Private
Foundations
& Donor Advised Funds
All slides are
taken from this
book.
Available from
Amazon.com
Full Color version available at
www.createspace.com/4707238
Private foundations (non-operating)
and donor advised funds hold
money and distribute grants
78%
14%
5% 3%
Assets
81%
3% 14%
2%
Charitable Distributions Private
Foundations
(non-operating)
Charitable
Remainder
Trust...
0
2
4
6
8
10
12
14
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
$Billions
Total Assets in Fidelity,
Schwab, and ...
Psychology’s “terror management theory”
suggests a defense to mortality reminders
is to create symbolic immortality (one’s...
Dead
• Josiah K. Lilly (1948)
• Edsel Ford (1943)
• Robert Wood
Johnson II (1968)
• W.K. Kellog (1951)
• Andrew W. Mellon
...
The rules of a private foundation
can be permanent
This differs from leaving
an inheritance or
company where later
generat...
A private foundation allows donor and
descendents to control the foundation
assets and charitable payouts indefinitely
A private
foundation
can transmit
values by
involving
descendents
in specific
charitable
causes for
many
generations
Three types of charitable organizations
Public charity
Supporting organization
Private foundation
Public Charity
• Publicly supported
OR
• Operates ongoing
traditional
charitable activity
(e.g., hospital,
church, school)...
Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
cha...
Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
cha...
Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
cha...
At least 1/10 of
total support1
from small donors2
Typical private
foundation
• Funded by one
person, family,
or corporati...
Typical private
foundation
• Funded by one
person, family,
or corporation
• Makes grants,
rather than
directly running
cha...
or Charitable Trust
Under state
law create a…
Obtain federal tax
exempt status Initial Application
1023
Annual filing
990-...
Private foundations can be large,
but most aren’t
26%
39%
28%
4% 3%
Asset Size: Non-Operating Private Foundations
$1 under...
Foundation board
• Often the donor and close family members
• Can establish rules for succession
– Descendents who meet ce...
Tax rules for private foundations
Tax on net
investment income
• 2% tax on net
investment income
• Drops to 1% If
charitable grants ≥
assets X (avg. % payou...
Gifts to private foundations also have
lower income-based deductibility limits
Current Value: $25
1990 Paid $1
Long-term capital gain
(special election)
Tangible personal
property
(“unrelated” use)
Cas...
Current Value: $25
1990 Paid $1
Long-term capital gain
(no special election)
Tangible personal
property
(“related” use)
Ca...
Current Value: $25
1990 Paid $1
Long-term capital gain
(any)
Tangible personal property
(“related” or “unrelated” use)
Cur...
Charitable Purposes
To protect charitable distributions, many
transactions are prohibited or penalized
Insider Benefits
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
•...
IRS punishments for
transactions that
break the rules
include:
• Initial tax (10%-
30%)
• Additional tax if
transaction no...
Who is an insider (A.K.A.
a “disqualified person”)?
Insider Benefits Charitable Purposes
Insider or “Disqualified Person”
• Officer, director, trustee, or any employee with
responsibility for the act
• Ancestor,...
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
•...
Self-Dealing
• Sell, exchange, lease,
transfer or loan money,
goods, services,
property, or facilities to a
disqualified p...
Bargain sale
Suppose a
disqualified person
is willing to sell a
$200,000 property
to the foundation
for $10,000?
Bargain sale
Suppose a disqualified person gives a $200,000
property (with a recent $12,000 mortgage) to the
foundation?
(...
Self-Dealing Penalty
• Disqualified person taxed 10% of transaction (+5% tax
on foundation manager who knowingly participa...
Free gifts to the foundation of
money, property, or use of
money or property are allowed
Foundation can hire an insider to perform
necessary professional or managerial
services (called “personal services”) if
co...
Reimbursements of reasonable and necessary
expenses such as meals and travel
• Travel to foundation board meetings for boa...
Private foundations
allow for unlimited
multi-generational,
nearly tax-free (1%-2%)
control of wealth,
with ongoing abilit...
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
•...
The foundation must
distribute at least 5% of
non-charitable net assets
under its control by the end
of the following tax ...
Non-charitable net assets excludes
charitable assets and assets not yet
under foundations’ control
No charitable assets:
u...
5% payout is
reduced by
investment
tax and
unrelated
business
income tax
Administrative expenses
for grant-making or
fundraising (but not
investment management)
also count as charitable
expenditu...
5% can be spent on grants
to charity including
designated purpose funds,
but NOT to
• Another non-operating
foundation
• C...
