You may be considering starting a private foundation for a number of 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 private foundation and create alternative giving vehicles to accomplish your goals are vital to your decisionmaking process.
What Are Private Foundations?
The first step is understanding what a private foundation is.
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, which consist of funds coming 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.
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 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
With many steps involved, starting a private foundation can be harder than it looks. Beginning at square one requires exhaustive time and resources, not to mention expertise.
Many have found that even though they have managed to get their private foundation off the ground, maintenance costs are prohibitive. Resources can be quickly and significantly diluted by overhead and red tape, providing less funds for grantmaking than initially planned.
Private Foundation Solution: Donor-Advised Fund
Donor-advised funds can be your private foundation solution.
These giving vehicles provide the benefits of a private foundation without the administrative burden, including the ability to determine exactly how your individual program is structured. Opening a donor-advised fund requires less cost when compared to the startup and ongoing expenses for a private foundation.
As an added bonus, donors can deduct their donor-advised fund gift up to 50 percent of their Adjusted Gross Income (AGI) compared to 30 percent of a private foundation gift.
Other benefits involve privacy and peace of mind.
Unlike an IRS private 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 The San Diego Foundation were originally private foundations before families decided to simplify their lives by moving to a community foundation.
Private foundations are powerful giving vehicles, but they may not be the best fit to accomplish your goals. Learn more about how donor-advised funds can be a simpler alternative.