Tax season is always a good time to talk about charitable giving goals for the next year — and if those goals are large and long-term, clients might want to learn more about private foundations.
Charitable giving has become a centerpiece of tax planning for clients who rode the market rally over the last few years and are now in need of a way to mitigate the effect of capital gains taxes, get highly appreciated assets out of their estates or rebalance their portfolios.
Though clients have access to donor-advised funds for those kinds of purposes, the more ambitious donor might be interested in using a private foundation.
“Generally, private foundations are for those who take philanthropy seriously,” said Robert Chartener, chief executive of Foundation Source, a provider of administrative services for private foundations. “Many of these donors are entrepreneurial.” These clients want to be involved in the grant-making process, the board of directors overseeing the foundation and the investments chosen.
Data from Foundation Source shows that the number of private foundations has been climbing steadily in recent years. There were 93,126 of these charitable vehicles in in the U.S. in 2013, the most recent year for which data is available, up from 76,610 in 2010.
Source: Foundation Source
GIVING FOR THE LONG HAUL
Private foundations go hand in hand with legacy and estate planning: This is a giving mission that aspires to last longer than the client's lifetime and that will likely require involvement from other family members. Prospective donors will want to be ready to give both their money and their time.
“Ideally, you want a lasting family legacy. It's one thing to just talk about it and another to have a quarterly meeting as to why you're funding this hospital or this university,” said Carol Kroch, managing director and head of wealth planning at Wilmington Trust Co.
Donors can also use the private foundation as a proving ground for children and grandchildren as they learn to take greater responsibility with their family's wealth. “Even the youngest generations can marshal grants to some degree,” said Page Eberstadt Snow, chief marketing and philanthropic officer at Foundation Source.
TAX NITTY GRITTY
Potential donors should expect to spend more time with their attorneys, advisers and accountants — not just their family members — to figure out the tax and legal difficulties that may arise.
Ronni Davidowitz, chair of the New York trusts and estate department at Katten Muchin Rosenman, said that clients should be ready to have a minimum of $3 million to $5 million to fund their private foundation, because if the sums are too low, then it makes little economic sense to use this vehicle, considering the related costs of setting it up.
Further, small private foundations are under scrutiny in New York State, where the state attorney general wants to discourage tiny foundations that will be more likely to run afoul of good operating governance, Ms. Davidowitz said. “You'll wind up with certain expenses, and if the fund is too small, then these expenses loom large in comparison to the size of the fund,” she added.
Private foundations must be registered with state agencies where they're based. This could be with the state's attorney general, secretary of state or department of justice. These foundations are also expected to file reports with that regulatory body.
There's also a federal component to the filing requirements. Form 990-PF must be filed with the IRS (and state regulators), as does Form 1023, a form that organizations use to apply for tax-exempt status under section 501(c)(3).
Be ready to seek legal help, too. An attorney will need to draft the governing document that sets the rules for the private foundation, said Ms. Kroch.
Advisers and accountants getting into the mix need to be aware of the rules that apply to private foundations, such as the requirement that the foundation make a minimum distribution of 5% of its assets and the fact that private foundations can't participate in self-dealing or enter into transactions where there are conflicts of interest.
At the heart of it all, donors need to keep their families in the loop when it comes to making a private foundation part of an estate plan. Clients probably don't want to surprise their survivors who find out years later that the money they thought they would inherit is earmarked for a private foundation.
“The sad thing is when you disappoint family members who were expecting to get the money and — surprise! — your parents wanted to create a foundation and they didn't tell you,” said Ms. Kroch. “Even a testamentary plan for a foundation is worthwhile: Can I give some guidance and let the family in on it, even if it isn't heavily funded yet?”
“You want to have this conversation before it happens,” she added. “Lay the seeds for a happy situation, not a contentious one.”