Buying or improving assets used
directly in charitable purposes also
count towards 5%
Buying or improving
assets used directly
in charitable
purposes also count
towards 5%
Can the foundation
postpone payouts
to save up for a big
gift?
Yes. If…
• It is for a project better
accomplished through set
aside than by immediate
payout (e.g., constructing
a buildi...
If the foundation
makes a big gift,
will the amount
above 5% carry
over to future
years?
If the foundation
makes a big gift,
will the amount
above 5% carry
over to future
years?
Yes.
Gifts above 5%
can carry
for...
• Foundation pays a tax of 30% of required amount not
distributed
• Additional 100% if not corrected in 90 days of IRS not...
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
•...
What’s the problem with
excess business holdings?
• Donor still controls
the business even
though he has taken
a charitable
deduction
• Donor decides if any
profit is distr...
Foundation +
Insiders
20%
+15% If
Another Has
Effective
ControlOthers
65%
Private foundation can’t own >2% if foundation a...
• Charitable function such
as a school or hospital
• Business run by unpaid
volunteers or selling
donated items
• Business...
Full ownership is
allowed if business is
passive – simply
collecting dividends,
interests, royalties, or
real estate rent ...
Time to dispose of
excess business holdings
• 90 days if foundation buys
• 5 years if foundation
receives as a gift [and c...
• Foundation pays a tax of 10% of highest business
holdings above maximum
• Up to 200% if not corrected in 90 days of IRS ...
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
•...
Crazy investment
gambles can
jeopardize the
charitable purpose
Nothing is
automatically
disqualified, but
special attention
given to options,
margin trading,
short selling,
commodity
fu...
High risk investments
are allowed if they are
primarily charitable
• Needy student loans
• Low-income housing
• Urban rene...
• Foundation pays a tax of 10% of the jeopardizing
investment (manager pays 5%, up to $10k)
• Another 25% if not corrected...
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
•...
Taxable expenditures
• Non-charitable purposes
• Political campaigning or
lobbying (except non-
partisan research)
• Grant...
• 20% of the taxable expenditure (manager pays 5% up
to $10k if no reasonable cause)
• Another 100% if not corrected withi...
What if creating a private
foundation is just too much hassle?
I give to a donor
advised fund and
“advise” when and
where it will be
distributed to other
charities
Donor Charities
The Donor Advised Fund
Donor’s
DAF
$
$
Sponsoringcharityhaslegal
ownershipofDAFs
$
Gifts are to a public
c...
Donor advised fund
• No minimum payout
• Minimal setup &
administrative expense
• Expected control of grants
• Investment ...
End of year DAF contributions pull
forward deductions
Many use DAFs as a short-
term conduit to take an
earlier tax deduct...
DAF Limitations
• No benefits (grants, loans, compensation, or indirect benefit) to
donor, family, or organizations 35%+ c...
Private
Foundations
& Donor Advised Funds
Help me
HERE
convince my bosses that continuing to build and
post these slide sets is not a waste of time. If
you work for...
If you clicked on
the link to let
me know you
reviewed these
slides…
Thank
You!
This slide set is from the curriculum for
the Graduate Certificate in Charitable
Financial Planning at Texas Tech
Universi...
Private foundations
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Private foundations

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An overview of private foundations (non-operating) for the financial advisor, planned giving officer, or philanthropist interested in learning about the legal and tax structure.

