Private foundations provide flexibility for charitable legacy planning, which may make them an appealing option for those able to cover the initial and maintenance costs.
High-net-worth and ultra-high-net-worth individuals interested in building their charitable legacy have an advantage in some respects, but they may also face some unique challenges, such as higher taxes and expectations of heirs. One option that may help address these challenges is a private foundation.
What is a Private Foundation?
A private foundation is a 501(c)(3) nonprofit organization that isn’t a public charity. Private foundations may be set up by individuals, families, or companies and the setup has traditionally required a sizable initial donation.
While most options for charitable legacy givers are accounts, such as Donor Advised Funds (DAFs), a private foundation is its own distinct legal entity controlled by the founder and a board of directors, and the foundation can hire family or board members as employees.
Private foundations are not for everyone. In fact, for the vast majority of charitable legacy builders, I am an advocate of DAFs as an optimal vehicle, given its relatively low cost, low administrative burden, and high charitable income tax deduction limits. However, there are some high net worth charitable legacy builders for whom a private foundation might be a good option to consider.
What about a Donor Advised Fund?
In contrast, a DAF is essentially an account held by a sponsoring charitable entity in the donor’s name. The donor has advisory rights to give direction to the charitable giving process, but ultimately, the legal authority rests with the sponsoring entity. Now, the sponsor is going to honor your wishes if they want to keep your business, but in theory they could override your directions.
And especially if you die without a successor advisor in place, then they essentially control the funds, and I’ve learned in conversations with some nonprofit executives that many of these DAF sponsors drag their feet in disbursing donated funds, especially if the donor passes away without naming a successor advisor (because the sponsors get paid on assets in the DAF but not once the assets are disbursed – follow the money!) This means there is a slim by non-trivial risk that funds donated to a DAF could start to get away from the charitable causes you intended them for.
Private Foundation Giving and Funding Choices
A private foundation may only fund charitable causes, but you have flexibility in the type of charitable beneficiaries. Of course, your private foundation could provide grants to 501(c)(3) public charities, but it could also provide grants to other foundations or individuals in need, or even to fund specific scholarship programs. Again, your private foundation is dedicated to charitable purposes, but the definition of a charitable purpose comes with more leeway than some other forms of giving, such as DAFs, which can usually only donate to 501(c)(3) public charities.
You also have flexibility in terms of how you choose to fund your private foundation. Of course, funding it with cash and securities is an option, but you can also include tangible assets, such as art, buildings, or land. Additionally, you may have the ability to donate partial or complete business interests through a private foundation, though there are certain limitations surrounding business holdings. Again, this gives you far more flexibility than most other options, such as a DAF, which typically only allows funding through cash and securities.
Tax Considerations of a Private Foundation
No one wants to pay more in taxes than they have to, but for those of us building a charitable legacy, every dollar we pay in taxes is one less dollar we have the ability to put towards charitable giving. Keeping this in mind, one caveat with a private foundation is the tax deduction limits and excise taxes on investment income.
With a private foundation, the tax deduction limit is only 30% of AGI for cash as opposed to 60% for a DAF. If you’re planning on gifting less than 30% of your annual income, this shouldn’t be an issue, but if you’re planning to donate more, it’s possible that you’ll miss out on some potential tax savings. For appreciated securities, such as stocks or bonds, as well as privately held assets, such as real estate, the tax deduction limit for a private foundation is 20% of AGI as opposed to 30% of AGI for DAFs. Additionally, the IRS imposes an excise tax on the investment income of a private foundation, which typically falls between 1% and 2%.
Advantages of a Private Foundation
As we’ve seen, the major advantage proffered by a foundation is the higher level of control it gives donors over the charitable giving process, but this is not its only potential advantage.
Some argue private foundations are more conducive to bringing together a group of people, such as a family, around a common charitable goal. However, I would contend that this is not an advantage limited to private foundations. For example, as long as a DAF sponsoring entity allows the ability to name successor advisors (someone who receives advisory rights to the DAF in the event of your death), and many do, this provides the jumping off point to begin engaging children and grandchildren around the charitable vision and setting the expectation that the wealth stewardship and philanthropic responsibilities will eventually rest with them.
In other words, private foundations often bring together a group of people around a charitable goal, but there is no reason this cannot also be achieved through other charitable giving vehicles; whether you’re using a foundation, a DAF, or some other giving vehicle, you must be intentional about engaging and communicating with heirs, successor trustees, etc. if you want to ensure your charitable vision does not die out with you.
Communication is Key
Especially for those of us with charitable legacy goals, it’s easy to assume that everyone has the same goals or expectations that we do, but miscommunication is shockingly easy regardless of your net worth, though high-net-worth individuals may struggle with the unique expectations of future generations.
For example, if you say you want to leave “a lot” of your estate to charitable causes does this mean 10%, 50%, or all of it? The answer is, of course, entirely up to you, but if you think a lot means your entire estate and your heirs think it means closer to 10%, it’s likely that issues will arise later on.
Especially for high-net-worth individuals, if you want your charitable legacy to be sustainable through generations, it is critical to communicate openly and intentionally with family to ensure the charitable vision doesn’t die with you. Best practices involve meeting regularly as a family, particularly at year-end, to review the various charitable organizations the family members are passionate about, and then allocating the charitable gifts accordingly.
Potential Drawbacks of a Private Foundation
The biggest disadvantage of a private foundation is typically the additional time and money required to create and maintain it.
Creating a private foundation often takes weeks or longer. It also comes with substantial legal fees, as well as other start-up fees. Also, you traditionally needed to have an initial funding amount of several million dollars to make it worth establishing a private foundation, but better technology and processes to streamline ongoing administration of a foundation has dramatically lowered this hurdle. The costs that come with maintaining a private foundation are also usually comparatively high, although it can be much lower depending on how much of the ongoing administration you are willing to do yourself.
Though the creation and maintenance of private foundations may be cumbersome and costly, for some their increased flexibility may far outweigh these concerns.
If you are interested in exploring charitable giving vehicles and need some assistance along the way, please schedule a free consultation to discuss by clicking the “Free Consultation” button in the navigation bar.