By Israel Tannenbaum
One of the most effective ways clients can make a positive impact on the world is through charitable giving.
While giving can take many forms, private foundations have taken on a key role, with approximately 15 percent of all charitable gifts (about $60 billion) coming from such foundations in 2016, according to Charity Navigator. Use of this giving vehicle has continued to expand to include families of moderate wealth, in addition to more traditional foundation backers, such as corporations and very affluent individuals.
The primary distinction between a private foundation and a public charity is the source from which they derive their financial support. While a public charity gets its funding from the general public, a private foundation usually has one source of funding, typically an individual, family, or corporation.
It’s important to note that the term “foundation” is often used interchangeably to describe many different types of nonprofits, not all of which are private foundations. A private foundation is its own distinct classification of charitable entity. Additionally, while there are different types of private foundations, such as private operating foundations (which generally run their own programs and are comparable to public charities), for purposes of this discussion we will focus on traditional private non-operating/grant-making foundations.
Here are some of the key tax advantages that charitable giving through a private foundation can offer:
1. Tax Deductions
Contributions to private foundations are generally tax deductible by the donor. The amount that will ultimately be deductible is determined by the donor’s adjusted gross income and the types of property contributed.
For cash contributions, the deductible amount is limited to 30 percent of the donor’s adjusted gross income, whereas contributions of capital gain property, including gifts of appreciated stock, are generally deductible to the extent of 20 percent of adjusted gross income. Any unused amounts can be carried forward for five years to offset future taxable income.
2. Tax Savings
Private foundations are exempt from federal income tax because they are charitable, section 501(c)(3), organizations.
As such, donors can receive a double benefit. In addition to receiving a deduction for a contribution to the foundation, they can further reduce their taxable income through the donation of appreciated property, as no capital gain is realized when appreciated property is donated to a foundation and the deduction is based on the fair market value, as long as the property was held more than one year prior to the contribution; if held for less than one year, the deduction will be limited to the donors cost basis.
In addition, assets transferred to foundations are generally not subject to estate taxes, which may provide an additional level of tax savings.
3. Timing of Taxes
Donations to a private foundation are deductible the year in which they’re contributed. This is quite significant, as individuals who have decided to contribute to philanthropic causes, but have not yet determined the organizations they would like to support, can lock in their deduction for the current tax year by contributing to their foundation. This allows for a tax deduction to be received up front, while the actual charitable gift payout can be executed at a later date.
Donors can act as foundation trustees, remaining in control of the investment and the management of donated funds, as well as the final disposition of the gifts.
Furthermore, instead of making a gift directly to a public charity (at which point you no longer control how it’s distributed), you can actively monitor your favorite charities. If a supported organization changes its mission, or if a more meaningful cause is discovered, you can reallocate your foundation’s support appropriately.
5. Legacy and Family
Many individuals find it important to encourage family involvement in charitable giving.
Because foundations are their own separate legal entities, by establishing a foundation, the donor’s charitable legacy continues and will be associated with the foundation's charitable activities in perpetuity or for as long as the foundations assets are maintained.
A private foundation also provides an opportunity for multiple generations to work together on a meaningful endeavor. Family members can participate in implementing the charitable objectives, thereby continuing their engagement with the community. Family members may even receive reasonable compensation for their services, as well as serve on the board of directors.
Individuals may not claim charitable deductions for grants made to other individuals, foreign nonprofit organizations, or non-charitable organizations. However, an individual may achieve these expanded giving objectives by first making tax-deductible donations to a foundation, which may in turn make such grants, subject to specific Internal Revenue Service requirements.
A Word of Caution
While private foundations do offer many advantages, it’s also important to note that such organizations are subject to strict IRS rules, and that violation of those rules can result in severe excise taxes meant to curtail the risk of abuse. This is necessary because control of foundations usually rests with interested parties rather than an independent board, which makes abuse easier. Additionally, foundations are required to pay an annual 1 percent or 2 percent excise tax on their net investment income, depending on the value of their assets and the amount distributed to charities each year.
Private foundations also have additional compliance requirements; most significantly, they must generally make annual qualifying distributions of an amount based on a minimum investment return of 5 percent of average assets.
Furthermore, private foundations are required to file annual information returns with the IRS using Form 990-PF. This form requires comprehensive reporting of the foundation’s operations, so it’s important that detailed books and records are kept throughout the year of contributions, disbursements, expenses, sales of assets, capital gains and other comparable items. If a foundation has over $1,000 in unrelated business income in a specific year, it must also file a Form 990-T.
A private foundation is also required to file a copy of its 990-PF with the state in which it maintains its principal office. Many states also require private foundations to register and file annual reports with the state attorney general. The state rules can be complex, and each state has its own requirements, so it’s important to do an analysis of the foundation’s nexus and related state rules.
It is critical to understand the rules and regulations associated with these entities to ensure that your clients’ good deeds go unpunished.
Israel Tannenbaum is a senior manager in the Private Client Services practice at Mazars USA, a top-25 global accounting firm.