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Private foundations

  1. 1. Private Foundations & Donor Advised Funds
  2. 2. All slides are taken from this book. Available from Amazon.com Full Color version available at www.createspace.com/4707238
  3. 3. Private foundations (non-operating) and donor advised funds hold money and distribute grants
  4. 4. 78% 14% 5% 3% Assets 81% 3% 14% 2% Charitable Distributions Private Foundations (non-operating) Charitable Remainder Trusts Donor Advised Funds Charitable Lead Trusts Private Foundations are the Dominant Charitable Planning Vehicles Combining 2010 data from IRS Statistics of Income (PF, CRT & CLT) and National Philanthropic Trust (DAF)
  5. 5. 0 2 4 6 8 10 12 14 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 $Billions Total Assets in Fidelity, Schwab, and Vanguard Donor Advised Funds Donor Advised Funds are Growing Rapidly
  6. 6. Psychology’s “terror management theory” suggests a defense to mortality reminders is to create symbolic immortality (one’s name, impact, story will live on)
  7. 7. Dead • Josiah K. Lilly (1948) • Edsel Ford (1943) • Robert Wood Johnson II (1968) • W.K. Kellog (1951) • Andrew W. Mellon (1937) • John D. Rockefeller (1937) Alive • Lilly Endowment • Ford Foundation • Robert Wood Johnson Foundation • W.K. Kellog Foundation • Andrew W. Mellon Foundation • The Rockefeller Foundation
  8. 8. The rules of a private foundation can be permanent This differs from leaving an inheritance or company where later generations make all rules
  9. 9. A private foundation allows donor and descendents to control the foundation assets and charitable payouts indefinitely
  10. 10. A private foundation can transmit values by involving descendents in specific charitable causes for many generations
  11. 11. Three types of charitable organizations Public charity Supporting organization Private foundation
  12. 12. Public Charity • Publicly supported OR • Operates ongoing traditional charitable activity (e.g., hospital, church, school) Private Foundation • Default if charity not a public charity or supporting organization
  13. 13. Typical private foundation • Funded by one person, family, or corporation • Makes grants, rather than directly running charitable activity • Expenditures funded by investment income
  14. 14. Typical private foundation • Funded by one person, family, or corporation • Makes grants, rather than directly running charitable activity • Expenditures funded by investment income Traditional charity (e.g., operates church, hospital, school)
  15. 15. Typical private foundation • Funded by one person, family, or corporation • Makes grants, rather than directly running charitable activity • Expenditures funded by investment income Publicly- supported charity Atleast1/3of totalsupport1 fromsmall donors2 1Includesgiftsandinvestmentincomeoverlast4years.Largeunusualgiftsfromoutsiderscanbe excluded. 2Giftsfromthosegiving≤2%oftotal supportandanysupportfromgovernment
  16. 16. At least 1/10 of total support1 from small donors2 Typical private foundation • Funded by one person, family, or corporation • Makes grants, rather than directly running charitable activity • Expenditures funded by investment income operated to attract new public or government support Smells like public charity “facts and circumstances” that it is a public charity 1Includesgiftsandinvestmentincomeoverlast4years.Largeunusualgiftsfromoutsiderscanbe excluded. 2Giftsfromthosegiving≤2%oftotal supportandanysupportfromgovernment
  17. 17. Typical private foundation • Funded by one person, family, or corporation • Makes grants, rather than directly running charitable activity • Expenditures funded by investment income Atleast1/3oftotalsupport1 from memberships+charitable operations+smalldonors2 No more than 1/3 of total support1 from investment income 1 Includesgiftsandinvestmentincome.Largeunusualgiftsfrom outsiderscanbeexcluded 2Includessupportfromgovernment Public charity by receipts
  18. 18. or Charitable Trust Under state law create a… Obtain federal tax exempt status Initial Application 1023 Annual filing 990-PF Create a Private Foundation Flexible; lower UBIT rates More founder control; foreign operations eliminate deductibility for corporate donors Nonprofit Corporation 1. 2.
  19. 19. Private foundations can be large, but most aren’t 26% 39% 28% 4% 3% Asset Size: Non-Operating Private Foundations $1 under $100,000 $100,000 under $1MM $1MM under $10MM $10MM under $25MM $25MM or more Source: IRS Statistics of Income for 2010. Domestic Private Foundations: Number and Selected Financial Data, by Type of Foundation and Size of End-of-year Fair Market. Excluding those not reporting any assets
  20. 20. Foundation board • Often the donor and close family members • Can establish rules for succession – Descendents who meet certain criteria – Unequal voting rights allowable – Junior board for minors advising on small gifts
  21. 21. Tax rules for private foundations
  22. 22. Tax on net investment income • 2% tax on net investment income • Drops to 1% If charitable grants ≥ assets X (avg. % payout in the last five years) + 1% of net investment income
  23. 23. Gifts to private foundations also have lower income-based deductibility limits
  24. 24. Current Value: $25 1990 Paid $1 Long-term capital gain (special election) Tangible personal property (“unrelated” use) CashOrdinary income property Inventory Short-term capital gain Public Charity Public Charity
  25. 25. Current Value: $25 1990 Paid $1 Long-term capital gain (no special election) Tangible personal property (“related” use) CashOrdinary income property Inventory Short-term capital gain Public Charity Private Foundation (non-operating)
  26. 26. Current Value: $25 1990 Paid $1 Long-term capital gain (any) Tangible personal property (“related” or “unrelated” use) Current Value: $25 1990 Paid $1 Private Foundation (non-operating) Private Foundation (non-operating)
  27. 27. Charitable Purposes To protect charitable distributions, many transactions are prohibited or penalized Insider Benefits
  28. 28. • Self-dealing • Failure to distribute income • Excess business holding • Investments that jeopardize charitable purpose • Taxable expenditures Insider Benefits Charitable Purposes
  29. 29. IRS punishments for transactions that break the rules include: • Initial tax (10%- 30%) • Additional tax if transaction not corrected (25%- 200%) • Revoking exemption
  30. 30. Who is an insider (A.K.A. a “disqualified person”)? Insider Benefits Charitable Purposes
  31. 31. Insider or “Disqualified Person” • Officer, director, trustee, or any employee with responsibility for the act • Ancestor, spouse, descendent, or spouse of descendent of above • Corporation, trust, or partnership owned 35% or more by above • Substantial contributor  >2% of all contributions from foundation start to end of tax year (+>5K total contributions)  Grantors of a charitable trust automatically qualify
  32. 32. • Self-dealing • Failure to distribute income • Excess business holding • Investments that jeopardize charitable purpose • Taxable expenditures Insider Benefits Charitable Purposes
  33. 33. Self-Dealing • Sell, exchange, lease, transfer or loan money, goods, services, property, or facilities to a disqualified person • Paying a government official
  34. 34. Bargain sale Suppose a disqualified person is willing to sell a $200,000 property to the foundation for $10,000?
