Frequently Asked Questions

What is a Private Charitable Foundation?

Clients who wish to integrate charitable planning into their estate plans have a variety of options, such as outright gifts during lifetime, a bequest in a Will or Trust or, among other choices, the establishment and gift to a private charitable foundation. While there are pros and cons for each type of planning, for some creating and gifting to a private charitable foundation is the right fit. The benefits of a private charitable foundation include long term control over assets and estate and gift tax planning. However, a private charitable foundation may not be for everyone. Factors to consider include the goals of the client, the client’s tax situation, the ability and desire for family members to participate in the foundation and the cost and expense of creating and maintaining the foundation.

What is a Private Charitable Foundation?

A private charitable foundation is defined under Section 501(c)(3) of the Internal Revenue Code (“IRC”) as an entity that is organized and operated exclusively for charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The term “charitable” includes relief of the poor, the distressed or the underprivileged, advancement of religion, advancement of education or science, erecting or maintain public buildings, monuments or works, lessening the burdens of government, lessening neighborhood tensions, eliminating prejudice and discrimination, defending human and civil rights secured by law, and combating community deterioration and juvenile delinquency.

After creation, the board or trustees must apply for Section 501(c)(3) tax exempt recognition with the IRS. The board or trustees are required to provide detailed information regarding the structure of the foundation, including disclosing compensation to board members and trustees, projected expenses and planned giving. The foundation will be required to file annual returns to ensure that the foundation is meeting its minimum obligations (discussed below).

Advantages of a Private Charitable Foundation

There are a number of benefits for clients who wish to setup a private charitable foundation, such as:

Control

Donors can make tax-deductible donations and still remain in control of the investment and management of the funds as trustees/board members. Furthermore, the foundation can continue to serve the clients charitable purposes after death.

Family Legacy

A foundation provides a vehicle to bring family members together for a common cause or purpose. It provides a unique opportunity for family members to serve on a board or as trustee and to gain experience in administering and operating a foundation for charitable causes. Finally, it is a vehicle to introduce family members to the community, thereby providing a gateway to meet with community leaders and other individuals.

Salaries

Family members serving as board members or trustees can receive salaries, although there are strict guidelines for doing so and if not necessary it is desirable to avoid them altogether.

Income Tax Deduction

The donor is able to take an income tax deduction immediately. Highly appreciated assets that are donated to the foundation can avoid capital gains tax and allow the donor to take an income tax deduction of 20% of adjusted gross income (with a 5 year carry forward for any unused income tax deduction). Cash contributions generally receive a 30% income tax deduction (with a 5 year carry forward).

Gift Tax Benefits

Gifts to the private charitable foundation do not affect the client’s annual gift tax exclusion or lifetime gift tax exemption.

Estate Tax Benefits

Assets transferred to a private charitable foundation are not subject to estate tax.

Types of Private Charitable Foundations

Private charitable foundations can be established as trusts or corporations, and during a client’s lifetime or at death. In addition, private charitable foundations can be subdivided into two further categories:

Private Operating Foundation

This type of foundation devotes most of its resources to the active conduct of its exempt activities. For example, a foundation created to operate a homeless shelter. (A more complete description of the types of foundations which fall under this category can be provided during a consultation with our attorneys.) The administration of these foundations can be extremely complicated and expensive to operate.

Non-Operating Foundation (or Private Pass-Through Foundation)

This type of foundation typically makes grants to help fund the efforts of other organizations or individuals. For example, a foundation created to provide grants to unrelated homeless shelters. The set up and administration of these foundations is a simpler process as it does not involve direct services and only supports other organizations by making grants.

Obligations and Limitations of a Private Charitable Foundation

Once a private charitable foundation has been approved by the IRS, certain requirements must be met under the IRC in order to continue to be deemed an exempt charitable organization:

Annual Excise Tax

A 2% tax is imposed annually on all investment income generated by the foundation. (Section 4940)

Self-Dealing

A foundation is prohibited from self-dealing which usually involves entering into financial transactions with disqualified individuals such as members of the board, trustees, managers, substantial contributors to the foundation and family members. The IRS can impose a 5% excise tax on such transactions and up to 200% of the amount involved if the self-dealing is not corrected. (Section 4941)

Distribution of Income

A foundation is required to distribute 5% of its investment assets in any given year. If this minimum distribution is not met, the IRS can impose an excise tax of up to 15% of the undistributed amount. (Section 4942)

Controlling Business Entities

A private charitable foundation may not own more than a certain percentage of any business entity. The IRS can impose a 5% excise tax of the amount in excess of the minimum. (Section 4943)

Inconsistent Investments

A foundation cannot invest in anything that may jeopardize its short and long term goals or otherwise jeopardize its charitable purpose. The IRS can impose a 5% excise tax of the amount of the investment plus an additional 5% exercise tax against the manager of the foundation. (Section 4944)

Prohibited Taxable Expenditures

A private charitable foundation is prohibited from making certain expenditures towards political activities or influencing legislation. The IRS may impose a 10% tax of any such expenditures. (Section 4945)

Conclusion

If prepared properly, a private charitable foundation can be an effective technique for those clients wishing to engage in on-going structured charitable causes with generations of family members and other individuals while continuing to maintain control over the foundation. A private charitable foundation should be seamlessly integrated into a client’s estate plan while avoiding or minimizing any of the aforementioned excise taxes, so it is critical that the client meets with an estate planning professional familiar with the intricacies of creating and operating such entities. We welcome the opportunity to discuss the benefits of creating a private charitable foundation with you. Please contact any of our estate planning attorneys for assistance.