Private Foundations – Advantages and Disadvantages

     Financial advisors should know the advantages and disadvantages of a private foundation in order to best advise their clients about when and why to use one. The following will briefly define what a foundation is and its tax and nontax implications.

     As an IRC §501 (c) (3) charitable organization, a private foundation pays no income or capital gains tax. Additionally, donations to a private foundation are tax-deductible. A private foundation differs from public-charity organization because funding is typically from one family. Hence, it is called a “private” or “private family” foundation.

Tax Advantages

1. Contributions to a private foundation are tax deductible against the income, gift, estate and generation-skipping taxes.
2. Tax deductible donations can be made to individuals and to foreign charities that are not recognized by the IRS through private foundations.

Tax Disadvantages

     Limitations of individual income-tax deductions for gifts to private foundations are 30% of adjusted gross income for gifts of cash and 20% of AIG for gifts of property. On the other hand, the limitations for gifts of cash and property to public charities are 50% of AGI and 30% of AGI, respectively. (Unused deductions may be carried forward up to five years after the gift was made.)

     Donors are limited to tax basis gifts of long-term appreciated property, such as real estate, closely held business interests and tangible personal property, but may deduct the full market value of the gifts of long-term appreciated publicly traded stock (or mutual funds) to private foundations. Donors to public charities face no similar limitations.

     Private foundations must file quarterly excise tax returns and pay excise tax on income and capital gains (2% maximum).

Non-tax Advantages

1. The donor maintains control over charitable distributions unlike other kinds of charitable organizations.
2. Administrative matters and investment management are decided by the foundation board which usually consists of the founders and their family members.
3. A private foundation often has a community presence as a charitable organization. This promotes awareness among the current generation of a family’s past and present generosity. Therefore, the private foundation trains future generations of philanthropists.

Non-tax Disadvantages

1. Relatively expensive to establish and maintain, private foundations are separate legal entities with limitations on the assets they can hold and on the investments they can make. This does not prohibit the use of foundation-owned life insurance as part of the portfolio.
2. Private foundation boards have potential for personal liability and are subject to penalties for distributions or expenses not allowed by law.

     Private foundations are often the charity of choice by charitable individuals because of the combination of control, flexibility and tax advantages.