A Foundation for
Your Giving?

You've achieved success. Now you want to give something back. You've been thinking about creating a private foundation. But is that really the best choice for you?

Private or family foundations have found increased popularity in recent years as an estate planning tool for community support, wealth distribution and tax planning. According to The Foundation Center, the New York-based organization that tracks foundation philanthropy in the United States, there were more than 30,000 family foundations throughout the U.S. in 2003, the most recent year for which figures are available. This is an almost 50% increase from only four years prior. Together, family foundations gave more than $12 billion, more than half of all giving identified by independent foundations.

Foundations Offer Benefits and Drawbacks
Establishing a foundation offers many benefits over making direct contributions to charity. For instance, you can establish and fund a private foundation when you experience unusually high income that you want to shelter with money you will eventually give to charity. This allows you to accelerate charitable income tax deductions to a high tax bracket year while controlling the timing of the donated funds. Any value of the contribution over the amount deductible in the current year can be carried forward and deducted over the following five years. Or, you can fund your foundation using low cost-basis, highly appreciated assets such as publicly traded stocks. And property you transfer to a private foundation during your lifetime eliminates the property and its income from your gift and estate tax base.

A private foundation also gives you control and flexibility over your charitable giving. For example, a private foundation, whether structured as a not-for-profit corporation or a wholly charitable trust, can establish programs within the community for education, scholarships, the arts and more, or it can support existing charitable organizations through grant giving. Distributions to be made after your disability or death will be governed by the terms of the document creating your foundation.

On the other hand, foundations require a substantial commitment of time and money, which means they aren’t the best answer for everyone. For some, a donor advised fund or a different type of charitable trust may be more appropriate for achieving their philanthropic and estate planning goals (see page 20 for more on other options).

Is a Foundation Right for You?
Before deciding which charitable vehicle is right for you, you need to clearly define your goals for giving and the amount of time and energy you want to devote to your philanthropic interests.

A private foundation must annually distribute at least 5% of its net investment assets, whether or not the amount is actually earned. Therefore, private foundations generally involve a substantial commitment of funds, typically $1 million or more. They also require a substantial time commitment by the donor to review grant applications, do site visits to potential recipients and administer the foundation’s activities. For this reason, they are best suited for people who intend to give away sizeable sums and want to take a relatively active role in their charitable activities. A private foundation may also be a good option for donors who want future generations to also be active in philanthropic endeavors.

You want to be sure you clearly understand the features and the commitment, both now and in the future, before establishing a foundation. If a private foundation needs to be terminated, the rules are complex and fraught with potential consequences, including a private foundation termination tax.

The best way to determine whether a foundation is the best vehicle for achieving your philanthropic goals is to clearly define those goals and then discuss them with your advisors. Here are some possible situations people have faced in transforming their giving into strategic philanthropy, and the vehicles they discovered that worked best for them.

Improve Education
Kendra and Danny had always felt strongly about the importance of education. With their children in college and starting their own careers, they felt they could shift their focus to helping other children. Kendra and Danny wanted to become more involved in their giving, and to seek out and support organizations in their community that were already making a difference in children’s lives. Kendra and Danny also had a sizeable holding of highly appreciated publicly traded stock, and their investment advisor felt they should consider selling it to diversify their portfolio.

After discussing their plans with their advisors, Kendra and Danny decided to create a private foundation and fund it with the stock, valued at $5 million, in a series of gifts over the next five years. Using the highly appreciated stock allowed Kendra and Danny to take a current income tax deduction and to avoid more than $70,000 of capital gains tax. The corporate trustee Kendra and Danny hired to administer the foundation was able to sell the stock and invest the proceeds in a more diversified portfolio, from which the foundation’s grants will be made.

Kendra and Danny wrote a mission statement for their foundation, clearly spelling out their philanthropic goals. They named themselves as co-trustees with full grant-making authority. During the first several years, while they were both still working, they chose to make grants only for the 5% of the foundation’s value they were required to distribute each year. After they retired and had more time to devote to reviewing grant applications, they increased the foundation’s programs significantly. The foundation’s trustee handled all of the tax reporting requirements, managed the investment portfolio and sent out grant checks as directed by Kendra and Danny.

They also specified in their foundation documents that upon their deaths, the foundation will distribute its remaining funds to their alma mater to create an endowed education chair and then terminate.

Fund a Wing for the Museum
Saul has been an avid photography collector since his youth. Over the years, he amassed a substantial collection of rare photographs. The local art museum had a small photography department and Saul wanted to help it do more. He decided to donate his photography collection to the museum and help the museum build a new wing to house it.

Saul wanted more control over his gift than he felt an outright donation would give him, so he went to his advisors to create a private foundation. However, after talking to Saul about his goals for giving, Saul’s advisors recommended against the foundation. Because Saul’s philanthropic goals were specific to one organization — his local art museum — creating a supporting organization was a better route to help him achieve his philanthropic goals.

