Starting a Private Foundation

Foundations with names like Gates and Buffett attached to them may grab the headlines, but the ones run by the “little guys” actually fund much of the boots-on-the-ground work that makes a difference in local communities.

Some 98 percent of the nearly 97,000 private foundations in the U.S. have assets under $50 million, and 60 percent have $1 million or less. Given that the number of foundations has tripled since 1990, more funders regard them as an integral component of their philanthropic strategy.

There are typically four main characteristics of a private foundation (for purposes of this discussion it excludes private operating foundations that run their own programs and services):

1)    It is a charitable organization recognized under federal tax regulations.

2)    It is initially funded from one source, such an individual, family, or business.

3)    Its assets—called an endowment—are invested to generate income to sustain the foundation.

4)    In most cases, it makes grants to other charitable organizations, rather than operating its own program or charity.

Foundations are a great way for a family to build a legacy and bond over a common cause. They can lend a certain level of prestige and gravitas that enable philanthropists to be noticed more readily. They also:

  • Allow donors to retain control over their gifts and charitable investments
  • Provide an immediate tax deduction when funds are placed in foundation accounts
  • Enable donors to fully deduct bequests to a foundation for estate tax purposes

As you would expect, however, starting a foundation entails a lot more than printing some letterhead and throwing up a website. Foundations must:

  • Be recognized as a charity under 501 (c)(3), the part of the IRS code that defines nonprofit entities. That includes filing a mission statement that outlines the purpose of the foundation and how it will be organized and run.
  • Spend at least 5 percent of their net investment assets on qualified grants and administrative expenses, which are carefully defined by the IRS. Experts say 60 percent of foundations typically give more than the required minimum.
  • Make grants only to other nonprofits, in most circumstances.
  • Pay up to a 2 percent excise tax on assets. However, contributions to the foundation can be claimed as a tax deduction, though it is limited to 30 percent of a donor’s adjusted gross income, compared to 50 percent for cash gifts to a public charity.
  • Incorporate with a state, establish by-laws, and appoint a board of directors.

Preparing such documents should not be attempted without the help of an estate-planning attorney or experienced accountant, who can also guide you through other important rules foundations must follow, such as not engaging in political activities or using the foundation to advance business purposes.

The IRS application—Form 1023—to be granted tax-exempt status is, to put it charitably, especially comprehensive. A professional can also help you decide whether to operate as a private foundation or a charitable trust, which is simpler to create but offers less flexibility in how it is operated (see accompanying article). Alternatively, you can use a company like Foundation Source, which provides outsourced management and advisory services for foundations.

The rules may be numerous and, at times, onerous, but so long as you follow them, a foundation can be a tremendously satisfying and enjoyable way for families to shape a philanthropic vision—and have something in common with Bill Gates and Warren Buffett.

ADDITIONAL RESOURCES

The Chronicle of Philanthropy provides a Grant Seeker's Guide to Understanding Foundations. (Although the title implies it is geared toward grant seekers, the material is adapted from a book about foundations, giving, and compliance, geared towards funders.)

Foundation Center, provides online tutorial with basic information about foundations.

Learn Foundation Law: an online tutorial.

Toolkit: Create a Private Foundation, from Minnesota Council on Foundations

Article: Creating a Family Foundation, provides more details on legal aspects of a foundation.

Chart: Foundations vs. Donor-Advised Funds: a side-by-side comparison from Foundation Source that outlines the advantages and disadvantages of both.

Foundation Knowledge Base, from GrantSpace; also provides links to websites, books, and articles.

Article: Small U.S. Foundations Break Through 5% Rule, Philanthropy Management magazine

Executive Summary: Key Facts on U.S. Foundations, 2014, Foundation Center