EXECUTIVE SUMMARY
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A SURPRISING NUMBER OF INDIVIDUALS
SET UP PRIVATE foundations and other
philanthropic entities without considering if they
are the best option to meet their charitable
inclinations. Income and estate tax savings are not
the only consideration.
A PRIVATE FOUNDATION IS THE CHOICE
OF THOSE who want to maintain maximum
control over their charitable dollars. Many
wealthy families set up foundations that last for
many years. But the income tax deduction is less
favorable for a foundation when compared with a
public charity, and donors face considerable
paperwork and other time-consuming and costly
overhead.
COMMUNITY FOUNDATIONS
RECEIVE DONATIONS
from individuals, businesses, private
foundations and other charities and make grants to
community charities. Typically falling into one of
four different types, community foundations are
exempt from excise taxes and administrative
burdens and let the donor deduct the fair market
value of appreciated property. But donors will not
be able to exert as much control as with a private
foundation.
A SUPPORTING ORGANIZATION FUNDS ONE
OR MORE specific charities, such as a
hospital auxiliary or an alumni association. These
entities escape the restrictive tax rules that
apply to private foundations, can own an unlimited
amount of closely held stock and offer the same
tax deduction limits as public charities.
Supporting organizations are not a good choice
when the donor does not want to be involved in
running the organization.
PROPRIETARY FUNDS
ARE ESSENTIALLY CHARITABLE
mutual funds. The law treats them like
public charities. Proprietary funds are convenient
for a last minute donor who may or may not want
grants to be made anonymously. Most funds are only
set up to handle marketable securities, so the
arrangement isn’t suitable for real estate or
similar assets. | LAURA PEEBLES, CPA/PFS, is a director
with Deloitte & Touche LLP in Arlington,
Virginia. Her e-mail address is Lpeebles@deloitte.com
. |
ew individuals would start a business without
a business plan. Nevertheless, many set up private
foundations or other philanthropic entities without
considering other available options. Too often, donors focus
on income or estate tax savings, missing the other
benefits—or headaches—of their chosen philanthropic vehicle.
Using examples drawn from real-life donors, this article
examines the advantages and disadvantages of four methods
for deferred charitable giving: private foundations,
community foundations, supporting organizations and
proprietary funds. It is intended to help CPAs guide clients
in making appropriate decisions on establishing
philanthropic entities.
The Visibility of Foundations
Foundations were next to last on
the list for awareness and familiarity among both
the influential public (including congressional
staffers and representatives of foundations and
grantee organizations) as well as the general
public. Only individual philanthropists received
lower awareness ratings. Both segments were more
aware of specific charities than a specific
foundation: 36% of the general public and 26% of
the influential public were unable to name any
particular foundation. In contrast, just 13% of
the general public and 7% of the influential
public could not name a particular charity.
Source: Council on Foundations, Washington,
D.C., www.cof.org
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PRIVATE FOUNDATIONS
Private foundations are
the best-known entities for deferred giving. Although the
federal tax laws defining private foundations didn’t come
into being until 1969, many private foundations predate that
law. Andrew Carnegie, John D. Rockefeller and Henry Ford
were among early donors—motivated by social rather than
financial concerns.
Advantages. Donors choose to
establish private foundations because they:
Allow donors and their families maximum control
over charitable giving.
Can be used to “fund” several years of normal
charitable giving.
Solution. After selling a substantial portion of
his company, Mr. A established a multimillion-dollar private
foundation to help offset his taxable gain. Because he had
not yet determined his philanthropic goals, a private
foundation was an attractive option to control future
grantmaking.
Can be used to give assets that are not easily
divided, such as real property. Property can be transferred
to the foundation and sold tax-free, with the foundation
distributing or keeping the proceeds.
Solution. Ms. B owns 2,000 acres of timber
property. Because the charities she supports could not
manage the property, she donates it to her private
foundation. The foundation owns the property and sells the
timber as it matures, distributing the sales proceeds to
various charities.
Provide a means to fund foreign charitable
endeavors. (Many public charities do not engage in
international grantmaking.)
Solution. Mr. and Mrs. C want to help educate
people in a specific developing country. Grants from their
private foundation help pay for secondary school
construction in remote villages.
Provide an organized structure for a family’s
charitable activities. A foundation—with a board composed of
family members—is an excellent reason for relatives to meet
regularly for a common purpose, renew family ties and pass
on a sense of social responsibility to the next generation.
It is, however, unlikely to mend broken ties. The IRS
regularly issues “foundation division” rulings that allow
the breakup of family foundations. In 1999, it permitted the
$13.5 billion Packard Foundation to split—the Packard’s son
established a new foundation with $1.5 billion from the
existing entity, while the three Packard daughters continued
to run the original foundation.
Disadvantages. Private foundations
also have a downside. In general, income tax deductions are
less favorable for donations to private foundations than to
public charities. (See the exhibit on page 25 for a list of
donation and deduction limits.) For example, when clients
contribute assets other than publicly traded stock, the
income tax deduction is limited to the donor’s basis, which
may differ from the purchase price, depending on basis
adjustments since the original purchase date. There are
other disadvantages as well:
Overhead can be extensive. If the foundation
holds a lot of assets, its recordkeeping and annual tax
return preparation are time-consuming. It must obtain
advance IRS approval for scholarship programs. It must make
its tax returns available to the public and grantseekers.
The foundation receives many grant requests and must
disclose the names of substantial donors to the public.
The foundation must take care not to engage in
“self-dealing”—transactions with certain individuals and
entities related to, or controlled by, the donor—which can
result in substantial financial penalties.
Each year, the foundation must distribute at
least 5% of its assets. This may be difficult for a
foundation with illiquid but valuable holdings, such as real
estate.
