When you think about charity and philanthropic work, what do you think of? Do you think of providing food, water, and shelter for children in third-world countries? Or is it an animal shelter that is underfunded and understaffed? There is certainly no right or wrong answer to the open-ended question we proposed, but the answer does give you some insight into what cause resonates the most with you and your family. If this question has stirred up some emotion inside you that makes you want to get out there and make a difference, then setting up a private foundation might be the next step that allows you to make a difference beyond your current sphere of influence.
As a financial advisor, I help executives establish a charitable giving plan that aligns with their financial portfolio. Part of that process includes exploring the key considerations you should make when setting up a private foundation, as well as exploring alternatives to private foundations that still allow you to achieve your charitable gifting goals. This ensures you’re setting yourself and the causes you’re impacting up for success now and in the future.
Private Foundation Rules and Regulations
According to the IRS, a private foundation is seen as a 501(c)(3) entity, and the first step in setting one up is structuring it. The IRS allows for a nonprofit organization (in your case a private foundation) to be structured as a corporation, a trust, or an unincorporated association. Depending on your unique situation, you will want to work with a trusted attorney to discuss options and draft documents to get your structure in place.
Once you have your baseline structure in place, consider who you want to have control of your private foundation. Do you want to invite friends, colleagues, and other professionals to be a part of your philanthropic journey, or would you rather keep it a more intimate family foundation? There is no right or wrong answer, but this is something you should consider and have a pretty solid opinion on before setting up a private foundation.
One of the major advantages of setting up a private foundation over setting up a public charity is the fact that more than 50% of your board members are allowed to be related by blood, marriage, or outside business co-ownership, and compensated as employees of the organization. This is in contrast to public charities that do not allow for that large of a concentration of family members on the board.
Another consideration is the amount of taxable income you can deduct in a given year for contributions to the private foundation. The IRS states that contributions made to a private foundation are limited to 30% of your adjusted gross income (AGI). On the other hand, you can deduct up to 50% of your AGI in most cases when donating to public charities and other charitable organizations. While this should not be the only determining factor in setting up a private foundation, taxable deductions should be considered.
Pros and Cons of Setting Up a Private Foundation
Along with the structure, you should also consider the benefits and drawbacks of setting up your private foundation. They include:
- Reducing income tax: Donating a portion of your income to a private foundation can help reduce your income tax bill.
- Avoiding capital gains tax: When you donate assets to a private foundation, the foundation is exempt from capital gains tax when it sells the asset.
- Reducing estate tax: The more assets that are held by other entities outside of personal ownership, the lower the overall amount of your taxable estate becomes.
- Growing assets in a favorable tax environment: A private foundation does not need to worry about capital gains or capital appreciation, allowing your donated assets to grow unencumbered.
While these benefits can be a tremendous advantage for executives that set up a private foundation, there are a few drawbacks to consider. One consideration involves the work that goes into operating a private foundation, such as tax filings and donor documentation. How much administrative work are you willing to take on or pay to have someone do for you and your foundation? Also, if your board is primarily family and friends, sometimes those relationships can get in the way of hard decisions that need to be made.
If these drawbacks are making you rethink setting up a private foundation, there is an alternative we often recommend to executives looking to create a charitable legacy.
Donor-Advised Fund as an Alternative to a Private Foundation
After discovering all of the rules and regulations that come along with setting up a private foundation, many executives we work with opt to set up a donor-advised fund instead. In general, we have seen donor-advised funds be effective for executives working with $5 million or less in charitable assets, and private foundations being more of a consideration for those that surpass that threshold.
A donor-advised fund (DAF) is a fund set up by the donor with the help of a trusted financial advisor. The DAF is able to accept funds that you earmark to be donated to charity. When you place the funds in the DAF, you recieve a tax deduction for that year, even if you don’t actually donate them to a charity yet. This allows those assets to grow inside of the fund. You can also donate appreciated assets and typically avoid capital gains tax because they are considered a charitable donation. Another benefit of the DAF is that you can donate to as many charities as you like, giving you flexibility as well as control over your philanthropic endeavors.
Seek an Expert in Charitable Gift Planning
Whether you choose to set up your own private foundation or utilize a donor-advised fund to achieve your charitable support, you need to find an experienced advisor that has a proven track record of helping executives through this same journey. The right advisor can help you look at the pros and cons of setting up a private foundation and walk you through some alternatives to ensure you’re making the right charitable giving decision that aligns with the rest of your financial portfolio.
K. Wade Carpenter, CFP®, AIF®, ChFC®, CLU®, is an innovative wealth manager serving corporate executives and entrepreneurs from coast to coast. Throughout his more than 25-year career, Wade’s focus on C-level clients has made him a top strategist for charitable gift planning. For more information on how Wade and the Carpenter Team can advise you on setting up a private foundation or donor-advised fund, reach out today for a complimentary consultation.
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