Private Foundations & Donor Advised Funds: Tax Rules and Insider Benefits
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1. Private foundations and donor advised funds hold money and distribute grants to charities. Private foundations are the dominant charitable planning vehicles, holding 81% of assets compared to 3% for donor advised funds. 2. Private foundations are typically funded by an individual, family, or corporation. They make grants to charities rather than directly conducting charitable activities. Private foundations are subject to a 2% tax on net investment income and strict rules around insider benefits and payouts. 3. Donor advised funds are accounts housed within public charities. They offer donors similar tax benefits to private foundations with less complexity and cost. However, donors do not have legal control over grants from donor advised funds.
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Private Foundations & Donor Advised Funds: Tax Rules and Insider Benefits
- 1. Private Foundations & Donor Advised Funds Professor Russell James Texas Tech University
- 2. Private Foundations & Donor Advised Funds 1: What are PFs & DAFs?
- 3. Private foundations (non-operating) and donor advised funds hold money and distribute grants
- 4. 78% 14% 5% 3% Assets 81% 3% 14% 2% Charitable Distributions Private Foundations (non-operating) Charitable Remainder Trusts Donor Advised Funds Charitable Lead Trusts Private Foundations are the Dominant Charitable Planning Vehicles Combining 2010 data from IRS Statistics of Income (PF, CRT & CLT) and National Philanthropic Trust (DAF)
- 7. Psychologyâs âterror management theoryâ suggests a defense to mortality reminders is to create symbolic immortality (oneâs 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
- 11. A private foundation can transmit values by involving descendents in specific charitable causes for many generations
- 12. 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.
- 13. Private foundations can be large, but most arenât 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
- 14. Foundation board ⢠Often the donor and close family members ⢠Can establish rules for succession â Descendents who meet certain criteria â Unequal voting rights allowable â Junior board for minors advising on small gifts
- 15. Private Foundations & Donor Advised Funds 1: What are PFs & DAFs?
- 16. Private Foundations 2: PFs v. Public charities
- 17. Three types of charitable organizations Public charity Supporting organization Private foundation
- 18. 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
- 19. Typical private foundation ⢠Funded by one person, family, or corporation ⢠Makes grants, rather than directly running charitable activity ⢠Expenditures funded by investment income
- 20. 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)
- 21. 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. 2Giftsfromthosegivingâ¤2%oftotal supportandanysupportfromgovernment
- 22. 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 âfacts and circumstancesâ that it is a public charity 1Includesgiftsandinvestmentincomeoverlast4years.Largeunusualgiftsfromoutsiderscanbe excluded. 2Giftsfromthosegivingâ¤2%oftotal supportandanysupportfromgovernment
- 23. 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
- 24. Private Foundations 2: PFs v. Public charities
- 26. Tax rules for private foundations
- 27. Tax on net investment income ⢠2% tax on net investment income ⢠Drops to 1% If charitable grants ⼠assets X (avg. % payout in the last five years) + 1% of net investment income
- 28. Gifts to private foundations also have lower income-based deductibility limits
- 29. Current Value: $25 1990 Paid $1 Long-term capital gain (special election) Tangible personal property (âunrelatedâ use) CashOrdinary income property Inventory Short-term capital gain Public Charity Public Charity
- 30. Current Value: $25 1990 Paid $1 Long-term capital gain (no special election) Tangible personal property (ârelatedâ use) CashOrdinary income property Inventory Short-term capital gain Public Charity Private Foundation (non-operating)
- 31. Current Value: $25 1990 Paid $1 Long-term capital gain (any) Tangible personal property (ârelatedâ or âunrelatedâ use) Current Value: $25 1990 Paid $1 Private Foundation (non-operating) Private Foundation (non-operating)
- 34. Charitable Purposes To protect charitable distributions, many transactions are prohibited or penalized Insider Benefits
- 35. ⢠Self-dealing ⢠Failure to distribute income ⢠Excess business holding ⢠Investments that jeopardize charitable purpose ⢠Taxable expenditures Insider Benefits Charitable Purposes
- 36. IRS punishments for transactions that break the rules include: ⢠Initial tax (10%- 30%) ⢠Additional tax if transaction not corrected (25%- 200%) ⢠Revoking exemption
- 37. Who is an insider (A.K.A. a âdisqualified personâ)? Insider Benefits Charitable Purposes
- 38. Insider or âDisqualified Personâ ⢠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 ď§ >2% of all contributions from foundation start to end of tax year (+>5K total contributions) ď§ Grantors of a charitable trust automatically qualify
- 39. ⢠Self-dealing ⢠Failure to distribute income ⢠Excess business holding ⢠Investments that jeopardize charitable purpose ⢠Taxable expenditures Insider Benefits Charitable Purposes
- 40. Self-Dealing ⢠Sell, exchange, lease, transfer or loan money, goods, services, property, or facilities to a disqualified person ⢠Paying a government official
- 41. Bargain sale Suppose a disqualified person is willing to sell a $200,000 property to the foundation for $10,000?
