Setting up a family foundation allows philanthropically minded families to achieve any number of worthy goals while also providing significant tax benefits. Many donors are surprised to find that they need not be extravagantly wealthy to create their own family foundation. This helps to explain why more than 1,300 private foundations operate in Wisconsin alone. Nationwide, there are more than 90,000 foundations holding more than $600 billion in assets.
1. Gifts & Grants
Simply stated, a private family foundation is an independent charitable entity organized under Sec. 501(c)(3) of the United States Internal Revenue Code. This entity makes annual grants to one or more public charities. At inception, the foundation usually is funded by a tax-deductible gift of cash or appreciated securities from one individual or family. After a gift is received, the foundation board can sell the gifted asset, paying no capital gains tax, and reinvest the funds to provide future net income. The board then uses the investment income to make annual grants to the charitable organizations of its choice.
2. Family Collaboration
Board members are typically part of the extended family that created the foundation. Serving on the board can encourage family collaboration, reinforce important family values, and prove a useful training ground for younger generations. The foundation can help to keep a family together, supporting mutually agreed on causes and beliefs. Family members who serve can receive salaries that are reasonable and customary for administrative or board duties. But salaries usually are not large, ranging from a few hundred to a few thousand dollars per year.
3. Tax Benefits
The funding of a private foundation offers important income tax and estate tax benefits. Gifts of cash to a family foundation can be deducted from individual income taxes up to 30% of the donor’s adjusted gross income (AGI). Gifts of qualified appreciated stocks (publicly traded stocks or mutual funds) can be deducted at their fair market value, up to 20% of the donor’s AGI per year. These deduction limits are slightly less favorable than those on gifts to public charities, but any unused deduction can be carried forward for a period of five years.
Gifts of closely held company stock are not typically donated to a private foundation because of valuation concerns, business reasons, and unfavorable tax treatment. For example, if you elect to contribute closely held stock to a family foundation, the deduction is limited to the cost basis up to a ceiling of 20% of AGI. In addition, an appraisal of the company stock would be required in order to determine a value for purposes of income tax deduction.
4. Estate Tax Benefits
Estate tax benefits also come into play. Upon a funder’s death, a private foundation can receive gifts or bequests free of any federal or state estate tax. The foundation can be a designated beneficiary of an IRA, for instance, or a remainder beneficiary of a charitable remainder trust. Family members frequently make their largest contributions to the private foundation at death, as part of their overall estate planning.
While the benefits are many, the primary advantage of a private foundation versus other charitable alternatives can be stated in one word: control. The founder, together with selected family members or friends, controls the assets, the investment decisions, and the grant-making process. When a family foundation is properly structured, the founder can guide nearly every aspect of the operation. Unlike direct gifts, which benefit one charity on one occasion, a private family foundation can perpetuate the donor’s generosity by giving to more recipients over a longer period of time.
The IRS imposes a very modest excise tax of only 1% to 2% on the net investment income of foundations. Because they offer so many advantages, however, private foundations are subject to serious oversight and strict operational constraints. Under what is known as the “big tax rule,” the IRS requires a private foundation to distribute at least 5 percent of its total assets to approved charities every year. The tax requirements for establishing and governing private foundations can be challenging, so the creator will need help from a lawyer, CPA, or trust professional with experience in charitable giving. Particularly vital is a competent attorney to advise on foundation structure and prepare the Internal Revenue Service tax-exemption application (Form 1023) at inception.
How Trust Point Can Help
Where does Trust Point come into the picture? A lot of time and energy can be involved in the day-to-day business of foundation charitable giving. Naturally, the scale of the family foundation’s assets, and the number and size of gifts to be awarded, have a direct impact on the management time required. In most cases, family members serving on the Board of Directors maintain control over the funds by making all of the grant decisions, while our experienced professionals assist with functions such as these:
- Developing and clarifying the purpose and legal structure of the foundation
- Recording gifts of cash and securities from family members, and sending tax- acknowledgment letters
- Investing the foundation assets in a diversified portfolio, using both individual securities (stocks and bonds) and institutional mutual funds
- Assisting with the grant-making process, including processing grants, maintaining records, and communicating with charitable organizations
- Meeting minimum annual IRS distribution requirements and assisting with long-term budgets for charitable pledges
- Preparing governmental reports and annual income tax return Form 990-PF
- Overseeing foundation board meetings and communications with the family board
Compliance requirements and other issues can require substantial daily activity, which means that running a family foundation sometimes is an expensive and time-consuming proposition. For more modest contributors, a donor-advised fund (DAF) can be a less expensive and easier way to pursue philanthropy while still maintaining some level of control. A DAF is a named family fund created by a donor who transfers control of the fund’s assets to a public charity while retaining the ability to recommend distributions.
Donors who plan to contribute very significant sums usually find that a family foundation is preferable to a DAF. A well-funded foundation will have the resources to hire the experts necessary to handle investments and management duties while allowing the family to maintain control over the funds.
In the end, families seeking philanthropic flexibility, family involvement, and control may find a private foundation to be the best charitable option.