In light of the tax rules governing gifts of art work, Saul’s advisors recommended he give the photography collection directly to the museum. This will allow him to take a tax deduction for the full market value, based on a new appraisal. Then Saul and his advisors established a trust to finance a new wing at the art museum to house the photography collection. The trust is overseen by a professional trustee, and the agreement names Saul, the museum’s director and the photography curator as co-trustees and members of the advisory board. A portion of the trust will fund construction of the new wing, and the remainder will serve as a permanent endowment to fund future photography acquisitions.

Get the Children Involved
Anita was an executive in a large publicly traded company. When she left the company, she decided to use some of her company stock to create a charitable legacy for herself and her family. She was also concerned that her children, ages 10 and 15, had a sense of entitlement and lacked fiscal and social responsibility.

Anita met with her advisors, who determined that a family foundation — a private foundation in which the founder or the founder’s family plays a significant governing role — would be the best way to help Anita achieve her goals. A family foundation would allow Anita to create a lasting charitable legacy for her family. At the same time, by getting her children involved in the foundation, she would help them become more fiscally competent and create a sense of social responsibility.

Anita funded the foundation with some of her company stock, receiving a tax-deduction and reducing her concentrated holding. She also received a charitable contribution carryforward for the next five years for the amount of the donation that exceeded 20% of her adjusted gross income, the annual deduction limit for stock donated to a private foundation.

In her foundation documents, Anita named her two children to a junior board, and made each of them responsible for researching and awarding a small grant each year. She also involved the children in creating a mission statement for the family’s philanthropic activities. Upon her death, two new foundations will be created from the remaining family foundation assets, with each of her children acting as trustee of their own foundation. This will allow the family’s philanthropic activities to continue, even if the children have different philanthropic visions.

Making the Right Choice
To ascertain if the private foundation is the right solution, first determine what you are trying to accomplish with your philanthropy and why. Are you trying to set up an entity that will continue in perpetuity? Do you want to establish a philanthropic effort that will involve your family, children and grandchildren? Do you want to take ownership of your giving in a way that is much more hands-on than just writing a check?

Director/Trustee Compensation Under IRS Scrutiny

Photography by Peter Dazeley/Getty Images A private foundation can be set up as either a not-for-profit corporation, managed by a board of directors, or as a wholly charitable trust, managed by trustees. The directors or trustees you name can be paid reasonable compensation for their services but otherwise generally cannot receive benefits from the foundation. This holds true for you and any members of your family who serve as directors or trustees. In the past, donors often compensated younger family members while they “learned the ropes.” However, this may not be the best practice today. Both the IRS and Congress have been focusing attention on excessive compensation. In fact, the Senate Finance Committee has been holding hearings on charitable abuses as it prepares for the first overhaul of tax laws governing charity since 1969. To avoid running afoul of regulators, be certain to err on the conservative side when determining compensation for family member directors or trustees. A good practice would be to compensate family members for actual hours worked, based on a benchmark rate paid by other foundations of similar size (for example, based on the compensation rates published in the Council on Foundations’ annual Grantmakers Salary and Benefits Report).

Beyond Foundations: Other Options for Giving

Photography by Andrew Olney/Masterfile Even if a private foundation isn’t right for you, there are a number of vehicles for charitable giving that can increase control over your giving and help maximize the effect of every dollar. In a donor advised fund, a sponsoring public charity holds a fund through which you make irrevocable contributions. You as the donor, or a committee you establish, can then recommend to the charity where to direct grants from the fund, although the sponsoring charity retains the right to make the ultimate decision on distributions. These funds generally provide a current income tax deduction for a lifetime contribution, and can be established in less time and with a smaller initial outlay than a foundation typically requires. A charitable remainder trust (CRT) helps you benefit a charity, provide an income stream for yourself, a family member, or another individual, while potentially giving you substantial tax savings. When you establish a CRT, you or your beneficiaries can receive payments from the trust for life, or for a specific term such as 20 years. After a beneficiary’s death, the remaining assets are distributed to a chosen charity or charities. A charitable lead trust (CLT) is the reverse of a CRT. With this trust, a charity receives regular payments over a certain number of years. Once the charitable term expires, the remaining assets are distributed directly or in trust to your named beneficiaries. Generally, a CLT is best used as a tool for reducing gift, generation-skipping and estate taxes. Endowments can be set up to carry additional guidelines in their use that go beyond simply signing the check. In some cases, you can retain a stake in how the funds are invested or distributed, and may lend professional or personal expertise to their management. Whatever your choice, becoming wise in your charitable giving enables you to make a lasting contribution while also obtaining potential tax benefits for you and your heirs.