You may be considering starting a private foundation for several reasons.
Maybe you recently sold a business, have a large, illiquid asset to donate or are contemplating retirement. Perhaps you and your family are ready to invest in social causes you care about.
When the time is right, understanding how to start a foundation and alternative giving options are vital to accomplishing your goals.
What are Private Foundations?
According to the Council on Foundations, “private foundation” is the umbrella term that includes corporate, independent, family and operating foundations. These independent legal entities make grants from their charitable investments, consisting of funds from one source or a small list of sources, such as an individual, family or corporation.
The fund is managed by the foundation’s own appointed trustees or directors.
Like public charities, a private foundation is classified as a tax-exempt 501(c)(3) organization by the IRS. Unlike public charities, however, private foundations do not raise funds or seek financial support from the public.
There are many benefits to starting a private foundation. Private foundations can provide a significant source of funding for charitable causes. They can also allow you to have a significant impact on the causes you and your family care about. Additionally, private foundations can provide a way for you to leave a lasting legacy.
However, there are also some challenges associated with starting a private foundation. For example, private foundations are subject to a number of regulations, which can be complex and time-consuming. Additionally, private foundations must make grants to qualified charitable organizations, which can be a challenge if you have a specific cause in mind.
Setting Up a Private Foundation in 12 Steps
Starting a private foundation generally consists of the following 12 steps:
- Define a philanthropic objective
- Create a mission statement
- Solidify grantmaking guidelines
- Hire a legal team and financial advisors for initial planning and ongoing compliance, recordkeeping 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 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
With many steps involved, starting a foundation can be more complicated than it looks. Beginning at square one requires exhaustive time and resources, not to mention expertise.
Many have found that maintenance costs are prohibitive even though they have managed to get their foundation off the ground. Resources can be quickly and significantly diluted by overhead and red tape, providing fewer funds for grantmaking than initially planned.
Private Foundation Alternative: Donor-Advised Fund
Donor-advised funds can be your private foundation solution.
A donor-advised fund (DAF) is a type of charitable giving account that allows you to make tax-deductible donations to a sponsoring charitable organization. DAFs are often seen as an alternative to private foundations, as they offer many of the same benefits with less administrative burden. Opening a donor-advised fund requires less cost when compared to the startup and ongoing expenses for a foundation.
As a bonus, you can deduct their donor-advised fund gift up to 50% of your Adjusted Gross Income (AGI) compared to 30% of a private foundation gift.
Other benefits involve privacy and peace of mind.
Unlike an IRS foundation, a family foundation through a donor-advised fund is not required to disclose certain financial information, including tax returns. Beyond that, strict and complex legal requirements of a private foundation disappear – no worries about compensation rules, expenses, grant expenditure responsibility, tax filings, or any possibility of inadvertent self-dealing.
When you add up all the benefits, it’s no surprise that many of our funds at San Diego Foundation were originally private foundations before families decided to simplify their lives by moving to a community foundation.
If you are considering starting a private foundation, you may want to consider using a DAF instead. Learn more about how donor-advised funds can be a simpler alternative.