The private independent foundation (not the private operating foundation), as qualified under Section501(c)(3) of the Internal Revenue Code, has the most restrictive rules of all of the five different organizations that can be qualified under this section of the code. Many of the rules apply only to the private foundation. Also, the rules as to the deductions for income tax purposes are different when a contribution is made to the private foundation as compared to a public charity under the other four types of organizations allowed under 501(c)(3) of the code. It should be noted, however, that all bequests and gifts made through an estate are one hundred (100%) percent deductible from the federal estate tax whether made to a private foundation or one of the other four classifications of charities under Section501(c)(3).
For more information see the summary of types of charitable organizations.
QUESTION: What is a private foundation?
ANSWER: The private foundation is a personal charity- organized as a trust- - - or as a corporation- by an individual- - - or by a family- - - or by a business.
QUESTION: What does a private foundation do?
ANSWER: The private foundation first determines what charitable goals it wishes to accomplish- - - a charitable agency is selected to carry-out these goals - - - the foundation provides money and support - - - and monitors the results.
QUESTION: Why would an individual or family form a private foundation?
1. To focus charitable giving in certain specified areas.
2. To involve family members now in charitable giving.
3. To accomplish charitable goals that family members truly believe in.
4. To monitor the results of personal charitable giving.
5. To recognize that part of life should include sharing wealth.
6. To gain the income and estate tax benefits.
QUESTION: Why would a business form its own private foundation?
1. To organize the charitable giving of the corporation to accomplish set goals.
2. To assist those less fortunate.
3. To give back something to the community in which it prospers.
4. To gain the favorable advantages in the community.
5. To involve employees to help reach charitable goals.
6. To gain the satisfaction that people are being helped.
7. To shield officers and owners from many requests to give.
8. To gain the income tax advantages.
QUESTION: Is it difficult to form a private foundation?
ANSWER: No. The process is relatively simple. A trust or a charitable corporation is formed and an application is made to the Internal Revenue Service for exempt status.
QUESTION: Does the private foundation have to distribute a certain amount of dollars each year?
ANSWER: Yes - an amount equal to at least five (5%) percent of its assets each year. It has the year in which the amount is earned and all of the subsequent year to make this distribution. Also, if in a particular year it distributes more than five (5%) percent it is allowed to carry-over these amounts to later years.
QUESTION: Can the private foundation distribute more than five (5%) percent each year?
ANSWER: Yes. The amount it can distribute each year is unlimited.
QUESTION: How long does a private foundation last?
ANSWER: It can last forever.This depends upon the persons who are operating the foundation.
QUESTION: Is it difficult to end a private foundation once formed?
ANSWER: The private foundation can be ended anytime by simply distributing the foundation assets to a charity - - - no part of funds can be paid to private individuals.
Activities of the Foundation
QUESTION: Are the charitable activities that can be carried-on by the private foundation limited?
ANSWER: While there are some broad limits, there is a very wide area of opportunity for the private foundation limited only by the imagination of the trustees or directors of the foundation.
QUESTION: Does the private foundation have to be large in order to be effective?
ANSWER: Clearly the answer is no. While there are many very large private foundations, it is clear that the private foundation that is "small" can still be very effective in a community and in the lives of many people.
QUESTION: What are some examples of the ways in which a small private foundation can be effective?
ANSWER: The answer to this question could fill a book. A private foundation can be effective by providing dollars but also can be effective - - -
By being an advocate - - -
By pulling together resources of a community - - -
By loaning money - - -
By being a catalyst for action - - -
By spurring others to action with awards and recognitions.
QUESTION: Does the private foundation conduct its own charitable activities?
ANSWER: While this is possible - - - in most cases the private foundation will decide upon charitable goals - - - will then award a grant to an agency - - - and the foundation will monitor the results.
QUESTION: Can the private foundation grant scholarships to qualified individuals?
ANSWER: If the foundation conducts its scholarship program through a school - - - the foundation provides the funds and the qualifications and the school processes the scholarships. The foundation can conduct its own scholarship program directly if it wishes as long as advance approval is received from the Internal Revenue Service.
QUESTION: Can a private foundation pay its charitable dollars directly to individuals?
ANSWER: No - not to pre-selected individuals. In most cases private foundations pay funds to other charities who then provide benefits to individuals who are members of a group or class of eligible persons in need of help. A charity cannot be formed for the benefit of selected private individuals, family members or business employees. Charitable dollars are to be used to meet charitable needs.
Summary of the Tax Rules
QUESTION: What are the income tax benefits of the private foundation?
1. Donations will be eligible for income tax deductions.
2. The earnings of the foundation will not be subject to income tax.
QUESTION: What are the basic income tax rules?