  35. 35. Bargain sale Suppose a disqualified person gives a $200,000 property (with a recent $12,000 mortgage) to the foundation? (Payment of the insider’s debt is a benefit, but allowed if debt is 10+ years old)
  36. 36. Self-Dealing Penalty • Disqualified person taxed 10% of transaction (+5% tax on foundation manager who knowingly participates) • Must correct in 90 days of IRS notice else disqualified person taxed 200% (+50% tax on foundation manager)
  37. 37. Free gifts to the foundation of money, property, or use of money or property are allowed
  38. 38. Foundation can hire an insider to perform necessary professional or managerial services (called “personal services”) if compensation is reasonable • Investment advice • Legal work • Accounting/tax services • Banking • Administrative assistance The Council on Foundations’ Foundation Management Report contains compensation information for various positions
  39. 39. Reimbursements of reasonable and necessary expenses such as meals and travel • Travel to foundation board meetings for board members (and junior board members who perform some functions in that role) • Travel to grantees or potential grantees sites to investigate current or potential awards
  40. 40. Private foundations allow for unlimited multi-generational, nearly tax-free (1%-2%) control of wealth, with ongoing ability to provide insider travel and employment for professional/ management services, and limiting charitable activities to founder’s desires
  41. 41. • Self-dealing • Failure to distribute income • Excess business holding • Investments that jeopardize charitable purpose • Taxable expenditures Insider Benefits Charitable Purposes
  42. 42. The foundation must distribute at least 5% of non-charitable net assets under its control by the end of the following tax year
  43. 43. Non-charitable net assets excludes charitable assets and assets not yet under foundations’ control No charitable assets: used for charitable purposes, such as paintings on loan to a museum, or office furniture used to manage the foundation No assets not yet under foundation’s control: a right to receive property after death, after estate administration, or after payment of a pledge.
  44. 44. 5% payout is reduced by investment tax and unrelated business income tax
  45. 45. Administrative expenses for grant-making or fundraising (but not investment management) also count as charitable expenditures towards the 5%
  46. 46. 5% can be spent on grants to charity including designated purpose funds, but NOT to • Another non-operating foundation • Charity controlled by the foundation or disqualified persons • Donor advised funds
  47. 47. Buying or improving assets used directly in charitable purposes also count towards 5%
  48. 48. Buying or improving assets used directly in charitable purposes also count towards 5%
  49. 49. Can the foundation postpone payouts to save up for a big gift?
  50. 50. Yes. If… • It is for a project better accomplished through set aside than by immediate payout (e.g., constructing a building) • Pay out within 60 months of first set-aside
  51. 51. If the foundation makes a big gift, will the amount above 5% carry over to future years?
  52. 52. If the foundation makes a big gift, will the amount above 5% carry over to future years? Yes. Gifts above 5% can carry forward for up to 5 years
  53. 53. • Foundation pays a tax of 30% of required amount not distributed • Additional 100% if not corrected in 90 days of IRS notice Penalty for Failure to Distribute
  54. 54. • Self-dealing • Failure to distribute income • Excess business holding • Investments that jeopardize charitable purpose • Taxable expenditures Insider Benefits Charitable Purposes
  55. 55. What’s the problem with excess business holdings?
