An overview of private foundations (non-operating) for the financial advisor, planned giving officer, or philanthropist interested in learning about the legal and tax structure.
7. Psychology’s “terror management theory”
suggests a defense to mortality reminders
is to create symbolic immortality (one’s
name, impact, story will live on)
8. Dead
• Josiah K. Lilly (1948)
• Edsel Ford (1943)
• Robert Wood
Johnson II (1968)
• W.K. Kellog (1951)
• Andrew W. Mellon
(1937)
• John D. Rockefeller
(1937)
Alive
• Lilly Endowment
• Ford Foundation
• Robert Wood Johnson
Foundation
• W.K. Kellog Foundation
• Andrew W. Mellon
Foundation
• The Rockefeller
Foundation
9. The rules of a private foundation
can be permanent
This differs from leaving
an inheritance or
company where later
generations make all rules
10. A private foundation allows donor and
descendents to control the foundation
assets and charitable payouts indefinitely
12. Three types of charitable organizations
Public charity
Supporting organization
Private foundation
13. Public Charity
• Publicly supported
OR
• Operates ongoing
traditional
charitable activity
(e.g., hospital,
church, school)
Private Foundation
• Default if charity
not a public
charity or
supporting
organization
14. Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
charitable
activity
• Expenditures
funded by
investment
income
15. Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
charitable
activity
• Expenditures
funded by
investment
income
Traditional charity
(e.g., operates church, hospital,
school)
16. Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
charitable
activity
• Expenditures
funded by
investment
income
Publicly-
supported
charity
Atleast1/3of
totalsupport1
fromsmall
donors2
1Includesgiftsandinvestmentincomeoverlast4years.Largeunusualgiftsfromoutsiderscanbe
excluded. 2Giftsfromthosegiving≤2%oftotal supportandanysupportfromgovernment
17. At least 1/10 of
total support1
from small donors2
Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
charitable
activity
• Expenditures
funded by
investment
income
operated to
attract new
public or
government
support
Smells like public
charity
“facts and
circumstances”
that it is a
public charity
1Includesgiftsandinvestmentincomeoverlast4years.Largeunusualgiftsfromoutsiderscanbe
excluded. 2Giftsfromthosegiving≤2%oftotal supportandanysupportfromgovernment
18. Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
charitable
activity
• Expenditures
funded by
investment
income
Atleast1/3oftotalsupport1
from
memberships+charitable
operations+smalldonors2
No more than 1/3 of total
support1
from investment income
1 Includesgiftsandinvestmentincome.Largeunusualgiftsfrom
outsiderscanbeexcluded 2Includessupportfromgovernment
Public charity by
receipts
19. or Charitable Trust
Under state
law create a…
Obtain federal tax
exempt status Initial Application
1023
Annual filing
990-PF
Create a Private Foundation
Flexible; lower
UBIT rates
More founder control;
foreign operations
eliminate deductibility
for corporate donors
Nonprofit
Corporation
1.
2.
20. Private foundations can be large,
but most aren’t
26%
39%
28%
4% 3%
Asset Size: Non-Operating Private Foundations
$1 under $100,000
$100,000 under $1MM
$1MM under $10MM
$10MM under $25MM
$25MM or more
Source: IRS Statistics of Income for 2010. Domestic Private Foundations: Number and Selected Financial Data, by Type of Foundation and Size of End-of-year Fair Market. Excluding those not reporting any assets
21. Foundation board
• Often the donor and close family members
• Can establish rules for succession
– Descendents who meet certain criteria
– Unequal voting rights allowable
– Junior board for minors advising on small gifts
23. Tax on net
investment income
• 2% tax on net
investment income
• Drops to 1% If
charitable grants ≥
assets X (avg. % payout
in the last five years) +
1% of net investment
income
24. Gifts to private foundations also have
lower income-based deductibility limits
25. Current Value: $25
1990 Paid $1
Long-term capital gain
(special election)
Tangible personal
property
(“unrelated” use)
CashOrdinary
income
property
Inventory Short-term
capital gain Public
Charity
Public
Charity
26. Current Value: $25
1990 Paid $1
Long-term capital gain
(no special election)
Tangible personal
property
(“related” use)
CashOrdinary
income
property
Inventory Short-term
capital gain
Public
Charity
Private Foundation
(non-operating)
27. Current Value: $25
1990 Paid $1
Long-term capital gain
(any)
Tangible personal property
(“related” or “unrelated” use)
Current Value: $25
1990 Paid $1
Private Foundation
(non-operating)
Private Foundation
(non-operating)
29. • Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
30. IRS punishments for
transactions that
break the rules
include:
• Initial tax (10%-
30%)
• Additional tax if
transaction not
corrected (25%-
200%)
