Alternatives to Private Foundations

Private foundations, while popular, are beginning to be eclipsed by two alternatives. The first alternative is a donor-advised fund sponsored by a community foundation. The second is a supporting organization. Which alternative best suits you depends on your need for donor control, financial flexibility, manageability, economy, desire for tax benefits and type of asset being used.

« Private Foundations

Private foundations have been used for years to fund philanthropic interests in a way that allows the donor and family to maintain privacy, enjoy tax benefits and exercise maximum control over foundation policies, investments and distributions.

An individual creates a private foundation by executing a document and contributing cash or assets. Distributions are usually made to public charities. These charities apply for grants which are reviewed by the foundation. Grants are then awarded to the organizations and programs most consistent with the founder's values. Private foundations require a considerable degree of reporting and are subject to numerous restrictions. The donor, if serving as foundation manager, is responsible for attending to these requirements which often necessitates the assistance of an experienced attorney and accountant. Many practitioners feel that $1,000,000 is a practical minimum initial contribution to establish a foundation but many private foundations are created during the donor's life with as little as $100,000. Many donors who establish small foundations during life may intend to provide major funding from assets in their estates. But even with a small foundation they can involve the family in the management of the foundation during their life and prepare them to manage the balance of the family wealth.

« Supporting Organization

A supporting organization is a separate tax-exempt entity that is classified as a public charity. Thus, it qualifies for the same favorable tax benefits as public charities. It is formed to support the charitable organizations specified in the founding document and distributions are limited to these charities. These organizations can be named individually or by class. The donor selects the charitable organizations and can appoint the board members. The donor and family can serve on the board. The supported organization must have a significant voice in the supporting organization and there must be a close and continuing working relationship between the organizations. Thus, it is possible for the donor to maintain effective control over the affairs of the supporting organization, even though the donor cannot have legal control the donor can have effective control. Like the private foundation, a $1,000,000 minimum initial contribution is considered practical but a donor may wish to start with much less and provide additional funds from the estate.

« Community Foundation (DAF)

An individual can make a gift to a donor-advised fund (DAF), a separate account held under the tax and administrative umbrella of a community foundation. This account or fund is not a separate legal entity but is part of the community foundation's assets. The funds are treated as though they were held in a segregated account giving the appearance of a private fund. The donor retains the right to “advise” the board of directors of the community foundation on how to distribute the income generated by these assets each year. The donor does not have a legal right to require adherence to this advice but most community foundation boards comply with reasonable requests. Each community foundation has its own policies regarding the types of funds that can be created and the specific rules applicable to each type.

A donor-advised fund is simple, quick, and inexpensive to create. Some minimums are as low as $2,000. The community foundation handles all of the administrative duties and usually charges the account a percentage annually to cover these services. It offers very favorable tax benefits since community foundations are public charities. Although donor control is more than adequate for most circumstances, the board of directors makes the final decisions regarding distributions and investments.

Technical Considerations

The purpose of this article is to provide an introduction to the topic. There are several different kinds of private foundations and supporting organizations. Additionally, community foundations each have their own set of policies regarding donor advised funds. The following comparison is generally applicable to the common use of these terms.

Practical Considerations

The donor must find the appropriate balance between control, tax benefits, economy, manageability and financial flexibility. Control is the ability to influence policies and distributions. Economy relates to establishment and ongoing management costs. Manageability is the ease of letting others attend to the operational details.

Financial flexibility is the degree to which the donor can use the entity to accomplish family financial goals unrelated to its exempt purpose, such as receiving a gift of closely-held stock and selling it to the donor's heirs to maintain family management of the business. While these factors are somewhat subjective, the following table provides a useful comparison of the relative strengths of each choice.

It is vital to involve competent counsel to evaluate the advantages and disadvantages of each option. As a member of NAPP (National Association of Philanthropic Planners) a national organization of independent financial planning professionals with demonstrated expertise in these matters, we are able to help you through the many speed bumps in this process as a member of your advisory team.

	Private Foundation	Supporting Organization	Community Foundation (DAF)
Governing Board	Donor members of donor’s family and other appointed parties	Donor appointed board positions must be less than 50% of board. Balance appointed by supported organizations	Donor may not serve on board but can advise board.
Successor Management	Children can serve on the board	Children can serve on the board	Children cannot serve on the board but can advise.
Purposes and Programs	Broad flexibility — Grants generally made to public charities.	Must distribute to supported organizations. Can be named individually or by class.	Broad flexibility — distributions generally made to public charities.
Deductibility of cash contributions	Deductible up to 30% of donor’s adjusted gross income.	Deductible up to 50% of donor’s adjusted gross income.	Deductible up to 50% of donor’s adjusted gross income.
Deductibility of appreciated long-term capital gain property	Cost basis deductible up to 20% of donor’s adjusted gross income.	Fair market value deductible up to 30% of donor’s adjusted gross income.	Fair market value up to 30% of donor’s adjusted gross income.
Excise tax on Investment Income	2% or 1% of net investment income if certain distribution requirements are met.	None	None
Penalty Taxes on organization and management	Penalty taxes can be imposed for failure to make minimum distributions, excess business holdings, jeopardizing investments and taxable expenditures.	None	None
Penalty taxes on disqualified persons	Penalty taxes can be imposed on persons who participate in acts of self-dealing	None	None
Limits on self-dealing	There can be no business transactions between a private foundation and its “disqualified persons.”	None	None
Payout requirements	Generally, 5% of investment assets must be distributed annually.	None	None
Limits on business holdings	A private foundation and its disqualified persons cannot hold an aggregate of more than 20% of the voting control of a business entity.	None	None
Limits on investments	Jeopardizing investment must be avoided.	None. Investment policy established by board.	None. Investment policy established by board.
Limits on distributions	Generally, grants may be made for any charitable purpose.	Distributions must be made to organizations identified in the founding document.	Distributions are made by the board, taking into consideration the wishes of the donor.
Reporting requirements	Annual report on Form 990-PF. Detailed reporting and allocation of expenditures required.	Annual report on Form 990.	Annual report on Form 990.

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