How do I start a Private Foundation?
How do I start a private foundation?
Private foundations are charitable organizations generally created and funded by a limited donor base (usually an individual person and/or their family).
In theory, private foundations seem like a great way to give back to society and champion causes that you care about. However, in practice, there seems to be better alternatives to accomplish the same objectives in a more time and cost efficient manner.
But, for the sake of clarity, I thought it would be helpful to give you a roadmap as to what it would take for you to start a private foundation and how a private foundation compares to donor advised funds (which are sometimes labeled as “foundations”) and how private foundations compare to public charities.
Twelve steps to start a private foundation:
Define a philanthropic objective
Create a mission statement
Solidify grant making guidelines
Hire a legal team and financial advisors for initial planning and ongoing compliance, record keeping and tax returns
Establish a board structure and appoint board members or trustees
Consider your personal time investment vs. hiring a staff to manage your foundation
Determine if your foundation should cease or continue after your lifespan
Form your foundation as either a trust or corporation under state law
Apply for an employer identification number (EIN)
Apply to the Internal Revenue Service (IRS) for recognition as a tax-exempt 501(c)(3) charity and to receive tax-deductible contributions
File any additional required paperwork to obtain tax-exempt status from your state
Follow IRS private foundation guidelines, including:
Make grants worth at least 5 percent of your foundation’s investment assets each year
Must provide grants only to other nonprofits or for educational scholarships
Must pay up top a 2 percent excise tax on your foundation’s investment assets
If you are reading this list and thinking to yourself, “this seems like a lot of work, but I’m still interested” then you may want to consider hiring a third-party to handle all the boring stuff.
For example, there is a company called Foundation Source that handles the process of setting up a foundation so you can focus your time on fulfilling your intentions rather than spending your time filling out IRS forms.
Here’s an excerpt from their website to give you an idea of what they do for you:
Creation of a Delaware non-stock corporation
Certificate of Good Standing from the state of Delaware
Bylaws and essential governance policies/guidelines for a private foundation
Services of a registered agent in Delaware for the corporate entity
Completed Application for Employer Identification Number (Form SS-4)
Completed Tax Information Authorization (Form 8821)
Completed Application for Recognition of Exemption (Form 1023)
Filing of all signed forms returned to us
Tracking of Form 1023 while pending with the IRS
Handling of any routine inquiries from the IRS regarding Form 1023
After your foundation is set up, [foundation source] provide comprehensive services to keep it running smoothly. [They] take care of all the back-office tasks, including grant and expense processing, tax preparation and filing, transaction monitoring for potential compliance
It’s also important to note that your CPA may also offer this service in-house or may be affiliated with someone who specializes in this, so if you have a local contact then I’d start there first.
Why would I do a private foundation instead of a donor advised fund?
The primary difference between a donor advised fund and a private foundation are flexibility and control.
For example, with a private foundation you can:
Hire staff (although that may be the exact opposite of what you want to do)
Reimburse expenses
Set up structured giving such as scholarships
May make grants to specific individuals (in limited circumstances)
Can contribute assets that otherwise cannot be contributed to donor advised fund (for example, restricted stock)
Have more investment options
However, unlike donor advised funds, private foundations do have a minimum distribution requirement of 5% (with some exceptions), whereas a donor advised fund does not have an annual minimum distribution requirement.
Private foundations also have an excise tax of 1.39% on net investment income and have a lower limit on percent of adjusted gross income (AGI) that a person can deduct in a given year for income tax purposes. In other words, your charitable deduction may be more limited under a private foundation than it would be under a donor advised fund.
So, unless you have millions to donate and/or would like to build an organization from the ground up, it seems like donor advised funds are the more practical choice for most donors.
Why would I do a private foundation instead of a public charity?
But let’s say you are on the other side of the spectrum - you have millions in the bank and have a lot of wealthy friends who are happy to support your charitable inclinations - in that case you may be deciding between doing a public charity or a private foundation (since you can easily afford/finance the administrative costs).
In that case, the determining factor will once again be your preference for control and flexibility, but for different reasons. Unlike private foundations, public charities have two important prerequisites.
You’ll need a diverse board of directors. Public charities generally require a diverse board of directors. In other words, if you and your family or other affiliated entities hold more than 50% of the board seats, then you are stuck.
You’ll need public funding. Public charities also require substantial financial support of the “public” as the name implies. In legal terms, this means that at least 33% of the funding must come from small donors (those who represent less than 2% of the charity’s income), or from other public charities / the government.
The required diversity in control and wide donor base of public charities makes public charities much harder to start than a private foundation. These additional obstacles are why many who fall within the category of having a limited donor base and small circle of friends may have to resort to private foundations as the only reasonable solution.
Other Frequently asked questions about private foundations:
Can a private foundation receive donations?
Yes, but you must be careful in doing so because state regulations vary on soliciting donations (translation: more forms for you to fill out), plus disqualified persons have a higher level of scrutiny to ensure there is no self-dealing (a common temptation among founders private foundations).
Are there restrictions on who private foundations can donate to?
Private foundations are generally set up to make grants to other public charities, however, there are certain hardship exceptions that allow a private foundation to also make donations to individuals in limited circumstances.
How much should I have before starting a private foundation?
The old rule of thumb was $5 million, but now, thanks to technology and specialized services, that amount is closer to $1 million if you are a highly motivated individual.
If you are under that threshold, then you may want to consider a charitable trust or donor advised fund (the latter being the most simple and convenient option).
How does this tie into my estate planning?
While many clients consider giving most, if not all, of their wealth to their children and/or grandchildren, charitable giving can be a rewarding experience for both you and your family.
If you’d like to discuss how charitable giving may play a role in your estate planning, then give me a call at 781 202 6368, email jlento@perennialtrust.com, or click here to schedule your free personal consultation.
I’m always happy to help,
Joseph M. Lento, J.D.
Your Local Estate Planning Attorney
www.PerennialEstatePlanning.com
477 Main Street
Stoneham, MA 02180
