can be carried forward for up to five (5) subsequent years, allowing you to possibly deduct it in future tax filings, subject to the same AGI limitations.

Inside the foundation: flat-rate excise tax of 1.39% on the proceeds.

What are the consequences of failing to meet the minimum distribution requirement?

Private foundations are required to distribute at least 5% of the average market value of their net investment assets annually for charitable purposes. Failure to meet this requirement can result in several consequences:

Excise Tax on Undistributed Income: Foundations that do not meet the minimum distribution requirement are subject to a 30% excise tax on the amount below the required distribution.

Increased scrutiny: Repeated failures can attract increased attention from the IRS, leading to more thorough audits and reviews.

Reputational damage: Compliance issues can also affect a foundation’s reputation among donors, beneficiaries, and the public.

Corrective distributions: Foundations typically need to correct the shortfall by making additional qualifying distributions in the following years.

Maintaining compliance with the distribution requirements is essential to avoid financial penalties and maintain the foundation's good standing.

Demystifying Foundations

Let's be honest, is a foundation only for the ultra-wealthy?

No, the idea that foundations are only for the ultra-wealthy is a common misconception. Foundations can be established and maintained by a wide range of donors, not just the very wealthy. Here are a few points that illustrate this:

  1. Variety in Foundation Sizes: While many of the most well-known foundations are indeed backed by substantial wealth, there are thousands of smaller foundations around the world with more modest assets. These foundations are often started by individuals, families, or groups who are not necessarily wealthy but are committed to a specific cause or community.

  1. Flexible Structure Options: Foundations can be structured in various ways to accommodate different levels of assets and types of giving. Some foundations are set up to exist in perpetuity, while others spend down their assets over a defined period.

  1. Community Foundations: For those who might not have the resources to establish a private foundation, community foundations offer an alternative. Donors can contribute to a collective fund within a community foundation, gaining the benefits of charitable giving without needing to manage a private foundation. At Law and Tax, we generally do not setup community foundations.

  1. Tax Advantages: The tax benefits of creating a foundation can make it a financially viable option for individuals with the capacity to donate even smaller amounts. These benefits can help in maximizing the impact of their contributions while also providing financial advantages.

  1. Increasing Accessibility: New models and platforms for philanthropy, such as donor-advised funds and online giving platforms, have made it easier and more affordable to start and maintain a foundation. These innovations lower the barrier to entry for engaging in organized philanthropy.

In summary, while substantial assets can enhance a foundation's capabilities, the essence of a foundation is its purpose and impact, not the wealth of its founder. People of varying financial backgrounds can and do start foundations, driven by a desire to make a positive difference.

What types of individuals or groups commonly set up foundations beyond the ultra-wealthy?

Foundations are not solely the domain of the ultra-wealthy; many types of individuals and groups set up foundations for a variety of reasons. Here are some of the clients that we have worked with and helped structure foundations for:

  1. Entrepreneurs and Business Owners: Individuals who have experienced significant success in their businesses often establish foundations as a way to give back to communities or causes related to their industry or personal passions.

  1. Professionals: Many professionals such as doctors, lawyers, and corporate executives start foundations as a part of their legacy or retirement planning. These foundations often focus on areas they are passionate about, such as education, health, or the arts.

  1. Family Groups: Families often create foundations as a way to unify family members around a common charitable cause and to pass on philanthropic values to future generations. This can also serve as a way to manage and distribute family wealth in a purposeful manner.

  1. Small Businesses: Some small businesses set up foundations as part of their corporate social responsibility initiatives. These foundations can help enhance the business's community engagement and overall social impact.

  1. Close-Knit Groups: Groups of people united by a common interest or concern may form a foundation to address specific local issues like supporting local schools, parks, or healthcare facilities.

  1. Celebrity and Athlete Foundations: Public figures such as athletes, artists, and entertainers often establish foundations to leverage their visibility and influence to support charitable causes. These foundations can be powerful platforms for advocacy and fundraising.

  1. Grassroots Activists: Individuals or groups focused on particular or specific social, environmental, or political causes sometimes establish foundations to secure funding and increase the impact of their advocacy work.

  1. Religious Groups: Religious organizations often establish foundations to support their charitable work, be it local community service or global mission efforts.

  1. Academics and Researchers: Some scholars and researchers create foundations to support ongoing research in specific fields of study or to grant scholarships and fellowships.

  1. Investors: Many investors and investment groups also benefit from structuring a private foundation to support specific causes, or as a means of diversifying their portfolio as well.

These diverse groups are drawn to the foundation model as it offers structure for giving, potential tax benefits, and a formal way to manage and sustain their philanthropic efforts over time. Foundations allow them to make a lasting impact on the causes they care about most, while checking all the other boxes as well that pertain to asset protection, wealth preservation, and social contribution.

Questions about private foundations?

Visit our resources page to find more links, case studies, and information on foundations or schedule a call to speak to our team about your philanthropic goals

© Copyrighted Material 2024. All rights reserved.

Law and Tax Consulting, LLC.

IMPORTANT: LEGAL DISCLAIMER

The information contained on this page does not constitute legal, tax, of financial advice and is strictly for educational and entertainment purposes only. Please consult an attorney or advisor in your area to get a second opinion on legal matters. We are a consulting firm that houses attorneys, accountants, and other licensed professionals who who execute strategies for our clients. No attorney-client relationship is formed by scheduling a call, filling out forms, attending workshops, participating in the Hotline, or by sending us an email.