  56. 56. • Donor still controls the business even though he has taken a charitable deduction • Donor decides if any profit is distributed to the foundation • Donor controls his (and other’s) compensation at the business Foundation
  57. 57. Foundation + Insiders 20% +15% If Another Has Effective ControlOthers 65% Private foundation can’t own >2% if foundation and all disqualified persons combined own >20% of a company (35% if someone else has effective control)
  58. 58. • Charitable function such as a school or hospital • Business run by unpaid volunteers or selling donated items • Business for beneficiaries /employees such as a museum cafeteria Full ownership of a charitable business is allowed
  59. 59. Full ownership is allowed if business is passive – simply collecting dividends, interests, royalties, or real estate rent without leverage
  60. 60. Time to dispose of excess business holdings • 90 days if foundation buys • 5 years if foundation receives as a gift [and can request extension for another 5 years if unusual circumstances]
  61. 61. • Foundation pays a tax of 10% of highest business holdings above maximum • Up to 200% if not corrected in 90 days of IRS notice Excess Business Holding Penalty
  62. 62. • Self-dealing • Failure to distribute income • Excess business holding • Investments that jeopardize charitable purpose • Taxable expenditures Insider Benefits Charitable Purposes
  63. 63. Crazy investment gambles can jeopardize the charitable purpose
  64. 64. Nothing is automatically disqualified, but special attention given to options, margin trading, short selling, commodity futures, oil/gas interests Jeopardizing investments are excessively risky in the context of entire portfolio (“fails to exercise ordinary business care and prudence”)
  65. 65. High risk investments are allowed if they are primarily charitable • Needy student loans • Low-income housing • Urban renewal
  66. 66. • Foundation pays a tax of 10% of the jeopardizing investment (manager pays 5%, up to $10k) • Another 25% if not corrected within 90 days of IRS notice (manager pays another 5%, up to $20k) Jeopardizing Investment Penalty
  67. 67. • Self-dealing • Failure to distribute income • Excess business holding • Investments that jeopardize charitable purpose • Taxable expenditures Insider Benefits Charitable Purposes
  68. 68. Taxable expenditures • Non-charitable purposes • Political campaigning or lobbying (except non- partisan research) • Grants to individuals except – Travel, study, or similar if IRS approves non-discriminatory award process – Grants to impoverished persons or disaster victims – Prizes/awards to recognize achievement with no restrictions on use of funds
  69. 69. • 20% of the taxable expenditure (manager pays 5% up to $10k if no reasonable cause) • Another 100% if not corrected within 90 days of IRS notice (manager pays another 50%, up to $20k) Taxable Expenditures Penalty
  70. 70. What if creating a private foundation is just too much hassle?
  71. 71. I give to a donor advised fund and “advise” when and where it will be distributed to other charities
  72. 72. Donor Charities The Donor Advised Fund Donor’s DAF $ $ Sponsoringcharityhaslegal ownershipofDAFs $ Gifts are to a public charity, because charity has legal ownership Charity follows donor advice, otherwise no one would give again $
  73. 73. Donor advised fund • No minimum payout • Minimal setup & administrative expense • Expected control of grants • Investment management sometimes allowed • Legislatively new • High income limits & valuations • No tax on earnings Private foundation • 5% minimum payout • Significant setup & administrative expense • Legal control of grants • Investment management always allowed • Legislatively stable • Low income limits & valuations • 1% or 2% tax on earnings
  74. 74. End of year DAF contributions pull forward deductions Many use DAFs as a short- term conduit to take an earlier tax deduction for expected future gifting to charities
  75. 75. DAF Limitations • No benefits (grants, loans, compensation, or indirect benefit) to donor, family, or organizations 35%+ controlled by these. Ex: no major donor event tickets • No excess business holdings (same rule as private foundations) • No distributions to private foundations (rare exceptions) or individuals
  76. 76. Private Foundations & Donor Advised Funds
  77. 77. Help me HERE convince my bosses that continuing to build and post these slide sets is not a waste of time. If you work for a nonprofit or advise donors and you reviewed these slides, please let me know by clicking
  78. 78. If you clicked on the link to let me know you reviewed these slides… Thank You!
  79. 79. This slide set is from the curriculum for the Graduate Certificate in Charitable Financial Planning at Texas Tech University, home to the nation’s largest graduate program in personal financial planning. To find out more about the online Graduate Certificate in Charitable Financial Planning go to www.EncourageGenerosity.com To find out more about the M.S. or Ph.D. in personal financial planning at Texas Tech University, go to www.depts.ttu.edu/pfp/ Graduate Studies in Charitable Financial Planning at Texas Tech University

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