Financially successful individuals often contemplate the highest and best use of their assets. In some cases, those same individuals have decided that the natural objects of their bounty (i.e. the children) already have enough resources or that mom and pop have otherwise adequately provided for their children. Alternatively, some of the successful individuals have no apparent heirs to inherit the assets. If these same successful individuals are charitably-minded, the private foundation is an excellent option to fulfill the individual’s objective. This article provides a primer on the private family foundation.
How is the foundation set up? The donor works with his or her professional team (financial advisor, attorney, and accountant) to formulate a mission and vision for the foundation that will necessarily meet the tax-exempt criteria set out by the IRS.
What is the legal and tax structure? A nuanced discussion of legal form and tax structure is beyond the scope of this article. But, in simple terms, a private foundation can be legally structured as either a charitable trust or a non-profit corporation. Either form falls under applicable state law for the applicable form – trust law for trusts or corporate law for corporations. Further, a private foundation can be structured as either an operating foundation or a non-operating foundation. After formation (as either a trust or a non-profit corporation), the entity must seek the tax exemption status with the IRS through application. If approved, the tax-exempt status usually runs from the date of application so that funds or property contributed can be immediately booked as a charitable contribution with a corresponding tax deduction.
Who runs the private foundation? The private foundation can be run by the donor, or it can be run by a professional staff, or both. Effectively, the donor can choose to what extent they wish to be involved. Sometimes, the donor is heavily involved in the management of the foundation. Other times, the donor finds paid professionals to take on some aspect of the administration of the foundation. For example, the private foundation might be established to provide scholarships. And, the donor may only want to pick the awardees and present the gifts to the awardees. That same donor would then pay a professional to administer the foundation, advertise the scholarship, develop the application process and packet, and deliver those same documents to the donors.
Get the kids involved. The private foundation can be a great way to get the donor and the children involved in the mission of the private foundation. The children can even have paid positions within the foundation (based on the child’s education, experience, and job description within the foundation).
How much do you need to start a private foundation? There is no magic number that determines whether a private foundation makes sense. But, practically speaking, the private foundation can be costly to set up (mainly attorney and accountant fees in setting up the organization and applying for the tax-exempt status). Additionally, it will typically have ongoing maintenance costs (again, mainly attorney and accountant fees). It might also incur other administrative fees if the donor wants to hire someone to tackle any of the administrative duties. Of course, the more of the workload handled by the donor, the less the fees incurred. As a very fluid number, this author begins looking at a private foundation when the donor can contribute somewhere between $500,000 and $1M.
What are the alternatives to a private foundation? If a donor is not able to give the amounts described above or if the donor just doesn’t want the hassle of forming a new private foundation, great alternatives are available. A donor-advised fund (DAF) is one option. A DAF allows an individual to donate to a charity (the DAF) and then control the distribution of funds from the DAF over time to one or more 501(c)(3) organizations. Like the private foundation, the donor can get his or her children involved and appoint them as “advisors” or alternate advisors to the fund so that the child ends up directing the charitable gifts from the DAF. Another alternative is a community foundation. Often, a community foundation can fulfill the charitable intent and mission of a donor for the donor without the private foundation. As an example, assume the donors from above want to establish a scholarship for a local college. Instead of setting up a private foundation, the donor can make a gift to a community foundation with instruction on how the scholarship should be administered. Then, the community foundation follows the instructions and implements the scholarship as instructed.
Interested individuals should talk to their financial advisor, attorney, or accountant, to see if the private foundation is a good option.
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- Licensed, not practicing.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.
