For donors who wish to control their philanthropic giving, forming a private foundation can be alluring. You get to form a new charitable entity with your name on it. You can pack the Board of Trustees with family members. You can distribute your giving to whatever organizations you choose.
The reality, however, can be quite different. Private foundations are not suitable for everyone, depending on your financial and philanthropic goals.
Here are three reasons why a private foundation may not be right for you:
COSTS + COMPLIANCE = HEADACHE
Private foundations have significant start-up costs, particularly legal and accounting. Ongoing costs are also significant, from administration to accounting to audit. Private foundations are subject to annual tax returns and information filings.
The expenses can add up quickly. To be cost effective, you should consider funding a private foundation with at least $1 million.
One solution to the administrative burden is to use an outsource solution like Foundation Source, which provides comprehensive support services for private foundations. But you will still incur ongoing costs that will be paid from the pool of charitable dollars you have.
One question to ask yourself: how long do you envision your foundation lasting? If you foresee your foundation continuing past your lifetime, then the costs make sense as they will be amortized over a much longer time period. If you aren’t sure that you want your foundation to outlive you, other alternatives (see #3 below) may be more appropriate to achieve what you want at a lower cost.
LOWER TAX DEDUCTION LIMITS
The law imposes limits on how much you can deduct from your income when making charitable contributions. That limit is based on your adjusted gross income (AGI) for the year in which the contribution is made, and the limit is based on the type of organization to which you have contributed and the type of asset given.
When making gifts to public charities like the American Red Cross or your alma mater, gifts of cash are deductible up to 50% of your AGI. Gifts of long-term capital gain property are deductible up to 30% of your AGI.
With a private foundation, those limits are lower than with public charities: 30% of AGI for gifts of cash and 20% of AGI for gifts of long-term capital gain property.
In reality, most donors never hit these limits. If these limits are reached in any one year, the unused contribution carries forward for up to five additional years.
Still, donors need to understand these limits when considering a private foundation.
BECAUSE YOU HAVE OTHER OPTIONS
If you are looking to establish a vehicle for your charitable giving in which you can include your family in the decision-making while also giving you control and flexibility, there are several alternatives worth considering that avoid the high costs and limitations of a private foundation:
- Donor Advised Fund (DAF) – Most frequently cited as the primary alternative to a private foundation, DAFs are simple to establish, have a lower barrier to entry, can accommodate family decision-making, can be established to outlast your lifetime if desired, and enjoy the higher deduction limits of a public charity.
While DAFs have been the subject of some criticism lately, for many donors they remain extremely popular precisely for the reasons cited.
- Charitable Lead Trust (CLT) – Another “Foundation Lite” vehicle, the CLT can be a powerful tool for achieving your philanthropic aims. A CLT will make annual charitable gifts during its existence, and at the end of the trust term the remaining assets either revert back to the donor or are transferred to heirs.
The CLT has some modest start-up and ongoing costs, but nowhere near those of a private foundation. You can change the charitable recipients as often as you like, and you can control the management of the investments. One drawback is that the annual amount being paid to charity needs to be established upfront and cannot be changed.
CLTs are particularly appealing in a low-interest rate environment such as the current one. Low interest rates magnify the tax benefits of CLTs.
Private foundations work well for many donors and families. For those who are thinking about creating one, careful consideration of the pros and cons of the proper giving vehicle will help make the charitable experience that much more rewarding.
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