“A family foundation can provide a large number of opportunities, both tax and non-tax, for families and individuals interested in philanthropy.”
Family Foundations
Families (or individuals) commonly establish a foundation to pursue their philanthropic endeavors. A foundation is an independent charitable organization (it may be a corporation or a trust) under individual or family control. Family members make charitable contributions to the foundation. The foundation may hold and invest the funds (the foundation pays an annual 1.39% tax on its net income). Generally, the foundation makes grants to charitable organizations of 5% of its assets annually. A foundation can provide a large number of opportunities, both tax and non-tax, for families and individuals interested in philanthropy.
Income Tax Considerations
Individuals receive a charitable tax deduction for contributions to the foundation in the year of the contribution. However, the individual retains control of the ultimate charitable use of the contributed funds by serving as trustee or director of the foundation. This allows an individual to make a contribution (and receive a current income tax deduction) while making charitable grants in perpetuity, or at least waiting for a later time.
Because the amount of charitable deduction allowed to a donor is a percentage of the donor’s taxable income in the current year (charitable deductions are allowed to be carried forward on the donor’ tax return for five years), this allows an individual that recognizes a large amount of current income to take advantage of the current charitable deduction while allowing the individual the freedom to wait to make decisions about grantees and charitable programs. This is very useful for individuals who are anticipating a liquidity event and expect to have far less annual taxable income after the liquidity event. Foley has worked with many clients about timing their charitable contributions for maximum tax benefit.
Estate Tax Considerations
Amounts contributed to a foundation are not considered to be part of the contributor’s estate for estate tax purposes. In this way, family members may retain control of the donated assets (for use in charitable endeavors) after the contributor family member passes away without having to pay estate tax on the assets contained in the foundation.
Visibility of Philanthropic Activity
Members of a family, especially a larger extended family, sometimes feel that when various members of the family (and perhaps affiliated businesses) make separate charitable contributions to a variety of organizations, the impact is diluted. By having a single foundation make all of the grants, the family may raise its profile in the community. This may be more important for families that own a business which could benefit from the goodwill generated by community involvement.
The formation of a foundation helps establish the perception that the family desires to be an active, committed, long-term partner in philanthropy. Forming a foundation and making a philanthropic commitment means that the family and its members will have more ability to influence the giving of other charitable donors. Charitable grantees may be more willing to ask the foundation and the family for advice about new programs or current operations and be more willing to listen to the family and the foundation when family members have ideas.
Individuals with a special skill set or expertise (such as business or financial acumen), may find that their most important philanthropic contribution is in guiding the operations of charitable organizations. Or, a family member may wish to work with charitable organizations to implement a new vision or program. Establishing a foundation may help facilitate both of these activities.
Family Involvement in Philanthropy
The formation and operation of a foundation can provide opportunities for younger members of the family to play meaningful roles in family philanthropy. Family members who may not necessarily be making large charitable contributions at present may be asked to serve as trustees or as board members and be given responsibilities, such as reviewing and making recommendations for grants. The experience that family members gain working with the foundation can be vital in preparing them to be good stewards of the family’s philanthropic efforts in the future.
Streamline and Focus Philanthropic Endeavors
A family may use a private foundation as a mechanism to organize their charitable giving. Instead of family members receiving myriad requests for contributions throughout the year and then making decisions on each request as they come up based on the whims of the moment, a foundation can be used to help family members examine their charitable interests and strategize about how to best deploy the family’s giving. At the very least, charitable requests can be redirected to the foundation and the foundation can be responsible for denying a request for funds.
Promote Creative Philanthropic Ideas
While foundations must adhere to IRS rules, there is much room for creativity. For instance, with IRS approval, foundations may operate scholarship programs. They may also award certain types of prizes to individuals (such as an award for the best original piece of artwork). Within certain parameters, they may make grants to non-section 501(c)(3) organizations.
Foundations are increasingly engaged in making “program related investments” or PRIs. In a PRI, a foundation invests in an organization or project with an overall charitable purpose. In contrast to a grant, the foundation is allowed to receive a return on its investment (either as interest or a dividend). Commonly, foundations make or guarantee loans for charitable building projects (such as low-income housing). However, with the current explosion of social entrepreneurism, foundations are making PRIs in a wide variety of organizations, such as business incubators, medical research, venture capital, and housing loan funds.
Additional Considerations
Annual Distribution Requirement
A foundation must make, at a minimum, charitable distributions of 5% of its assets annually. The distribution requirement may be met with both charitable grants or expenditures made directly by the foundation for charitable activities.
Responsibilities of the Trustees or Directors
The managers of a foundation (its directors or trustees) have a legal responsibility to ensure that the assets of the foundation are used for charitable and not personal purposes. The directors or trustees must invest the assets of the foundation to not only generate sufficient income to pay the grants, but also to have the foundation’s funds appreciate over time.
The Internal Revenue Service expects that the managers will meet these requirements and improper activities can cause the managers to be subject to IRS penalties:
- There are significant limits on the foundation holding stock or ownership in a family business.
- A foundation may not purchase an investment that is so risky it jeopardizes the purpose of the foundation.
- The foundation may not engage in transactions with its managers, its contributors, family members of the same, and business entities owned by the same.
