Newsletters
Press Releases
Our Columns
From
Morningstar &
Horsesmouth
|
|
The Benefits of Private Foundations
By Roger D. Silk, PhD, CFA
and CEO of Sterling Foundation Management
January 15, 2002 6:00 am ET
Creating a private foundation can help your affluent clients pursue their philanthropic goals, minimize their tax bills, and keep their assets on your book.
Private foundations have long been the vehicle of choice for the extremely wealthy. Among the best known, and largest, private foundations are the Ford Foundation, the Bill and Melinda Gates Foundation, and the Rockefeller Foundation. But there are also thousands of smaller, less well-known private foundations in existence, controlling billions of dollars.
Private foundations have been responsible for some of the great gifts society enjoys today. These include lifesaving medical breakthroughs such as the Salk polio vaccine and the yellow fever vaccine, and the elimination of starvation in much of the world. Perhaps more importantly, private foundations play a primary role in improving the quality of millions of lives through strategic local initiatives.
Establishing a private foundation can also help your high-net-worth clients on a more personal level. Not only will they be able to pursue their charitable goals, they can minimize their tax bills while doubling (or more) the total assets they control. Before recommending this strategy, review the benefits and limitations inherent in creating a private foundation.
What is a private foundation?
A private foundation is a separate legal entity, either a not-for-profit corporation or a tax-exempt trust, which has received tax-exempt status as a private foundation from the IRS. Most private foundations are funded and controlled by an individual or a family. The founder and his or her family may make tax-deductible gifts to the foundation, and there is no income tax on the income earned by the foundation. The foundation must distribute a certain minimum amount each year, generally 5%, to public charities. Most foundations function as general-purpose endowment funds that the families use to make their charitable contributions.
The basic activity of a private foundation is simple. It consists of four elements:
- Receiving donations (usually from the founder)
- Managing assets (done by directors, or by a professional advisor)
- Complying with the relevant tax and other governmental requirements
- Making contributions to charities in at least the minimum required amount each year
Benefits of private foundations
While private foundations offer a number of tax benefits, taxes are not a sufficient reason to create a foundation. A would-be foundation creator must be interested in supporting charity, either immediately or at some time. Given some charitable intent on the part of the founder, there are several substantial financial and personal benefits to creating a foundation.
A private foundation can help a donor accomplish one or more of the following: establish a legacy, bring him closer to his children and grandchildren, save taxes, and, ultimately of most importance, improve and even save lives through the charitable work it funds.
Understanding the benefits offered by private foundations is key to understanding how, when, and for what purposes clients should consider using them. Here are some of the major benefits clients may expect from creating a foundation:
- Making a difference. In almost every case, the creator of a private foundation has a deep-seated desire to help make the world-or a small part of it-a better place. This might take the form of alleviating specific ills such as homelessness, treating a certain disease, helping the disadvantaged, preserving and protecting the environment, fostering the arts, etc. The range is wide, and limited only by the imagination of donors and the constraints of what is legally considered charitable. While many donors have a hard time articulating their vision for a better world, especially when they first think about committing a large amount of assets, the desire to make a difference is always there.
- Personal satisfaction. Personal satisfaction is perhaps the single overriding reason why people create private foundations. Although relatively few donors will come right out and admit it, most tend to be very appreciative of the attention, social status, and other intangible rewards associated with being known in the community as a significant donor. Of course, deep, lasting satisfaction also comes from making a difference in people's lives.
- Immediate income tax savings. Contributions to charity are tax deductible, and contributions to private foundations are no exception. While most advisors are aware that charitable contribution deductions are subject to limitations, there is some confusion about the application of the charitable contribution limits. Generally speaking, donors can cut their income tax bills immediately by up to 30% by creating a private foundation.
- Avoidance of transfer taxes. All contributions to qualified charities are exempt from transfer taxes. This includes contributions to private foundations. Hence, all contributions, whether made during life or upon death, to private foundations are outside of the donor's estate, and therefore free of any gift tax, estate tax, or generation-skipping tax. This is particularly important when considering the long-term intergenerational accumulation of wealth for charitable use.
- Advantage of giving appreciated stock. Appreciated publicly traded stock given to a private foundation may count for up to 20% of a donor's adjusted gross income. To receive a deduction based on fair market value, the donor must have held the stock for at least one year, and the stock must be traded on an exchange.
The advantage of giving appreciated stock is twofold. First, the deduction for the full fair-market value is usable against ordinary income, and second the unrealized capital gains are not subject to income tax it when the foundation sells the stock.
- Income-tax-free growth. A private foundation is a tax-exempt entity. As such it may earn income without owing income tax. Tax-free compounding, of course, is a very powerful tool, facilitating long-term growth of assets.
- Maintain flexibility. Unlike all other alternatives for charitable giving, private foundations allow the their creators to maintain maximum flexibility. Since donors retain control over the way their assets are invested, when money will be given to charity, which charities money is given to, and how much money is given, the private foundation enables donors to adapt their charitable behavior as their needs and circumstances dictate.
- Maintain control. Control is very important for most high-net-worth individuals. In many cases, this carries over into their charitable activities as well. The private foundation rules allow a foundation creator to retain complete legal control over the foundation during his lifetime and to pass that control to his chosen successors in perpetuity. Probably for this reason, more than any other, private foundations continue to be the vehicle of choice for most wealthy donors.
- Buy time. The great majority of successful people have a strong desire and commitment to give something back to society, in one form or another. Most currently give to one or more charities, or plan to do so when they get a little more time to focus on that aspect of their lives. But busy people often face a dilemma. They need a tax deduction this year, but aren't yet prepared to make major commitments to specific charities. A private foundation makes it possible to do both. They can get a tax deduction now, yet decide later (even years from now) how to best spend their charitable dollars.
Large gifts to charity are serious business and they deserve thoughtful attention. The flexibility of a private foundation and the requirement that the foundation give only 5% of its assets each year to charity, enables donors to take advantage of the tax breaks, yet still provide themselves with the opportunity over time to devote the attention large gifts deserve.
- Involving children and grandchildren. A private foundation can provide an excellent vehicle for involving children and/or grandchildren in the founder's charitable activity. The formal structure of a private foundation provides a very natural framework for involving children, for example, as directors. Many foundation creators choose to involve their children informally for a period during which they evaluate each child's level of interest, involvement, and commitment. There are of course many different approaches and no single approach can be said to be right for all founders. In some cases, the children may become seriously involved and the foundation directors may choose to pay these children reasonable salaries for the work they perform.
These are only some of the major reasons why people create and fund private foundations. Often founders grow into these reasons, especially the "soft" ones only after they've already created the foundation. So often the initial discussions focus more on the financial and tax nuts and bolts, and the real reasons are gotten to only after the foundation has been created.
|
contact us
