Establish Your Private Foundation

Understanding Private Foundations

A private foundation is a tax-exempt charitable organization created and funded by an individual, family, or corporation to make grants to other charitable organizations or conduct its own charitable programs. Unlike public charities that receive ongoing donations from many sources, private foundations are typically funded by a single source and controlled by the donor's family or appointed trustees. Foundations provide a structured, permanent vehicle for philanthropy, enabling donors to create a lasting charitable legacy while enjoying significant tax benefits.

Foundation vs. Donor-Advised Fund

Before establishing a private foundation, it's important to understand how it compares to donor-advised funds (DAFs), which are simpler charitable giving vehicles:

• Control: Foundations give you complete control over investments, grantmaking, and operations. DAFs give the sponsoring charity legal control, though they typically follow your recommendations. Foundations can employ family members; DAFs cannot.
• Privacy: Foundation grants and Form 990-PF filings are public information. DAF grants can remain anonymous if desired.
• Cost and Complexity: Foundations cost $5,000-$20,000 to establish and $5,000-$15,000 annually to maintain (legal, accounting, tax prep). DAFs typically charge 0.6-2% annually with no setup costs.
• Tax Deductions: Foundations allow deductions up to 30% of AGI for cash and 20% for appreciated assets. DAFs allow deductions up to 60% of AGI for cash and 30% for appreciated assets—higher limits.
• Minimum Size: Foundations should typically have $1-5 million to justify costs. DAFs can be opened with as little as $5,000-$25,000.
• Distribution Requirements: Foundations must distribute at least 5% of assets annually. DAFs have no minimum distribution requirement.
• Permanence and Legacy: Foundations can exist in perpetuity with your name, visible to the public. DAFs are accounts within larger charities and may not provide the same legacy recognition.

Generally, if you have less than $1-2 million to contribute, want simplicity, or prefer privacy, a DAF is more cost-effective. If you want complete control, family employment, public recognition, and have substantial assets, a foundation makes sense.

IRS Requirements and Compliance

Private foundations face extensive IRS regulations and must comply with strict rules to maintain tax-exempt status:

• Form 1023 Application: Detailed application for 501(c)(3) status (can be 50+ pages) demonstrating charitable purpose, governance structure, and compliance with IRS requirements. Process typically takes 6-12 months.
• Annual Form 990-PF: Complex annual return disclosing assets, grants, salaries, investments, and compliance with regulations. This is public information available on sites like GuideStar.
• Excise Tax on Investment Income: Foundations pay 1-2% excise tax on net investment income (interest, dividends, capital gains).
• Prohibited Transactions: Cannot engage in self-dealing (transactions benefiting foundation insiders), excess business holdings, jeopardizing investments, taxable expenditures, or lobbying beyond minimal limits.
• Grant Approval Process: Must exercise "expenditure responsibility" when making grants to non-public charities or individuals, documenting that funds are used for charitable purposes.
• Board Requirements: Must have a board of directors (typically 3+ members) with regular meetings, documented minutes, and conflict of interest policies.

Non-compliance can result in excise taxes, penalties, or loss of tax-exempt status. Our ongoing compliance services ensure your foundation meets all requirements.

Excise Taxes and Distribution Requirements

Private foundations are subject to several unique tax rules:

• Minimum Distribution Requirement: Foundations must distribute approximately 5% of average net investment assets annually for charitable purposes. This includes grants to charities, reasonable administrative expenses, and program-related investments. Failure to meet this requirement triggers a 30% excise tax on the shortfall (increasing to 100% if not corrected).
• Excise Tax on Investment Income: Foundations pay 1.39% excise tax on net investment income (2% if distributions are less than historical averages). This applies to interest, dividends, capital gains, and rents. The tax is paid from foundation assets, not added to distributions.
• Self-Dealing Excise Taxes: Transactions between the foundation and "disqualified persons" (substantial contributors, board members, officers, family members) can trigger excise taxes of 10% for the disqualified person and 5% for foundation managers who participate, increasing to 200% and 50% if not corrected.
• Excess Business Holdings: Foundations generally cannot own more than 20% of a business (including family and disqualified persons' holdings). Excess holdings trigger a 10% excise tax, increasing to 200% if not corrected.

These rules seem complex, but with proper planning and professional guidance, they're manageable. Most family foundations operate successfully within these parameters for decades.

Building Your Foundation's Legacy

Creating a successful, enduring foundation requires strategic planning beyond just legal compliance:

• Mission and Focus: Define your foundation's charitable mission and focus areas. Will you support specific causes (education, healthcare, environment) or remain flexible? A clear mission guides decision-making and creates impact.
• Governance Structure: Design your board composition thoughtfully—family members, independent directors, or both? Plan for generational transition. Will the next generation maintain control or will independent directors gradually take over?
• Grantmaking Strategy: Determine your approach—proactive grantmaking (seeking out organizations), reactive (responding to proposals), or both? Will you fund general operations or specific programs? Local, national, or international focus?
• Investment Policy: Develop an investment strategy balancing growth, income, and risk tolerance. Many foundations aim for 7-8% returns to grow assets while meeting the 5% distribution requirement plus investment expenses.
• Family Engagement: Create opportunities for family members to participate—grant committee involvement, site visits, evaluation responsibilities. This builds philanthropic values across generations.
• Professional Support: Engage qualified professionals—legal counsel for compliance, investment advisors for portfolio management, grant consultants for effective philanthropy, and accountants for tax preparation.
• Sunset vs. Perpetual: Decide whether the foundation will exist in perpetuity or spend down assets within a set timeframe. Each approach has advantages depending on your goals.

We help you address all these strategic considerations, not just legal formation, to ensure your foundation achieves your philanthropic vision and creates lasting impact.