What do the last names Walton, Clinton, Bezos and Gates all have in common? Among other things, if you haven’t guessed already, they are all the titles of well-known family foundations. According to a study conducted by the Council on Foundations, family foundations make up over half of all private (family, corporate, independent and operating) foundations which is as much a testament to their effectiveness as it is to their popularity as a financial planning tool.
A family foundation is a type of private foundation whereby members of a family are generally involved in the initial funding and ongoing governance of its philanthropic mission. First introduced in the Tax Reform Act of 1969, a private foundation is recognized as a 501(c)(3) charitable organization and can be organized as a nonprofit corporation or a trust. Legally bound by its Articles of State Incorporation, private foundations are required to maintain a Board of Directors (typically three or more) and distribute 5% of its assets annually, generally in the form of grants). As a charitable entity, the private foundation receives exemption from income tax, but bears a 1-2% excise tax on investment income. The specific mission of a particular family foundation will vary, but much of the operational logistics are quite similar.
Advantages and Disadvantages
One of the primary advantages of a family foundation is that it provides a vehicle for tax deductible contributions while retaining control over the future giving of those contributions. The donor’s adjusted gross income and the nature of the property contributed determine the deductibility of contributions. Cash contributions are deductible up to 30% of the donor’s adjusted gross income while in-kind contributions of securities or property are deductible up to 20%. Both have five-year carryforward provisions as well. Another substantial advantage of the family foundation involves the legacy created beyond the dollars and cents. With no financial threshold required to start, a family can create a foundation simply to engage multiple generations and encourage the continual development of the foundation’s ongoing branding and charitable giving.
As for the disadvantages, managing a family foundation isn’t for the faint of heart. Operationally speaking, the responsibilities of tax filings, state filings, recordkeeping, fraud monitoring, legal review, governance and budgets are often where intention meets reality. As a legal entity, a private foundation must abide by all applicable laws and is held to a high standard of prudence by the State’s Attorney General and the IRS. Any violations of prohibited activity or negligence can subject the foundation to additional taxes as well as penalties on the liable individuals. The question then becomes, is there an alternative to the family foundation?
Alternatives to the Family Foundation
One such alternative is a donor-advised fund which is a program of a public charity or mutual fund. Through this vehicle, individuals can make contributions, take immediate tax deductions and still retain influence by recommending grants to various charities at a future date. There is one meaningful catch though: the beneficiary of your contribution to a donor-advised fund cannot be a private foundation. For some, this restriction may prove too great of a roadblock, however, donor-advised funds may still offer a viable solution given its lower cost and administrative efficiency.
Unlike a family foundation, a donor-advised fund does not require legal filings or ongoing administration and while overall costs vary some, they are a fraction of the overall cost of running a foundation. Another added benefit is that professional investment management is already built into the donor-advised fund and there are no excise taxes on investment income generated. Furthermore, the deductibility of the donations themselves compares favorably to private foundations. Cash contributions are deductible up to 50% of the donor’s adjusted gross income and in-kind contributions of securities or property are deductible up to 30%. Both have the same five-year carryforward provision as well.
Faced with creating a private family foundation and thereby retaining greater control over the assets or utilizing a lower cost donor-advised fund, both offer invaluable financial planning options when it comes to charitable giving.
Please contact any of the professionals in The Wealth Office™ for more information on the nuances of these programs or to discuss the resources of DiMeo Schneider & Associates, L.L.C.
