What's a Private Foundation?
A private foundation is one type of nonprofit organization that typically makes grants to public charities and doesn’t provide programs of its own. Often funded by a person, married couple, family, or corporation, foundations enjoy tax-exempt status as long as they meet certain state and federal requirements. You may set up a private foundation as a not-for-profit corporation or a trust and then invest its funds in order to generate income for grants as well as to support the foundation.
Key Advantages and Disadvantages
Foundations require a substantial amount of time, work, and money to establish and maintain. While it’s much easier to write a check to a charity you’d like to support, starting your own private foundation does offer many benefits. Read on to learn about the key advantages and disadvantages associated with these organizations.
Starting a private foundation provides you with a range of benefits, including:
More Effective Philanthropy
If you just want to write a check and send it to your favorite charity, that’s a fairly quick and simple process. While you can easily donate to one organization this year and then to another the next, this approach doesn’t require you to keep track or have a formal plan. In contrast, foundations provide a more organized, strategic, and targeted way of giving. They encourage founders to carefully determine how they want to use their resources to make a positive impact and then implement a practical plan to achieve that goal.
Expanded Giving Opportunities
Foundations provide more options in terms of how — and to whom — you may give your charitable contributions. An individual cannot claim tax deductions on a donation to another individual, foreign nonprofit, or a non-charitable organization. However, foundations may make grants to such recipients just like public charities. That means if you donate to your foundation, your foundation can then give grants to this wider net of recipients.
Greater Financial Control
With a private foundation, the founding individual, family, or corporation maintains financial control because this small group of donors provides the nonprofit’s funding. In contrast, a public charity depends on public support and its board of directors or trustees to make decisions.
Like public charities, private foundations benefit from four major tax incentives in order to encourage charitable giving. Those incentives include:
- Income Tax Deductions: Private foundation donors can claim tax deductions on both their federal and state tax returns. Donors may deduct the value of cash donations up to 30% of their adjusted gross income (AGI) as well as the value of appreciated property up to 20% of their AGI.
- Tax-Free Asset Growth: All investment returns — whether from interest, dividends, capital gains, or other forms of investment returns — remain tax-free if earned within a foundation.
- No Gift or Estate Taxes: Generally, assets transferred to family foundations are not subject to gift or estate taxes.
- Double Capital Gains Benefits: Because foundations invest all donor contributions, those donors may claim a charitable deduction for the full market value of appreciated stocks held in publicly traded companies. Furthermore, as property owned by a foundation increases in value that added value doesn’t count as a capital gain and so doesn’t incur a capital gains tax.
Consistency in Giving
Many people start private foundations because they want a consistent way to support their favorite charities. Foundations also enable them to continue giving even after they’re gone.
Reasonable Compensation for Your Services
While members of a public charity’s board of directors can’t receive compensation for their work, a foundation’s board members or trustees can receive reasonable compensation for services rendered to the foundation under normal circumstances.
Reimbursement of Travel and Other Expenses
A foundation’s board of directors, trustees, and founding family members may receive reimbursement for reasonable and direct costs of services rendered to the foundation. If you must travel to your foundation’s board meetings, for example, you can receive reimbursement for your travel expenses.
Stronger Public and Community Relationships
Foundations can create strong, well-recognized relationships throughout the community and with the general public. For example, Bill and Melinda Gates are well-known for their business leadership. However, their work with the Bill & Melinda Gates Foundation further elevates their public image and community relationships because people recognize all the good they do for the community. Heightened public recognition also can help foundations bring more attention to a specific cause.
Foundations make it easy for people who regularly receive requests for charitable donations and fundraising appeals to refer all such inquiries to their foundation. This can prove especially beneficial in protecting the privacy of a high-profile figure.
Private foundations can provide a great way to leave a legacy — or to honor a friend or family member — by supporting a cause important to you or your loved ones. Because most founders set up private foundations to operate in perpetuity, this type of nonprofit enables them to continue supporting a cause indefinitely. Family foundations, in particular, help donors engage generations of family members in a specific cause or charitable effort, deepening their social consciousness and creating a true family legacy.
Greater Freedom to Take Action
Private foundations do more than simply enable founders to leave legacies and gain tax benefits. They also allow founders to create organizations that address specific needs in specific ways they deem appropriate. That means you can take risks and pursue actions that others — even the government — can’t or won’t do.
Starting a private foundation also involves several disadvantages you should be sure to consider, including:
Substantial Time Commitment and Costs
Starting a foundation involves a substantial amount of time and money because of the work required to incorporate or establish the organization in another acceptable way. Setting up a foundation typically also requires engaging outside professionals — such as attorneys, accountants, and others — who can provide expert advice on how to form and run your foundation.
Annual Excise Tax Payments
Private foundations must pay a 1% to 2% annual excise tax on their net income. The exact percentage depends on a foundation’s annual grantmaking.
Detailed Record-Keeping Requirements
Foundations must maintain good records to provide evidence of regulatory compliance and grantmaking, document board and committee meeting minutes, and create financial reports. A foundation also should create and store other important documentation that shows how its work meets its charitable purpose and proves there’s no misuse or abuse of funds.
Greater Regulatory Requirements
Private foundations must distribute at least 5% of their investment income each year through charitable grants. Foundations also face greater scrutiny by state and federal governing bodies than public charities because only a few trustees manage them under much less public scrutiny.
Mandatory Annual Reporting
While different states may have different annual reporting requirements, the Internal Revenue Service mandates annual reporting by all private foundations. This process typically takes four to eight hours to complete and often requires an accountant or attorney to finalize and submit the necessary paperwork.
Lower Deductibility Caps
Individuals may make cash contributions worth up to 30% of their AGI and appreciated property donations valued at up to 20% of their AGI to private foundations. That’s significantly lower than the limits set for public charities to which individuals may contribute cash donations worth up to 50% of their AGI and appreciated property valued at up to 30% of their AGI.
Less Favorable Treatment of Some Capital Gain Gifts
While public charities may deduct the fair market value of any gifts of appreciated property they receive, foundations may only make deductions for such gifts on a cost basis. Publicly traded stocks represent an exception to this rule, and foundations may deduct stocks at their fair market value.
While creating and running a private foundation requires significant time, effort, and money, this type of organization also provides many advantages. For example, private foundations offer greater control, tax benefits, and more flexibility in how they spend their funds. To help you decide if starting a private foundation is right for you, carefully consider the goals for your charitable giving as well as the key advantages and disadvantages of this form of nonprofit. If you want to get started, check out our How to Form a Nonprofit guide.