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Is Setting Up a Private Family Foundation Right for You? Thumbnail

Is Setting Up a Private Family Foundation Right for You?

How to Start a Private Family Foundation

By: William Lalor, CFP®, CFA

The clients we work with often express a desire to give back to their communities by supporting charitable causes they’re passionate about. Establishing a private family foundation can be an effective vehicle to accomplish one’s charitable wishes. 

With a private family foundation, you can create a framework for giving that helps you build a philanthropic family legacy. This vehicle may also provide income and estate tax benefits. Family foundations account for more than half of all private foundations, according to the Council on Foundations.

What is a Private Family Foundation?

Private family foundations are set up by families and funded with assets such as cash, securities, real estate (both residential and commercial), artwork and antiques, jewelry and intangible property (e.g., patents and intellectual property rights). Their main function is to preserve family wealth over generations and direct a family’s philanthropic efforts through grants that are made to public charities. Private family foundations usually don’t perform their own charitable operations; instead, they donate assets to qualified charitable organizations.

Like charitable organizations, private family foundations receive tax-exempt status under Internal Revenue Code 501(c)(3). To qualify for this status, their purpose must be “charitable, religious, educational, scientific, literary, testing for public safety, foster national or international amateur sports, or prevent cruelty to children or animals,” according to the IRS.

One of the most recognized private family foundations in the U.S. is the Carnegie Foundation. This foundation was established in 1905 with the wealth accumulated by steel magnate Andrew Carnegie. The Carnegie Foundation makes grants and funds programs designed primarily to benefit educational institutions “so that every student has the opportunity to live a healthy, dignified and fulfilling life,” according to the foundation’s website.

Why Start One?

A private family foundation can be established at any time, including after a wealthy individual has died. The impetus for starting a foundation often comes when a wealthy individual or family realizes that they have more than enough wealth to meet their needs for the rest of their lives and they want to be more strategic about building a philanthropic family legacy.

Certain events can also trigger the establishment of a private family foundation, such as selling a closely held business. If a business owner sells stock in a company but remains a substantial shareholder, donating shares of company stock to a private family foundation can reduce income and estate taxes. When sold, stock held by a private foundation is assessed an excise tax of 1.39%, instead of a capital gains tax of up to 20%.

Receiving a large inheritance or other financial windfall may also be a good reason to set up a private family foundation. For example, after the sale of a business, entrepreneurs may establish a foundation as a way to give back, and to avoid some of the tax issues they may encounter.

Sometimes, wealthy retirees establish private family foundations as a “second act” to reinvent themselves as philanthropists. Their main “job” in retirement becomes running the foundation, which can be a good way to give back to those who have helped them achieve success. Assets contributed to a private family foundation are excluded from an individual’s estate upon death, which may reduce estate taxes.

Steps to Setting Up a Private Family Foundation

While there are no legal requirements specific to private family foundations, the IRS sets forth guidelines for them. For starters, a private family foundation must make grants worth at least 5% of its investment assets each year. Also, it can only make grants to other charitable organizations, not to grant recipients themselves. (One possible exception to this rule is granting scholarships to students.) 

And as noted above, private family foundations must pay an excise tax of 1.39% on the foundation’s net investment income each year.

Private family foundations can be managed by family members or an outside professional who is hired to serve in the role of an operating partner. It’s usually a good idea to create a family governance system that details things like who will participate in philanthropic discussions and decisions, how much time family members are expected to devote to the foundation, guidelines for making grant recommendations, and how family members will be educated about the foundation and its mission when they are old enough to get involved.

Here are 7 steps to follow when establishing a private family foundation:

1. Define your mission.

The IRS requires private family foundations to have a mission statement in their incorporating documents that specifies its charitable intent. This can be fulfilled by using the IRS’s broad statutory language for nonprofits that’s noted above. However, it’s often beneficial to define the foundation’s mission more narrowly than this. 

Your mission statement will serve as a guideline for both current and future generations to follow when making decisions about what kinds of charitable organizations to fund. It should give family members clear direction as to the founder’s charitable intent and be narrow enough to filter out funding requests from charities that aren’t a part of this intent.

Sometimes founders and families aren’t sure what the foundation’s mission is when they’re just starting out. In these cases, foundations may take an evolutionary approach to defining their mission by making grants to several different charities and then deciding which ones motivate them the most and achieves the greatest impact. Allow all family members who are involved in the foundation to give input into your mission statement.  

2. Establish the foundation.

Private family foundations can be established as a charitable trust or a nonprofit corporation.  This decision can have lasting implications, so it is important to seek professional advice to determine the best structure to fit your needs. Trusts have fewer paperwork and recordkeeping requirements, but corporations (especially Delaware corporations) offer a more flexible structure and greater legal protections for the officers. Delaware permits sole-director corporations and allows annual meetings to be held virtually instead of in-person, as well as electronic minutes. Corporate filings are also usually faster and less expensive in Delaware.

Once you decide on a trust or corporation, you’ll need to apply for an employer identification number (EIN) to establish your foundation. This number will serve as your foundation’s tax identification number, similar to a Social Security number for individual tax filing.

