This guide will help you identify client scenarios where a private foundation may be the right solution for your clients’ planning needs. These scenarios are covered at a high level and are not intended as investment, tax, or legal advice.

Investment Planning

ADVANTAGES OF A PRIVATE FOUNDATION

These assets can be donated directly to a private foundation and provide a fair-market-value charitable income tax deduction without triggering capital gains taxes. Once in the foundation, these assets can be held or converted to a diversified, managed portfolio.

CONSIDERATIONS

If and when the foundation sells the stock, it will pay a nominal excise tax (1 .39%) on the net capital gains. The client cannot donate shares that obligate the foundation to sell those shares at a pre-negotiated price.

ADVANTAGES OF A PRIVATE FOUNDATION

Not only can these assets be used to fund a private foundation, but the foundation can continue to hold these assets long term, subject to prudent investor rules and applicable state laws.

CONSIDERATIONS

The foundation needs to obtain a qualified appraisal to substantiate the charitable income tax deduction. The amount of this deduction is typically determined by cost basis, not fair-market value.

A foundation’s level of ownership in a business may be limited by IRS excess business holdings rules. If and when the foundation sells the stock, it will pay a nominal excise tax (1 .39%) on the net capital gains. The stock may not be sold to foundation insiders or their family members.

ADVANTAGES OF A PRIVATE FOUNDATION

Private foundations provide complete control over how the portfolio is managed and what assets they can hold, subject to the foundation’s investment policy. Some advisors consider alternative assets to be an important part of a foundation’s portfolio strategy for increasing investment returns and further diversifying assets to reduce risk.

CONSIDERATIONS

Some alternative assets, such as S Corp stock and certain partnership interests, will generate Unrelated Business Income Tax (UBIT), which requires the fi ling of IRS Form 990-T and is taxed at the for-profit tax rate. This includes purchases with borrowed funds, such as securities on margin.

A foundation’s level of ownership in a business may be limited by IRS excess business holdings rules. The foundation should ensure that it has sufficient liquidity reserves to meet operating needs.

ADVANTAGES OF A PRIVATE FOUNDATION

When donated to a private foundation, real estate can be used to generate a steady stream of income and liquid funds. If the real estate to be donated is part of a gross estate, the cost basis will be “stepped up,” typically to the date of death.

CONSIDERATIONS

The foundation needs to obtain a qualified appraisal to substantiate the charitable income tax deduction. Income tax deductibility is limited to whichever is lower: cost basis or fair-market value at the time of the gift. Clients cannot donate real estate that is encumbered by a mortgage, which could result in a self-dealing violation. Also to be avoided are “pre-arranged sales,” where the terms of a sale of property are negotiated prior to it being donated, and the sale is consummated by the foundation.

ADVANTAGES OF A PRIVATE FOUNDATION

The types of tangible property that can be used to fund a private foundation are virtually unlimited, plus a foundation has the opportunity to hold the assets long term. If the item is used by the foundation to further its charitable purpose, the value of the asset would be excluded from the asset base upon which the foundation’s annual 5% payout requirement is calculated.

CONSIDERATIONS

The foundation needs to obtain a qualified appraisal to substantiate the charitable income tax deduction. Tax deductibility is limited to whichever is lower: tax basis (typically what the client paid for it) or fair-market value at the time of the gift. Once donated to the foundation, the asset cannot be displayed in a residence or commercial property belonging.

Tax and Estate Planning

ADVANTAGES OF A PRIVATE FOUNDATION

The client may be eligible for a charitable income tax deduction as high as 30% of Adjusted Gross Income (cash donations) for the year in which the gift is made to the foundation, plus there is a five-year carry-forward for contributed amounts that exceed this limit. For donations of non-cash assets, the cap is 20% of AGI. Funding a foundation during high-income years allows the client to continue philanthropic activities during retirement.

CONSIDERATIONS

If there is a need for additional deductions, the client can max out the contribution to the private foundation, then make additional tax-deductible contributions to public charities, which have higher AGI caps (60% for cash and 30% for non-cash donations).

ADVANTAGES OF A PRIVATE FOUNDATION

Donating shares of a business to a private foundation can be a means of reducing income and/or estate tax liabilities.

CONSIDERATIONS

The client cannot donate shares that obligate the foundation to sell those shares at a pre-negotiated price. Whether the shares qualify for a cost-basis deduction or a fair-market-value deduction may depend on whether or not it is a long-term capital gain asset in a publicly traded company.

A foundation’s level of ownership in a business may be limited by IRS excess business holdings rules. Donated shares may not be sold to foundation insiders or their family members.

