Is a Private Foundation Right for You?

I love using Paul Newman’s spaghetti sauce—in part, because I know the profits go to their private foundation where they give to charitable causes.^[1] The foundation has donated over $600 million since its founding in 1982.

Private foundations are tax-exempt organizations created by an individual, family, or corporation. Their purpose is simple: to manage and distribute charitable funds. Now, they get a bad rap sometimes. That’s because some think they’re used to skirt tax codes or for dynasty families to take advantage of tax rules. What people don’t realize is that private foundations must abide by strict IRS regulations—but we’ll get to that in a minute.

Having your own foundation is a meaningful way to further causes you feel strongly about. It’s also a strategic tax strategy if you have substantial wealth and a strong, long-term commitment to philanthropy. But is a private foundation right for you? Let’s look at pros and cons.

Pros

• Tax advantages. If you’re a high-net-worth individual, having a private foundation is a perfect vehicle to manage your wealth in a tax efficient way. When you give to your private foundation, you get immediate tax deductions in the year you give. Keep in mind that for tax purposes, you’re limited to giving 20-60% of your income.^[2]
• Control over charitable giving. Private foundations offer more giving opportunities than giving directly to charity. This is because when you give directly to a charity, you typically lose 100% control over the funds. But by setting up a private foundation, you can take your time investing the foundation’s funds and approving grants and charitable causes that you align with. This is a huge advantage.
• Flexibility. When you donate to a family foundation, you open a world of possibilities. Foundations accumulate funds and then give you the choice about when and how to distribute them. Instead of giving in spurts, you can give a consistent flow of funds to your favorite ministries or nonprofits. (However, you can’t claim any charitable deductions for grants made to individuals, foreign nonprofit organizations, or non-charitable organizations.)
• Legacy preservation. Maybe you have a burning desire for a cause to support in perpetuity once you’re gone, but you don’t want to burden your entire estate and trust documents with this charitable purpose. A private foundation can fulfill your vision and impact generations to come.
• Compensate family and friends: I say this carefully because of recent bad press and IRS scrutiny, but you’re allowed to pay reasonable compensation to family members and others who provide administrative work to the foundation. Your family foundation can cover reasonable costs like site visits and board meetings for family members, employees, and trustees. But be careful! This is a critical place to take extra time to ensure you’re in compliance with IRS

Cons

Now, no tax strategy is perfect. Here are some disadvantages to weigh the scales fairly:

• Complex Regulations. Private foundations require expert guidance and must adhere to intricate regulations during set up and maintenance. You can expect to work closely with financial advisors and CPAs to manage the complexities involved.
• Cost. You’ll need to be willing and positioned to dedicate six figures annually or large, seven-figure sums every few years to ensure its success. Most people assume they want to start a foundation, but after further research, they quickly backtrack because of the set up expenses that mount from legal, accounting, and financial advice standpoint along with other operations expenses.
• Administrative responsibilities. You’ll have to give an accounting to the IRS. Depending on the state you live in, you may be required to have an audit. Also, if you expect to have the foundation in perpetuity, you may want a regular audit to occur too. Audits aren’t cheap. But it’s essential that your private foundation stays in compliance with the IRS so you don’t lose any tax deductions and then owe the taxes, penalties, and interest for your voided tax deduction.
• Minimum distribution requirements. To remain in compliance with IRS code, a private foundation can’t hoard its assets. It must distribute 5% or more of its assets per year to remain in compliance. This ensures the foundation has charitable intent.
• Reduced anonymity. Private foundations must disclose their grants—and their activities are shared with the general public. This reduces the privacy that many donors are seeking. I don’t know about you, but I already get a lot of mail pleading for additional donations. It can be exhaustive going through the mail even after we say we’re giving anonymously.

Summary

Galatians 6:10 says, “So then, as we have opportunity, let us do good to everyone, and e\specially to those who are of the household of faith.”

Private foundations can be a powerful tool for high-net-worth individuals seeking to leave a lasting charitable impact while receiving tax benefits. Many families have come to me seeking to set up a private foundation only to decide they would be better off with a Donor Advised Fund, which provides similar tax deductions plus the added advantage of anonymity. If you’re interested in exploring either of these options further, meet with your financial advisor and CPA.

[1] https://newmansown.com/mission/#:~:text=Fighting%20for%20kids%20since%201982,to%20good%20causes%20since%201982.

[2] https://www.irs.gov/charities-non-profits/charitable-organizations/charitable-contribution-deductions