So far, we’ve gone through the first four steps of the Tactical Philanthropy process. You can click on the following links to read about Goal Establishment, Legacy Planning, Asset Analysis, and Tactical Analysis. After giving an overview of the Tactical Analysis step, I gave a case study. Now I would like to begin talking about each of the five vehicles that donors can launch on their own.
- Private Foundations
- Donor Advised Funds
- Charitable Remainder Trusts
- Charitable Lead Trusts
- Supporting Organizations
At this time I am not going to cover the giving vehicles that nonprofits can set up and offer to donors (such as charitable gift annuities). I’ll save an overview of those for a later date.
So today let’s tackle private foundations.
When most people think of private foundations, multi-billion dollar grant-making institutions come to mind. When we think of someone starting their own foundation, we think of people like Gates, Rockefeller, Ford and Carnegie. But over the last few years, private foundations have emerged as a viable tool for a much larger group of people.
A private foundation is a legal entity, either a corporation or a trust, which makes grants to nonprofit entities. Just as many people create a legal entity through which to conduct their business dealings, a private foundation provides a legal framework for conducting philanthropic activities.
Because assets in a private foundation are required to be given to nonprofits, a donor to a foundation receives a tax deduction upon putting assets into the foundation, rather than at the time the foundation passes those asset on to a nonprofit. This separation of the point of tax impact from the point of actual gift is one of the important reasons to structure your giving.
I believe strongly that people do not give to charity because of the tax deduction. At the end of the day, a tax deduction can only reduce the cost of your gift. But since the tax reduction is never as large as the gift, someone who makes a charitable gift always ends up with less financial assets than someone who does not. However, tax deductions do drive the timing of charitable giving. The looming end of the year deadline for a charitable gift to reduce current year taxes is why so much charitable giving is down during the last two months of the year.
By setting up a private foundation (or other philanthropic vehicle), a donor separates the tax implications of giving from the personal charitable intent. A donor’s advisors can help determine when to put assets into the foundation for maximum tax benefit, while the donor can concentrate on making gifts out of the foundation (which has no tax implication) when those gifts best serve the donor’s philanthropic vision.
Private foundations are not the cumbersome, paperwork heavy entities they once were. While many advisors unfamiliar with philanthropy often assume that foundations are only appropriate for people who can put $3-5 million or more into the foundation, the rise of the internet has reduced the cost and administration needed to operate a foundation. While there are a number of firms that offer some sort of private foundation administration service, Foundation Source is clearly the leading company in this area (Full disclosure: My firm has a working relationship with Foundation Source, however we receive no revenue from them and do not benefit in any way from someone engaging their services).
Foundation Source has turned the client experience of operating a private foundation from a paperwork-laden process into a simple internet interface that is reminiscent of an online bill pay portal (you can see a demo of the private foundation web portal here). By centralizing the administration of hundreds of private foundations and delivering services over the internet, Foundation Source has made it cost effective to create private foundations with as little as $250,000 in funding (or as little as $100,000 in some cases). This is still a very large charitable gift for the vast majority of Americans. However, it changes the private foundation from being a vehicle exclusively for the ultra-wealthy (the Gates, Rockefellers, Fords and Carnegies) to a viable vehicle for people with over $3 million in investable assets.
Regardless of whether a donor uses a foundation administration firm, a CPA firm, a law firm or a family office to administer a private foundation, this vehicle offers the following benefits and drawbacks
- Involve family members in the giving process by naming them to the board.
- Make loans to nonprofits, invest in nonprofit ventures, and pay for the costs of charitable activities.
- Make grants to international entities, individuals experiencing emergencies and offer scholarships. None of these are activities that the IRS recognizes as charitable activities when performed by individuals.
- Have complete control over your philanthropic giving (as opposed to using a donor advised fund, which lacks donor control).
- Even after outsourcing administration, foundations still require some paperwork by the donor.
- Contribution of assets other than cash and common stock does not receive as favorable tax treatment as the contribution of those assets to a public charity.
- In some circumstances, when a donor makes a gift that is very large in comparison to their income, a gift to a private foundation may offer a smaller tax deduction then a gift to a donor advised fund.
- Income and capital gains created in a private foundation face an excise tax of 1-2%.
- The administration costs for a private foundation, while much lower than they were historically, are still higher than some donor advised funds.
Private foundations are still tools for major donors. However, as of 2004 nearly two-thirds of all private foundations held less than $1 million in assets. Since the operating costs have only begun falling in the last five years, we may see a day in the future when private foundations become accessible to a broad range of donors at much lower giving levels.
Next Up: Donor Advised Funds