A private foundation is a tax-efficient way for you and your family to create a philanthropic legacy, giving to causes you care about—or even funding your own charitable programs. And if you can’t cover the significant costs of setting one up, there’s a less expensive way to create your own giving fund.
What is a private foundation?
Under IRS code 501(c)(3), charitable organizations are divided into two types: 1) Public charities (think American Heart Association, Food for the Poor, etc.) or 2) private foundations—the Bill & Melinda Gates Foundation is perhaps the best-known. While public charities rely on donations, private foundations are usually funded by the individual or family giving birth to and naming the foundation.
The Bill & Melinda Gates Foundation is a non-operating private foundation—it grants money to outside programs, often run by public charities. In 2018, they funded programs for Save the Children and Habitat for Humanity, to name just two. Most people who create a private foundation are looking to fund a select cause and wish to do so over a period of years. Registering as a private non-operating foundation allows them not only to receive a tax break, but also to create a legacy of giving—by encouraging their loved ones to continue supporting their given cause after they pass away.
While non-operating private foundations grant money to outside charities, some foundations distribute funds to their own programs—they are therefore operating foundations. An operating foundation is basically any private foundation that spends at least 85% of its adjusted net income or its minimum investment return, whichever is less, directly for its own charitable purposes each year. Like public charities, they require more legwork, including raising funds from outside donors.
So you want to start your own foundation? Five quick questions.
- How much do you have? Unless you’re starting with at least a million dollars, a donor-advised fund (DAF) may be more suitable. That’s why most people don’t go the route of a private foundation, when looking to establish a charity fund. DAFs are usually free to set up, with low annual fees, and they allow you to make grants to existing public charities and private foundations. Also, you can deduct your cash contributions to a DAF, up to 60% of your gross adjusted income (whereas cash contributions to your own private foundation are tax deductible up to 30% of AGI). Unlike private foundations, all the funds in your DAF may be left to grow indefinitely—there’s no annual distribution requirement.
- What good will it do? Sit down and think about your vision. It’s possible that a charity already exists, adequately covering the area in which you hope to make a difference. Is there a real need for your foundation?
- What’s your business plan? As well as a clear mission statement, you’ll need to develop a business plan. That means balancing all projected expenses, including startup costs, against all the income you expect your foundation to receive in the first year.
- Who’s on board? Decide who the decision-makers are; select an advisory board. For an active nonprofit that’s typically 3-5 people—often, close family members. If the foundation is a family affair, it’s likely you will name it after yourselves, as did Bill and Melinda Gates.
- Is it tax-exempt? Once you’ve established your mission, and sure your foundation is economically viable, you’ll need to get an attorney on board to help you complete the necessary paperwork to gain charitable status. Completing the entire form can take 100 hours. Once completed, you will then need to then wait several months while the IRS processes the application.
Setting up a private foundation is a serious—and costly—undertaking. But if you are a budding philanthropist with the financial means to take your charitable giving to the next level—or simply want to make your existing charitable work more tax efficient—a private foundation could be your greatest gift to the world.