What is a private foundation?

A private foundation is a type of charitable organization that is typically established by an individual, family or corporation to support charitable activities. A board of directors or trustees oversees a private foundation and is responsible for receiving charitable contributions, managing and investing charitable assets, and making grants to other charitable organizations. It is also responsible for filing tax returns and other administrative reporting requirements.

Two types of private foundations

The IRS classifies every section 501(c)(3) organization as either a private foundation or a public charity. A private foundation is typically controlled and funded by an individual or family: The Bill & Melinda Gates Foundation is a well-known example. A private foundation is also subject to more-stringent tax laws and regulations than public charities. There are two types of private foundations:

• Operating foundations are directly involved in operating a charitable project or enterprise such as a museum.
• Non-operating foundations serve their charitable purpose primarily by making grants to charities. Although they can operate programs, that isn’t their primary purpose.

Non-operating foundations are the most common type of private foundation, and they can be organized in a variety of ways. For example, a non-operating family foundation typically represents the assets and interests of a single family, while an independent foundation, such as the Ford Foundation, is managed independently from the benefactor, the benefactor’s family or a corporation.

Donor-advised fund vs. private foundation

As the name implies, a public charity must get part of its support from the public, as required by the IRS. Unlike a foundation, a public charity’s board of directors must be composed of diverse members. Public charities comprise the majority of charitable organizations (such as hospitals, schools and homeless shelters), community foundations and charities that sponsor donor-advised fund programs, an alternative to a private foundation.

A donor-advised fund is a dedicated account for charitable giving that can be established under a name chosen by the donor, similar to a foundation. When you make an irrevocable gift to a donor advised fund, you are able to create a philanthropic legacy that offers grant-making flexibility, anonymity and advantageous tax deductions.

Donor-advised funds also offer streamlined recordkeeping because the sponsoring organization handles administrative reporting and other functions. Additionally, you can establish a donor-advised fund for significantly less than a private foundation. Some charities, like Fidelity Charitable, offer support and services for donors who make a generous philanthropic contribution to establish a donor-advised fund. In some cases, you may also consider using a donor-advised fund and a private foundation together for greater flexibility.

Learn more about donor-advised funds and how they work.

Benefits of a private foundation

Establishing a private foundation can create a legacy beyond your lifetime and allow family members to be employed or serve as members of the board. In addition, with full control over grantmaking, you can support organizations other than 501(c)(3) public charities. By following IRS procedures, donors can make grants to charitable programs undertaken by individuals, scholarship programs and other entities, making a foundation one of the most flexible charitable vehicles when it comes to supporting certain types of giving.

Other benefits include:

• Potential immediate tax deduction—up to 30 percent of adjusted gross income for cash gifts and up to 20 percent of adjusted gross income for long-term appreciated publicly traded assets.
• Potential elimination of capital gains tax for gifts of long-term appreciated securities.
• Ability to accept many types of assets.

In some cases, the tax treatment for contributions to a private foundation are less advantageous than the tax treatment of donations to public charities, including donor-advised funds.

Administrative and tax rules of foundations as compared to donor-advised funds

There are several administrative and tax considerations to keep in mind before setting up a private foundation. In many cases, the tax treatment and costs of a donor-advised fund may be more favorable.

• Charitable deductions for contributions to foundations are limited to 30 percent of adjusted gross income for cash and 20 percent of adjusted gross income for long-term publicly traded appreciated securities. For contributions to a donor-advised fund, those limits are 60 percent and 30 percent, respectively.
• For private foundations, non-publicly traded contributions, such as privately held stock or real estate, may be deductible only at cost basis rather than at fair market value. For contributions of non-publicly traded assets to a public charity like a donor-advised fund sponsor, the deduction can be at fair market value.
• You can be totally anonymous when making grants from a donor-advised fund, as opposed to a private foundation where your filings are public information.
• Although private foundations are exempt from federal income tax, their investment income is subject to an excise tax of 1.39 percent, whereas growth of a donor-advised fund is not taxed.
• Donations from an estate to a foundation receive the same unlimited deduction as donations from an estate to a public charity or donor-advised fund.

This chart provides a quick comparison of donor-advised funds, foundations and charitable trusts.

Setting up a private foundation

The task of establishing a private foundation may require the assistance of a CPA, lawyer or other advisors. Your advisors will initiate the process, which includes establishing the entity. This involves filing for tax-exempt status and other related administrative documents.

With the legal framework in place, you can focus on funding. The initial contribution generally comes from a single donor or very few donors—usually an individual, family or business. The contribution can include a variety of assets such as:

• Cash
• Publicly traded securities
• Life insurance and annuities
• IRA assets
• Real estate
• Private equity

Real estate and private equity have different tax implications than other assets. Keep in mind that privately held assets may be limited to cost basis.

The lifespan of a private foundation

In theory, a private foundation can operate in perpetuity. In practice, later generations may not want to continue the foundation after the death of a founder, or family members may discover they want greater privacy in their charitable affairs. If a private foundation no longer delivers on what a family needs, there are options. For example, the foundation’s lawyer can dissolve the organization and transition the assets to a donor-advised fund or funds. However, it is wise to think through all the potential options and discuss with family members the intended lifespan of a foundation prior to creating one.

Who’s a good fit for a private foundation?

Donors thinking about establishing a private foundation should consider several factors before making this significant financial and legal commitment. For instance, you will need to immerse yourself in the foundation’s granting strategy. And you will need to help operate the foundation, including hiring staff and investment managers, managing grantmaking, and fulfilling all reporting requirements.

Private foundations are powerful giving vehicles, but they can be costly, time consuming and an administrative burden. If you and your family are interested in creating a charitable giving vehicle that is efficient, simple and impactful, you might want to consider alternatives like a donor-advised fund. It is a good idea to talk to your lawyer or other trusted advisors about your charitable planning and which option is best suited to your circumstances.