Building a philanthropic legacy through family foundations
Key Points
- Family Foundations in Perspective
- Types of Family Foundations
- Special Tax Treatment: The Built-In Advantage
- Formation and Management
- Combining Charitable Intent With the Need for Income
- Points to Remember
Bill and Melinda Gates, John D. Rockefeller, Andrew Carnegie — famous, accomplished, wealthy Americans all. These titans of capitalism share another notable quality — the desire to build a philanthropic legacy. The charitable organizations established by these individuals are among the largest private foundations in the world. But your name doesn't have to be Gates or Rockefeller for you to have philanthropic goals. One way to pursue those goals is by establishing a family foundation. Aside from helping families channel their philanthropic intentions, family foundations can form a legacy of community involvement and responsible citizenship for generations to come. And, as their founders soon realize, private foundations offer potential tax and estate estate planning benefits.
Family Foundations in Perspective
What exactly is a family foundation? While there is no precise, legal definition, the Council on Foundations defines it as a foundation whose funds are derived from members of a single family, in which the donor and/or the donors relatives play a significant role in governing and/or managing the foundation throughout its life. Family foundations have proliferated in the United States and now represent a considerable portion of the broader independent foundation community.
Types of Family Foundations
In general, there are two types of family foundations: private foundations and supporting organizations. A private foundation is the more flexible and controllable of the two entities. By establishing a fund into which charitable gifts can be placed, private foundations allow donors and other family members to take charitable deductions in the year contributions are made, without having to make an immediate decision regarding which charity or charities to support. Although private foundations maintain their own Board of Directors and control their own funding decisions, they have less attractive tax benefits than supporting organizations (as noted below). In addition, the IRS requires private foundations to distribute a minimum of 5% of their net investment assets each year (calculated using special IRS rules) and to pay an excise tax of 1% or 2% on their net investment income.
By comparison, supporting organizations are neither required to pay excise tax nor distribute 5% of their assets each year. But what they enjoy in enhanced IRS treatment, they sacrifice in terms of governance and grantmaking control. For instance, supporting organizations typically can distribute funds only to those charities the family designates in its charter when the foundation is established. Private foundations, on the other hand, can change beneficiaries at will. Furthermore, a supporting organization requires that donors relinquish full control over the organization's governance. In some cases, the majority of the organization's Board of Directors must be made up of members appointed by the charity or charities supported.
Special Tax Treatment: The Built-In Advantage
Gifts made to family foundations are generally deductible for income tax purposes. These deductions differ depending on the structure (private foundation versus supporting organization), the type of property contributed, and the donor's adjusted gross income (AGI). For instance, cash and other nonappreciated capital assets donated to supporting organizations are typically deductible up to 50% of the donor's AGI versus 30% for private foundations. Appreciated noncash gifts such as stock, real estate, and other appreciated assets are generally deductible up to 30% of AGI for donations made to supporting organizations versus 20% for private foundations. Except for publicly traded stock, the charitable deduction for donations of appreciated assets to certain private foundations is limited to the donor's basis in the property. Regardless of structure, any excess deduction in the contribution year may be carried over for the next five years.
Generally, both the donor and the foundation avoid potentially steep capital gains taxes on appreciated assets, as long as the assets are used for the purposes for which the foundation was established. Perhaps most important to donors and their families, no estate or gift taxes are assessed against assets that have been transferred out of an estate into a foundation.
Yet beyond the tax and estate planning advantages, foundations provide a way for donors to pursue their philanthropic goals in a structured manner while encouraging communication and harmony within the family for generations to come.
Formation and Management
Family foundations, like the families who create them, come in all shapes and sizes, with equally diverse motivations, mission statements, and methods for pursuing their philanthropic objectives. Yet despite their differences, most families face similar issues when it comes to building, governing, and shaping the grantmaking activities of their foundations. If you are creating a family foundation, consider seeking the guidance of an attorney, accountant, or other trusted professional who is familiar with the tax laws and legal intricacies of the foundation world. Obtaining assistance early on — and retaining such counsel on a continuing basis — is key to making responsible decisions around key issues such as the following:
Structure — Should the foundation be set up as a corporation or a trust? Although the trust structure is still fairly popular due to its simplicity, it is becoming increasingly common to establish a foundation as a nonprofit corporation due to the flexibility it affords foundation management as well as the protection from personal liability it provides founders and trustees.
Governance — As in most corporations, the responsibility for the governance of a private foundation belongs to the Board of Directors or trustees. As the founder of a private foundation, it is your legal obligation to select a Board of Directors and to establish a succession plan. The Board will become the foundation's chief policymaking body, and its decisions will have a profound effect on the grantmaking, investments, and future of the foundation. As such, be sure to give careful thought to selecting those individuals (family or nonfamily) whose values and business leadership you admire.
Grantmaking — A mission statement that outlines the core values and philanthropic vision of the foundation forms the framework for grantmaking activities. It is important to prepare written guidelines and procedures describing the scope, focus, and criteria for grants made by the foundation.
Reporting and Compliance — Family foundations must adhere to strict guidelines around their tax-exempt status and are required to file annual reports (e.g., Form 990-PF with the IRS; an annual report with the state's Attorney General). Foundations must also maintain compliance around employment issues — how individuals are hired and compensated — and how those rules apply to family members.
Combining Charitable Intent With the Need for Income
Whether you are able to pursue a charitable agenda during your lifetime depends largely on your income needs and those of your dependents. While the tax deductions associated with most charitable giving reduce the cost of making charitable gifts, an individual's own needs will always be the determining factor. To address both goals, individuals may want to consider combining a family foundation with other charitable vehicles such as a charitable remainder trust or charitable lead trust. By so doing, you and your family may be able to enjoy an income stream during your lives, earn considerable tax savings, and maintain a significant degree of control over family assets — all while fulfilling your charitable goals.
Points to Remember
- Family foundations offer an effective way to pursue philanthropic objectives, involve family members in charitable activities, and reap tax and estate planning efficiencies.
- Family foundations account for a major portion of foundation giving in the United States.
- In general, there are two types of family foundations: private foundations and supporting organizations. Private foundations, the more common of the two, offer more flexibility and control (i.e., they select and oversee their own Board of Directors and grantmaking decisions), while supporting organizations enjoy more favorable IRS treatment.
- Gifts made to family foundations are generally tax deductible. These deductions differ depending on the foundation's structure, the type of property contributed, and the donor's income level.
- Outright gifts to a family foundation are generally removed from the donor's estate, avoiding estate and/or gift taxes.
Ameriprise Financial and its representatives and affiliates do not provide tax or legal advice. Consult with your tax advisor or attorney regarding specific tax/legal issues.