• Revoking
exemption
31. Who is an insider (A.K.A.
a “disqualified person”)?
Insider Benefits Charitable Purposes
32. Insider or “Disqualified Person”
• Officer, director, trustee, or any employee with
responsibility for the act
• Ancestor, spouse,
descendent, or spouse
of descendent of above
• Corporation, trust, or
partnership owned 35%
or more by above
• Substantial contributor
>2% of all
contributions from
foundation start
to end of tax year
(+>5K total
contributions)
Grantors of a
charitable trust
automatically qualify
33. • Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
34. Self-Dealing
• Sell, exchange, lease,
transfer or loan money,
goods, services,
property, or facilities to a
disqualified person
• Paying a government
official
36. Bargain sale
Suppose a disqualified person gives a $200,000
property (with a recent $12,000 mortgage) to the
foundation?
(Payment of the insider’s debt is a benefit,
but allowed if debt is 10+ years old)
37. Self-Dealing Penalty
• Disqualified person taxed 10% of transaction (+5% tax
on foundation manager who knowingly participates)
• Must correct in 90 days of IRS notice else disqualified
person taxed 200% (+50% tax on foundation manager)
38. Free gifts to the foundation of
money, property, or use of
money or property are allowed
39. Foundation can hire an insider to perform
necessary professional or managerial
services (called “personal services”) if
compensation is reasonable
• Investment advice
• Legal work
• Accounting/tax services
• Banking
• Administrative assistance
The Council on Foundations’ Foundation Management Report contains compensation information for various positions
40. Reimbursements of reasonable and necessary
expenses such as meals and travel
• Travel to foundation board meetings for board
members (and junior board members who
perform some functions in that role)
• Travel to grantees or potential grantees sites to
investigate current or potential awards
41. Private foundations
allow for unlimited
multi-generational,
nearly tax-free (1%-2%)
control of wealth,
with ongoing ability
to provide insider
travel and
employment for
professional/
management
services, and limiting
charitable activities
to founder’s desires
42. • Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
43. The foundation must
distribute at least 5% of
non-charitable net assets
under its control by the end
of the following tax year
44. Non-charitable net assets excludes
charitable assets and assets not yet
under foundations’ control
No charitable assets:
used for charitable purposes,
such as paintings on loan
to a museum, or office
furniture used to manage the foundation
No assets not yet under foundation’s control:
a right to receive property after death, after
estate administration, or after
payment of a pledge.
47. 5% can be spent on grants
to charity including
designated purpose funds,
but NOT to
• Another non-operating
foundation
• Charity controlled by
the foundation or
disqualified persons
• Donor advised funds
48. Buying or improving assets used
directly in charitable purposes also
count towards 5%
51. Yes. If…
• It is for a project better
accomplished through set
aside than by immediate
payout (e.g., constructing
a building)
• Pay out within 60 months
of first set-aside
53. If the foundation
makes a big gift,
will the amount
above 5% carry
over to future
years?
Yes.