- 42. Bargain sale Suppose a disqualified person gives a $200,000 property (with a recent $12,000 mortgage) to the foundation? (Payment of the insiderâs debt is a benefit, but allowed if debt is 10+ years old)
- 43. 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)
- 44. Free gifts to the foundation of money, property, or use of money or property are allowed
- 45. Foundation can hire an insider to perform necessary professional or managerial services (called âpersonal servicesâ) if compensation is reasonable ⢠Investment advice ⢠Legal work ⢠Accounting/tax services ⢠Banking ⢠Administrative assistance The Council on Foundationsâ Foundation Management Report contains compensation information for various positions
- 46. 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
- 47. 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 founderâs desires
- 50. ⢠Self-dealing ⢠Failure to distribute income ⢠Excess business holding ⢠Investments that jeopardize charitable purpose ⢠Taxable expenditures Insider Benefits Charitable Purposes
- 51. The foundation must distribute at least 5% of non-charitable net assets under its control by the end of the following tax year
- 52. Non-charitable net assets excludes charitable assets and assets not yet under foundationsâ 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 foundationâs control: a right to receive property after death, after estate administration, or after payment of a pledge
- 53. 5% payout is reduced by investment tax and unrelated business income tax
- 54. Administrative expenses for grant-making or fundraising (but not investment management) also count as charitable expenditures towards the 5% minimum required payout
- 55. 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
- 56. Buying or improving assets used directly in charitable purposes also count towards 5%
- 57. Can the foundation postpone payouts to save up for a big gift?
- 58. 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
- 59. 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.
- 60. ⢠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
- 63. ⢠Self-dealing ⢠Failure to distribute income ⢠Excess business holding ⢠Investments that jeopardize charitable purpose ⢠Taxable expenditures Insider Benefits Charitable Purposes
- 64. Whatâs the problem with excess business holdings?
- 65. ⢠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 otherâs) compensation at the business Foundation
- 66. Foundation + Insiders 20% Add If Another Has Effective Control 15%Others 65% A private foundation cannot own more than 2% if the foundation and all disqualified persons combined own more than 20% of a company (35% if someone else has effective control)
- 67. ⢠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
- 68. Full ownership is allowed if business is passive â simply collecting dividends, interests, royalties, or real estate rent without leverage
- 69. 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]
- 70. ⢠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
- 71. ⢠Self-dealing ⢠Failure to distribute income ⢠Excess business holding ⢠Investments that jeopardize charitable purpose ⢠Taxable expenditures Insider Benefits Charitable Purposes
- 72. Crazy investment gambles can jeopardize the charitable purpose
- 73. 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 (âfails to exercise ordinary business care and prudenceâ)
- 74. High risk investments are allowed if they are primarily charitable ⢠Needy student loans ⢠Low-income housing ⢠Urban renewal
- 75. ⢠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
- 76. ⢠Self-dealing ⢠Failure to distribute income ⢠Excess business holding ⢠Investments that jeopardize charitable purpose ⢠Taxable expenditures Insider Benefits Charitable Purposes
- 77. Taxable expenditures ⢠Non-charitable purposes ⢠Political campaigning or lobbying (except non- partisan research) ⢠Grants to individuals except â Travel, study, or similar if IRS approves non-discriminatory award process â Grants to impoverished persons or disaster victims â Prizes/awards to recognize achievement with no restrictions on use of funds
- 78. ⢠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
- 80. Private Foundations 7: v. Donor Advised Funds
- 81. What if creating a private foundation is just too much hassle?
- 82. Donor Charities The Donor Advised Fund Donorâs DAF $ $ Sponsoringcharityhaslegal ownershipofDAFs $ Gifts are to a public charity, because charity has legal ownership Charity follows donor advice, otherwise no one would give again $
- 83. 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
- 84. 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
- 85. 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
- 86. Private Foundations 7: v. Donor Advised Funds
- 87. Help me HERE convince my bosses that continuing to build and post these slide sets is not a waste of time. If you work for a nonprofit or advise clients and you reviewed these slides, please let me know by clicking
- 88. All slides are taken from the book Visual Planned Giving Available from Amazon.com
- 89. Private Foundations & Donor Advised Funds Professor Russell James Texas Tech University