ADVANTAGES OF A PRIVATE FOUNDATION

Assets donated to a private foundation are removed from the client’s estate, which may reduce estate tax liabilities.

If the assets to be donated are part of a gross estate, the cost basis of these assets will be “stepped up,” typically to the date of death. As stewards of the foundation, the family is able to maintain control of these charitable funds in perpetuity.

CONSIDERATIONS

This is an irrevocable transfer. The assets would not be available for an inheritance or to cover death costs.

Charitable Planning

ADVANTAGES OF A PRIVATE FOUNDATION

A life insurance policy can be used to make a significant contribution to the foundation upon the client’s death.

Option 1:

The client retains ownership of the policy, but names the foundation as the beneficiary. At the insured’s death, the death benefit passes to the foundation, and the estate should be eligible to receive an off setting charitable estate tax deduction.

CONSIDERATION

There is no charitable income tax deduction.

Option 2:

The client transfers all incidents of ownership of the policy to the foundation. Generally, the charitable income tax deduction would be the lesser of the policy’s fair-market value at the time of the donation and the donor’s basis in the policy

CONSIDERATION

There can be no outstanding loans against the policy when it is transferred to the foundation. Upon transfer, the policy’s donor can no longer change the beneficiary, borrow against the policy, surrender the policy, cancel the policy, etc.

ADVANTAGES OF A PRIVATE FOUNDATION

By naming the private foundation as the charitable beneficiary of the trust, the family, as stewards of the foundation, can continue to control the use of those charitable funds beyond the term specified in the trust.

CONSIDERATIONS

Not all trust documents allow the donor to change the beneficiary. Others may not permit distributions to a private foundation. If transferred from a charitable lead trust, the CLT donor cannot participate in grantmaking decisions involving the CLT assets.

ADVANTAGES OF A PRIVATE FOUNDATION

Many individuals have both a private foundation and a donor-advised fund account, which enables them to take advantage of the unique aspects of each. With the private foundation, clients have complete control over their philanthropic capital and are virtually unlimited in the ways in which they can carry out their philanthropy. But when complete anonymity is desired for certain grants, they can make a grant from the foundation to the donor-advised fund account, and from there to the public charity. This transfer counts toward the foundation’s 5% required minimum distribution.

CONSIDERATIONS

While a private foundation can make grants to a donor-advised fund account, the opposite is not true. You cannot transfer funds from a donor-advised fund account to a private foundation. So if there are lingering questions as to which vehicle is best for your client, you preserve options by starting with a private foundation.

ADVANTAGES OF A PRIVATE FOUNDATION

Private foundations have broad latitude to pursue any activities as long as they are charitable. In addition to supporting nonprofit organizations, a foundation can:

  • Make grants to individuals for relief from disaster, economic hardship, or medical distress
  • Provide loans to charities or unrelated parties that are repaid to the foundation
  • Set up scholarship programs, and choose the recipients
  • Grant to international organizations
  • Provide funds to for-profit companies, when it’s for a charitable purpose
  • Run its own charitable programs, such as mitten/coat drives, food pantries, etc.

CONSIDERATIONS

Foundations are required to distribute a minimum amount each year that is roughly equal to 5% of the previous year’s net average assets. Certain administrative expenses count toward this 5% requirement.

ADVANTAGES OF A PRIVATE FOUNDATION

A private foundation can reimburse donors for expenses that are reasonable and necessary for conducting the foundation’s charitable activities.

CONSIDERATIONS

If donors choose to pay expenses out of their own pockets, so that foundation assets go further, they can get a charitable income tax deduction for these non-reimbursed expenses.

ADVANTAGES OF A PRIVATE FOUNDATION

A foundation is allowed to hire employees, including family members. This is not allowed with a donor-advised fund account. In order to compensate these “foundation insiders,” services must be reasonable and necessary; compensation can’t be excessive; and they must be considered “personal services,” (i.e., professional or managerial).

CONSIDERATIONS

When hiring a family member, the foundation must base the compensation on objective criteria: what would a similarly sized foundation pay a non-family member with the same background to perform the same duties? Best practices advise the use of an independent, nonpartisan entity for performing this analysis and setting compensation.

NOTES

  • Donations to a private foundation are an irrevocable transfer, and may be used only for charitable purposes.
  • The contribution of any asset that is subject to a liability can cause adverse tax consequences to the donor.
  • When funding a foundation with illiquid assets, or those subject to a lock-down period, there may also be a need for cash or other liquid assets to meet the annual 5% required minimum distribution and other foundation expenses.
  • A foundation can never sell assets to foundation insiders or their family members, even if the sale price is fair or advantageous to the foundation.