Q. What is a private foundation?
A. A private grantmaking foundation (hereafter, just “private foundation”) is a nonprofit entity with 501(c)(3) tax status, whose funds typically come from one source (e.g., a founding individual or family), and are distributed as charitable grants. (In contrast, a private operating foundation uses its funds mainly to conduct its own charitable activities rather than to make grants.)
The Internal Revenue Code requires a private foundation to expend at least 5 percent of its endowment each year. The required distribution includes reasonable administrative expenses, such as staff salaries, as well as the grants. Individual philanthropists may choose to donate to existing foundations or start their own.
Q. How do I decide whether to start a private foundation? Is there a minimum amount needed?
A. In addition to its required annual payout, operating a foundation entails burdens absent from direct giving and DAFs. Properly administering a foundation and making annual reports to the IRS can be burdensome—though you can outsource many administrative responsibilities to organizations like Foundation Source. Among other things, a foundation must report the recipient organization, amount, and purpose of every grant made on the 990-PF form, which is publicly available. It has become a well-regarded practice for many private foundations to publish their grants on their websites.
In deciding whether a private foundation makes sense for you, consider whether its advantages in achieving your philanthropic objectives justify the burdens. One potential advantage is that all the costs of running a foundation are included in the required annual payout. If you plan to make a large number of complex grants, you may well need staff to manage them. You will probably incur further costs to rent or purchase an office for the staff, as well as legal and accounting costs for reporting and complying with regulations, and so on. (In contrast, you have no significant legal, reporting, or real estate expenses when you give directly or through a DAF.) You should consider whether these expenses actually increase the effectiveness of your charitable activities by at least the same amount as their costs.
Apart from these operational matters, a private foundation provides a good means of having your philanthropy last beyond your lifetime—though this can be achieved through a DAF as well.
All things considered, you should give serious second thoughts to establishing a private foundation with an endowment of less than eight figures.
Q. Are contributions to a private foundation tax deductible?
A. Yes, but like other charitable tax deductions, there are limits. Essentially, you can’t deduct more than 30% of your AGI for contributions of cash or more than 20% of appreciated assets to a foundation. Moreover, gifts to a foundation of appreciated assets that are not publicly traded generally cannot be deducted at fair market value; the taxpayer will instead be limited to a deduction equal to basis (which in the ordinary case means the cost). Again, there are many tax complications, including how the deduction for gifts to a private foundation are affected by deductions for gifts to public charities. You should consult your accountant or lawyer before setting up a foundation.
Q. Do assets in a private foundation grow tax-free?
A. Not completely. Unlike public charities and DAFs, which generally do not have to pay tax on their investment income, private foundations must pay a federal excise tax of 2% on their investment income (reduced to 1% in some cases).
Q. Can I make anonymous gifts to or through a private foundation?
A. No. Private foundations must disclose all gifts they receive of $5,000 or more in a given year. Private foundations also must disclose all grants that they paid or approved. This information generally will be available on the Internet through websites such as GuideStar.
Q. Can a private foundation pay out more than the required 5% of our endowment annually?
A. Yes, you have complete discretion to pay out more than the required 5%. There are no upper limits on foundation spending. If you wanted, you could, in theory, spend down your entire endowment within one year.
Q. Should I put my children on the foundation’s board?
A. Children often develop interests quite different from their parents’. As long as you are comfortable with making room in the foundation’s priorities for their interests, foundations offer a structured way to involve the next generations in your philanthropy.