3. Apply for tax-exempt status.

Receiving tax-exempt status for a private family foundation doesn’t happen automatically. You must apply to the IRS for recognition as a tax-exempt charitable organization. To do so, complete IRS Form 1023 along with its required supporting documentation, including how your foundation will be organized and operated. Then pay the required fee to finish setting up your private family foundation. You may also need to file additional paperwork with your state once the IRS has approved your tax-exempt status.

4. Designate a board of directors.

Your board of directors will help guide the direction of the foundation and help ensure that decisions are in alignment with the founder’s charitable intent. While family members may serve on a private family foundation’s board, many families choose to hire outsiders with expertise in the foundation’s mission. The larger and more active a foundation, the more likely it may be to bring in outside experts, including administrative staff to help execute the foundation’s mission.

5. Fund the foundation.

As a general rule of thumb, families should plan on starting their private family foundations with at least one million dollars in assets, although some foundations have been founded with as little as $250,000. You won’t have to make any grants during the first year, which will give you time to get everything set up and decide which charities you want to support. Also spend some time during the first-year planning how you will manage the foundation’s assets so you can continue to make charitable grants for many years in the future.

6. Establish grantmaking guidelines.

It’s helpful to set some guidelines for how your private family foundation will make decisions about which charities you’ll support with grants. Start with your mission statement and the founder’s charitable intent. Then be sure to perform thorough research and due diligence on any charitable organizations you’re considering offering grants to. Also put a mechanism in place to measure the impact of your grants on the charities you support so you can decide in the future whether to continue supporting them.

7. Carefully follow all IRS guidelines.

Running afoul of IRS guidelines could jeopardize the tax-exempt status of your private family foundation. Use the following checklist to make sure this doesn’t happen:

  • Your foundation is making grants worth at least 5% of its investment assets each year.
  • Your foundation is only making grants to charitable organizations, not directly to grant recipients (with the possible exception of scholarship recipients).
  • Your foundation is filing IRS Form 990-PF annually, where applicable. 
  • Your foundation is paying an annual excise tax on its net investment income.
  • Your foundation is avoiding prohibited activities, such as allowing more than an insubstantial accrual of benefits to individuals and organizations, allowing income or assets to accrue to insiders, or participating in any political campaigns on behalf of or in opposition to a candidate.

Visit the IRS website for more details on IRS guidelines.

What About Donor Advised Funds?

A donor advised fund (DAF) is one potential alternative to a private family foundation. A DAF is essentially a charitable investment account established with a public charity. The account is then used to support qualified U.S. charitable organizations. Donor advised funds can bear your family name if you desire.

A fiduciary financial institution will manage the fund’s assets and handle all administrative duties, including federal filings. DAFs don’t require IRS approval so they’re easy to set up and feature low administrative fees.

One big difference between private family foundations and DAFs is there is not a 5% annual distribution requirement with a DAF. Another is that DAF grants can remain confidential while private family foundation grants must be reported publicly. DAFs also offer the potential for higher tax deductions: Up to 60% of adjusted gross income (AGI) for cash and 30% of AGI for securities, compared to 30% of AGI for cash and 20% of AGI for securities with private family foundations. There’s also no tax on investment income with DAFs, compared to the 1.39% excise tax on investment income with private family foundations.

Drawbacks to Consider

Despite the potential benefits, private family foundations aren’t right for every situation. They are complex legal structures that may require a substantial investment of time and money to establish and operate. Foundation managers must maintain detailed records of all financial transactions and grants and stay on top of all IRS requirements, which sometimes change.

In fact, the IRS recently announced that they will be increasing scrutiny on private family foundations. They will be looking especially for excessive salaries and unsecured and interest-free loans to family members. 

Work with a Trusted Advisor

Given the complexity involved, it’s often smart to work with team of experts when establishing a private family foundation. This includes a financial advisor, attorney, and accountant. Simon Quick has helped many families establish private family foundations to preserve wealth over generations and to direct their philanthropic efforts. 

We can help you decide if a private family foundation is the right vehicle based on your philanthropic goals and other relevant criteria. Visit us online, call us at (973) 525-1000 or send an email to info@simonquickadvisors.com to discuss your situation in detail.

About Bill Lalor

Mr. Lalor serves as the Head of Financial Planning where he employs his extensive experience to oversee the firm’s financial planning services. He is based in our Morristown, NJ office. His expertise includes tax, retirement, and cash flow planning, as well as executive compensation. He also manages some of the firm’s family relationships, endowments, and foundations. Mr. Lalor earned an MBA with a finance concentration from Rutgers Business School. He graduated with a BS from Rutgers School of Engineering where he majored in Ceramic and Materials Engineering. Mr. Lalor became a CERTIFIED FINANCIAL PLANNER™ practitioner in January 2007 after completing Fairleigh Dickinson University’s Program for Financial Planners in 2006. He completed his Chartered Financial Analyst (CFA) designation in 2014. To learn more about Bill visit his LinkedIn.


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