We have discussed Donor-Advised Funds (DAF) on a couple of occasions and also discussed the charitable trust. However, we have not delved deeply into the private foundation, which may be the best known of all philanthropic vehicles available to donors.
The private foundation works like the charitable trust or the donor-advised fund in that the donor contributes money into the private foundation, takes the charitable contribution deduction in the year that this donation is made, and then can make contributions to charities anytime after that — even years later. Each of these philanthropic entities provides a donor with immediate tax advantages, while delaying the contribution to operating charities until sometime later, presumably when the donor has more time to decide where to donate.
The private foundation has some significant differences from the other two philanthropic vehicles and is subject to additional rules and regulations, some of which are quite easy to unintentionally break.
A private foundation is a legal entity that is controlled by the donor or founder of the foundation. It is different from a donor-advised fund because the fund’s assets remain under the control of the founder and are not given to a separate entity — the DAF. As with a DAF, the funds eventually are donated to a charity for their use in achieving their charitable mission. For some people, maintaining control over the assets until the point in time when they are donated to the ultimate recipient charity is an important consideration.
In the private foundation, the founder gets to choose how the money is invested and who has custody of the funds. A private foundation can own almost any type of asset including partnership interests, real estate, jewelry, art, etc. In addition, there is no other entity that must approve of the founder’s “recommendation” for the ultimate charitable contribution.
Private foundations are more difficult to manage than a DAF because there is no DAF sponsor that is taking on management responsibility. However, there are third-party entities that will assume the management responsibility of a private foundation and their cost can be paid out of the private foundation’s assets. Once upon a time, these third-party management organizations had a fairly high asset floor — as much as $5 million— before they would become involved with a private foundation. Now, with the advent of more and more automated management tools and computerization, many third-party management organizations are willing to take on private foundations with as little as $250,000 in invested assets.
Another advantage of the private foundation is that it can reimburse anyone (even the founder or family members) for their expenses in carrying out the foundation’s activities. Foundation staff can be compensated and these staff can also be family members.
One important rule in regard to private foundations is that they are required to annually pay out five percent of their assets. This may be a downside for donors who don't yet know where they may want to make grants.
A private foundation can have more interaction with the recipient charities that receive funding than can the DAF donor. Since the private foundation is making the donation, they can enter into agreements with the grantees setting forth the purpose, terms, and conditions of the grant with subsequent monitoring and benchmarks of progress that must be monitored and met. Doing this with a DAF is significantly more difficult.
One key point to understand about a private foundation is that it is usually established by a single donor. This is primarily why it is referred to as a “private” foundation — versus, for example, the community foundation that solicits and accepts donations from everyone. It is important to recognize that the word “foundation” is not descriptive of the tax-status of the legal entity. For example, the Silicon Valley Community Foundation and the Hewlett Foundation both use the word “foundation” in their name, but the SVCF is a public charity while the Hewlett Foundation is a private foundation in the eyes of the IRS and the state in which they are incorporated.
All charitable entities have compliance obligations with the state in which they are formed and operate. One of the compliance obligations of charitable entities is to register with the state when the charity is engaged in fund raising activities. This registration process is usually part of the state’s consumer protection laws designed to prevent citizens from giving to bogus organizations posing as charities.
Sometimes the founder of a private foundation has the opportunity to receive donations into his or her private foundation from others. Someone may be attracted to the work that the private foundation is doing and want to contribute to that effort. The charitable solicitation laws that require charities state registration usually require registration when the charity is soliciting or receiving donations from the public.
A private foundation usually is exempt from state charitable solicitation registration because funds are flowing into the foundation only from the founder and not the public in general. The public is also not being solicited for donations. However, such a foundation can easily go afoul of the charitable solicitation registration law once it starts to accept donations from others, even if those donations were never solicited!
During the past presidential campaign, much was written about the foundation activities of each candidate. Running afoul of the New York charitable solicitation registration law is one charge leveled against the Donald J. Trump Foundation that appears to be accurate. President-elect Trump noted that many people donated to his foundation for a variety of reasons, but he did not realize that even though he may not have solicited those contributions, these transactions triggered the New York charitable solicitation registration requirement.
You can see how complex the law is regarding private foundations. These can be very useful philanthropic vehicles for donors. However, it is in your best interest to obtain the very best professional assistance if you establish such an entity for your charitable giving.