1. Cash gifts are deductible up to thirty (30%) percent of adjusted gross income.
2. Gifts of publicly held stock deductible at market value up to twenty (20%) percent of adjusted gross income.
3. Other property gifts to the private foundation may be deductible but only at the cost basis of the donor.
4. Capital gains taxes on sales will be avoided.
QUESTION: If the gifts are over the percentage limits is the excess lost?
ANSWER: No, there is a five year carry-over for deductions in later years.
QUESTION: Are the percentage limits lower than for gifts to public charities?
ANSWER: Yes they are. The percentage limits that apply to gifts to public charities are:
1. Cash allowed up to fifty (50%) percent of adjusted gross income.
2. Contributions of publiclyheld stock to a public charity are allowed up to thirty (30%) percent of adjusted gross income.
3. Contribution of some other capital assets may be deductible at market value if given to a public charity while only deducted at cost basis if given to a private foundation.
QUESTION: Are there any other income tax limitations that I should be aware of?
ANSWER: Income tax itemized deductions including charitable contributions may be reduced by three (3%) percent of the amount by which your annual income exceeds a certain amount.
QUESTION: Does the private foundation have to pay income taxes?
ANSWER: No - - - but it does have to pay a two (2%) percent tax only on income earned by the private foundation - - - this is called an excise tax. In some cases this two (2%) percent tax can be reduced to one (1%) percent.
QUESTION: Does a private foundation have to file income tax returns?
ANSWER: Yes - - - an information return specifically called Form990PF - - - due by May15 will report the assets, the distributions, the contributions received and other information.
QUESTION: If I leave some of my estate to the private foundation will I avoid estate taxes?
ANSWER: Yes. All estate gifts to a private foundation are fully deductible from the estate tax without exception. There are no percentage limits here as there are in the income tax area- - - leaving a part of your estate to your private foundation may save a lot of taxes since the estate tax rates are from thirty-seven (37%) percent to fifty-five (55%) percent.
QUESTION: Are all of the foundations' activities subject to public scrutiny?
ANSWER: No. The only requirement on the private foundation is that it must furnish copies of its tax returns for the last 3 years to persons requesting them.
Basic Prohibitions - What The Private Foundation Cannot Do
QUESTION: What are the four basic things that cannot be done by the private foundation?
1. Self-dealing, that is, any transactions with a disqualified person.
2. Holding more than twenty (20%) percent of the stock of a private corporation.
3. Making investments which are very speculative and imprudent.
4. Spending foundation money for political or lobbying causes.
QUESTION: Why is it important to follow the rules?
ANSWER: Failure to follow the rules can lead to tax penalties assessed against the foundation, and in some cases, against the trustees, directors or individuals involved.
QUESTION: What is self-dealing?
ANSWER: A private foundation is prohibited from entering into any financial transaction with certain related parties defined in the law as disqualified persons. This prohibition applies even if the transaction is fair and reasonable and even if it benefits the private foundation. In summary, the private foundation should not sell any of its assets, lease any of its assets, lend money or furnish money, goods or services to or for the benefit of a disqualified person.
QUESTION: Who is a disqualified person?
ANSWER: A disqualified person is any officer, director, trustee, or any employee of the private foundation and also includes any substantial contributor. Disqualified persons as defined in the law also includes all family members of the disqualified person and even spouses of children, grandchildren, and great-grandchildren and can include corporations, partnerships or other business interests in which a disqualified person has an ownership interest.
QUESTION: Can salaries or reimbursement of expenses be paid by the foundation to a disqualified person?
ANSWER: Yes, so long as the total compensation paid is reasonable in relationship to the services rendered by the family member, and also if the services are reasonable and necessary forthe operations of the foundation. Out-of-pocketexpenses can be paid back to family members if the expense was necessary to the operations of the foundation.
QUESTION: What can the foundation do if a transaction may be classified as self-dealing.
ANSWER: It can request from its attorney a "reasoned legal opinion" that the transaction will not be a violation of the self-dealing rules.
QUESTION: What is the prohibition against holding more than twenty (20%) percent of private corporation stock.
ANSWER: A foundation is prohibited from holding more than twenty (20%) percent of any private, closely held corporation stock. If a foundation does receive such stock it has five years to divest itself.
QUESTION: What is meant by imprudent investments?
ANSWER: It cannot invest foundation funds in highly speculative investments.
QUESTION: Is the foundation prohibited from carrying-on lobbying or political activities?
ANSWER: With some very limited exceptions, in general, a private foundation is prohibited from paying funds for political activities, lobbying, or to government officials.
QUESTION: Is there a simple approach to staying within the rules?
ANSWER: Clearly there is. Remember that the private foundation is a charitable entity. Money that comes into the private foundation is to be spent for charitable purposes. Remember this basic rule in all activities that are conducted and the prohibitions will not be violated.