Gifts above 5%
can carry
forward for up to
5 years
54. • Foundation pays a tax of 30% of required amount not
distributed
• Additional 100% if not corrected in 90 days of IRS notice
Penalty for Failure to Distribute
55. • Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
57. • Donor still controls
the business even
though he has taken
a charitable
deduction
• Donor decides if any
profit is distributed
to the foundation
• Donor controls his
(and other’s)
compensation at the
business
Foundation
58. Foundation +
Insiders
20%
+15% If
Another Has
Effective
ControlOthers
65%
Private foundation can’t own >2% if foundation and
all disqualified persons combined own >20% of a
company (35% if someone else has effective control)
59. • Charitable function such
as a school or hospital
• Business run by unpaid
volunteers or selling
donated items
• Business for beneficiaries
/employees such as a
museum cafeteria
Full ownership of a charitable
business is allowed
60. Full ownership is
allowed if business is
passive – simply
collecting dividends,
interests, royalties, or
real estate rent without
leverage
61. Time to dispose of
excess business holdings
• 90 days if foundation buys
• 5 years if foundation
receives as a gift [and can
request extension for
another 5 years if unusual
circumstances]
62. • Foundation pays a tax of 10% of highest business
holdings above maximum
• Up to 200% if not corrected in 90 days of IRS notice
Excess Business Holding Penalty
63. • Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
65. Nothing is
automatically
disqualified, but
special attention
given to options,
margin trading,
short selling,
commodity
futures, oil/gas
interests
Jeopardizing
investments are
excessively risky
in the context of
entire portfolio
(“fails to
exercise
ordinary
business care
and prudence”)
66. High risk investments
are allowed if they are
primarily charitable
• Needy student loans
• Low-income housing
• Urban renewal
67. • Foundation pays a tax of 10% of the jeopardizing
investment (manager pays 5%, up to $10k)
• Another 25% if not corrected within 90 days of IRS
notice (manager pays another 5%, up to $20k)
Jeopardizing Investment Penalty
68. • Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
69. Taxable expenditures
• Non-charitable purposes
• Political campaigning or
lobbying (except non-
partisan research)
• Grants to individuals except
– Travel, study, or similar if IRS
approves non-discriminatory
award process
– Grants to impoverished
persons or disaster victims
– Prizes/awards to recognize
achievement with no
restrictions on use of funds
70. • 20% of the taxable expenditure (manager pays 5% up
to $10k if no reasonable cause)
• Another 100% if not corrected within 90 days of IRS
notice (manager pays another 50%, up to $20k)
Taxable Expenditures Penalty
72. I give to a donor
advised fund and
“advise” when and
where it will be
distributed to other
charities
73. Donor Charities
The Donor Advised Fund
Donor’s
DAF
$
$
Sponsoringcharityhaslegal
ownershipofDAFs
$
Gifts are to a public
charity, because charity
has legal ownership
Charity follows donor
advice, otherwise no
one would give again
$
74. Donor advised fund
• No minimum payout
• Minimal setup &
administrative expense
• Expected control of grants
• Investment management
sometimes allowed
• Legislatively new
• High income limits &
valuations
• No tax on earnings
Private foundation
• 5% minimum payout
• Significant setup &
administrative expense
• Legal control of grants
• Investment management
always allowed
• Legislatively stable
• Low income limits &
valuations
• 1% or 2% tax on earnings
75. End of year DAF contributions pull
forward deductions
Many use DAFs as a short-
term conduit to take an
earlier tax deduction for
expected future gifting to
charities
76. DAF Limitations
• No benefits (grants, loans, compensation, or indirect benefit) to
donor, family, or organizations 35%+ controlled by
these. Ex: no major donor event tickets
• No excess business holdings
(same rule as private foundations)
• No distributions to private
foundations (rare exceptions) or
individuals
78. Help me
HERE
convince my bosses that continuing to build and
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you reviewed these slides, please let me know
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79. If you clicked on
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Thank
You!
80. This slide set is from the curriculum for
the Graduate Certificate in Charitable
Financial Planning at Texas Tech
University, home to the nation’s largest
graduate program in personal financial
planning.
To find out more about the online
Graduate Certificate in Charitable
Financial Planning go to
www.EncourageGenerosity.com
To find out more about the M.S. or
Ph.D. in personal financial planning at
Texas Tech University, go to
www.depts.ttu.edu/pfp/
Graduate Studies in
Charitable Financial Planning
at Texas Tech University