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Would You Like to Start Your Own Charitable Private Foundation?

Many individuals, families and companies enjoy operating their own private foundations to make grants to charities for worthy causes that are important to them. Unlike a public charity, a private foundation is a charitable organization that is usually supported by just a few donors, possibly one person, one family or a company. Here is some information about starting your own private foundation! 

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Many individuals, families and companies enjoy operating their own private foundations to make grants to charities for worthy causes that are important to them. Unlike a public charity, a private foundation is a charitable organization that is usually supported by just a few donors, possibly one person, one family or a company. Here is some information about starting your own private foundation! 

Many individuals, families and companies enjoy operating their own private foundations to make grants to charities for worthy causes that are important to them. Unlike a public charity, a private foundation is a charitable organization that is usually supported by just a few donors, possibly one person, one family or a company 

Here is some information about starting your own private foundation!  

Set up an entity  

The first action step is to set up a separate legal entity, which is usually done by legal counsel. The entity may be a corporation or a trust. The articles of incorporation or trust instrument will need to include all the legal requirements under state lawthe dos and don’ts of operating a charitable private foundation. 

Apply to the Internal Revenue Service for tax-exemption  

The next action step is to apply to the Internal Revenue Service (IRS) for federal income tax-exemption by completing Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.  

The IRS Form 1023 is a one-time filing and asks questions about your Foundation’s organizational structureif it has the required tax provisions in your organizing document; a narrative description of your activities; compensation and other financial arrangements planned with your insiders and independent contractors; who will receive benefits from your Foundation; specific planned activities; financial projections; and whether the entity will be a public charity or a private foundation.  

You will need to apply for an employer identification number for the entity in order to file the Form 1023, as well as open a bank account, etc. A filing fee is also required.  

The IRS will review the tax-exempt application, a process that may take several months. If everything is acceptable and in order, the Service will send your Foundation a “determination letter” stating that the Foundation qualifies for federal income tax exemption and is a private foundation.  

Decisions, decisions, decisions 

But before taking these action steps to create your Foundation, you will have a number of practical decisions to make. 

Governance  

Who will be the Foundation’s board members? Will you have a written conflict of interest policy? Will your Foundation compensate anyone? It’s important to ensure that all the board members understand the fiduciary responsibility of serving on the board of a charity, any charity, including your private foundation. It’s a great idea to have a written conflict of interest policy, and the IRS does have a sample for foundations to use or to tailor. And although most grant-making private foundations don’t compensate their board members or officers, this is a decision you will need to make for your own Foundation. 

Funding your Foundation 

Who will fund your Foundation? You? Your family? Your company? An estate? Will there be a one-time contribution to start the Foundation off on its wayor will there be continual donations into the Foundation over a number of years? 

Cash and publicly traded stocks are the most common assets to be donated into a private foundation. Donations of other noncash assets into a private foundation are trickier and often don’t result in the favorable tax deductions expected.   

Make sure your Foundation provides you with required tax receipts needed to claim charitable contribution deductions for your income tax returns. It may feel like you are writing the tax receipt out to yourself, but actually it is the Foundation, as a charitable entity, that is providing you, the donor, with the written charitable acknowledgement. And make sure there is a process for providing donors with appropriate receipts in the future, as well, if needed.  

Investments  

You will also want to consider what types of investments your Foundation will hold and if you will need an investment manager. The board members will want to weigh the various options of prudent investing, and must be aware of certain complex restrictions for private foundations that have any sophisticated investments. Congress doesn’t want Foundations to invest in anything too risky, which are called “jeopardy investments.” 

Accounting and tax  

The foundation managers will need to decide who will take care of the administrative tasks of record-keeping, accounting and tax preparation. Some volunteer board members enjoy doing these activities themselves, whether or not this is within their professional expertise. Others outsource these functions and focus on the strategy and grant-making decisions. 

In either case, you may want to ensure you have access to highly specialized legal and/or tax professionals who are expert in private foundation tax law just in case one of your board members suggests your Foundation engage in anything other than plain vanilla activities, investing and grant-making, etc. It is not unusual for foundations to inadvertently run afoul of the very strict private foundation tax rules, so you do want to avoid that, which can end up costing more time and money in the long run. 

Grant-making 

Who is going to benefit from your Foundation’s grant-making? Will all grants be to qualified U.S. public charities? Will they be a certain type of charity, a particular cause or in a particular geographic region?   

Will your Foundation accept grant requests or will it only make grants to pre-selected charities?  

Would you like to provide scholarship grants to students? Will it make grants to any organizations that aren’t charities or to any foreign grantees? If the grants are not all to U.S. qualified public charities, you will need to be very careful. If any grants are made to foreign charities there are very specific time-consuming requirements and procedures to follow. If you would like your Foundation to provide scholarships to individuals, you will need pre-approval from the IRSreceived by request via a special attachment to the Form 1023 exemption application. Then your Board will need to follow the objective and nondiscriminatory process when your Foundation makes scholarship grants to individuals.  

Net investment income excise tax 

Yes, there is some tax your Foundation may need to pay. If the Foundation has any employees, there will be payroll taxes. If the Foundation invests in certain types of alternative investments, it may have federal and/or state unrelated business income tax.  

But the most common tax for private foundations is the net investment excise tax. This is a 2% excise tax on the Foundation’s net investment income. If the Foundation’s grant-making reaches a certain threshold each year, based on a five-year average of the charitable expenditures made as a percentage of the fair market of the investments, then your Foundation may qualify for a 1% excise tax. Many Foundations do annual planning to qualify for the 1% rather than the 2% tax. Your Foundation may need to pay in quarterly tax estimates as well. 

Distribution requirements  

Private foundations also have annual distribution requirements. The calculation of the distribution requirement is fairly specific, but very generally, it is requirement to distribute 5% of the average fair market value of the assets. Your Foundation has until the end of the following tax year to make its annual distribution requirement.  

For more information  

If you are serious about starting a private foundation, you will want to do a bit of researchespecially if this is your first time. There is plenty of information available. Here are some sources of information for you.  

The IRS has information on its website about the life cycle of a private foundation. Here is the link regarding creating a private foundation. https://www.irs.gov/charities-non-profits/private-foundations/life-cycle-of-a-private-foundation-starting-out  

Additionally, blumshapiro has published a three-part series on private foundations: 

Feel free to call us, as well866.356.BLUM. 

Conclusion 

Starting a private foundation is fairly straightforward. But unless you keep it simple, things can get complicated quickly. Make sure your Board educates itself and/or engages highly qualified professional advice. Then you and your Board can enjoy making the world a better place! 

 

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.  

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