The trust cannot hold a permanent, substantial
ownership interest in any business—even a publicly traded
company—unless the foundation’s and all related parties’
holdings amount to less than 20% of an operating business.
Investment income, including capital gains, is
subject to a 1% or 2% excise tax, which can be a substantial
tax liability if the donor transfers low-basis assets to the
foundation, which then sells them. (To avoid the excise tax,
donors should transfer the stock as grants. A 2% tax doesn’t
sound like much until you write the check to the IRS.)
Unrelated business income tax, which Congress
created to put charities and taxable corporations on an
equal footing, applies to any income from an S corporation,
including gain on the sale of the stock. (If a
limited liability company [LLC] or partnership has business
income, it will be taxable to the private foundation partner
or member, but gain on the sale of an LLC or partnership
interest is generally not subject to this tax.)
When to consider a private foundation.
CPAs should recommend their clients consider
establishing a private foundation if
Donor or family control is the driving factor.
The donor wants to perpetuate his or her family
name, or avoid direct charitable solicitation by referring
all requests to the foundation.
The donor has publicly traded stock, or is not
concerned by the donation limits for other assets.
The foundation will be established through a
bequest. The donor should consider another
alternative if he or she
Needs the higher tax deduction. (Consider a
public charity, such as a community foundation. To find a
community foundation near you, go to www.communityfoundationlocator.org
.)
Is unwilling to live with paperwork and other
restrictions. (Consider a supporting organization.)
Wants to avoid publicity. (Consider an
anonymous donor-advised fund at a community foundation or a
gift fund.)
Solution. Although Mr. D had served on the board of
a friend’s foundation, he decided, when he made a
substantial charitable donation, to use a supporting
organization within a community foundation. In his words: “I
hated telling people ‘no.’ The community foundation screens
all grant applications and brings me the best ones. I enjoy
saying, ‘Yes, let’s fund that one this year.’”
COMMUNITY FOUNDATIONS
Community foundations
receive donations from individuals, businesses, private
foundations and other charities and make grants to community
charities. Some of these entities define community very
broadly and even make grants internationally. Others define
the term in a strict geographic sense, focusing on local
needs. Still others focus on demographic profiles, religions
or other common grounds. Although the names may
vary, community foundations offer four basic types of funds,
all of which can be named for donors.
Donor-advised funds let donors
recommend how grants from their fund are given. The
foundation usually follows donors’ recommendations, provided
the prospective grantee is a valid 501(c)(3) organization.
(Some foundations impose geographic restrictions.)
Field-of-interest funds allow donors
to specify a general or specific area of interest, such as
education or health care. The foundation selects grantees.
Designated funds support specific
charities. If the named charity dissolves, the foundation
selects a similar entity.
Unrestricted funds often carry the
donor’s name (the Jane Smith Fund, the Smith Company Fund,
the Steve Smith Memorial Fund), but the foundation selects
the grantees. Community foundations offer
individuals and companies an efficient way to centralize
charitable giving and recommend grants to not-for-profit
organizations. They are also used to hold lawsuit settlement
funds when the injured party is an entire community (such as
water or air pollution settlements).
Advantages. A fund established
within a community foundation provides the donor with a tax
deduction for the fair market value of appreciated long-term
capital gain property. In addition it
Is exempt from excise taxes and administrative
burdens.
Can be established at a moment’s notice, making
it perfect for yearend giving.
Gives donors access to knowledgeable
professionals who can provide advice on programs and
community needs.
Allows donors to involve family members as fund
advisers—within limits. Family members can advise a
donor-advised fund. Depending on foundation rules, the fund
can exist for one or two generations and sometimes even in
perpetuity.
Allows donors to give anonymously—the
foundation’s tax return is public, but the donor list is
not.
Disadvantages. There are
disadvantages to establishing funds in a community
foundation. Donors have less control than with private
foundations or supporting organizations. And, depending on
the community foundation, the donor’s family may be limited
to one or two successor generations as advisers or may not
be able to advise in perpetuity.
When to consider a community foundation.
CPAs should consider recommending a community
foundation if a donor wants to
Establish a private foundation but has assets
to donate other than publicly traded stock. (Consider a
supporting organization instead.)
Support specific community programs but needs
more time to gather information about the programs and the
work they do.
Solution. On December 31, at 2 p.m., Mrs. H decided
to establish a charity to benefit public school teachers in
her community. With the help of her accountant, attorney,
broker and the local community foundation, the fund was
established in time for Mrs. H to take a tax deduction and
for all the participants to attend their New Year’s Eve
parties.
Favor a charity with a large donation but limit
the use of income to specific programs, or give to a charity
that is not ready for a large endowment.
Expose children or grandchildren to the joys
and responsibilities of philanthropy but the donor needs
expert assistance.
Remain anonymous. Foundation staff must know
who the donor is, but the ultimate recipient or the public
need not. There are times when CPAs should recommend
a client consider other alternatives, such as when the
assets to be donated—for instance, large blocks of closely
held stock, S corporation stock, real estate or timber
property—are inappropriate for a community foundation. CPAs
should also recommend other options when n The donor’s
desire for control surpasses the need for tax and
administrative advantages. (Consider a private foundation.)
The proposed fund is inappropriate for the
proposed grantee’s needs. For example, an endowment-type
fund may not meet the needs of a building fund drive. A
charity may also be large enough to manage its own
endowment.
The donor is not interested in continued
involvement. A donor planning to establish a donor-advised
fund should be willing to review grant recommendations from
the community foundation. (If not, consider a
field-of-interest-fund.)
SUPPORTING ORGANIZATIONS
A supporting
organization must fund one or more specific operating
charities. Examples include the ladies’ auxiliary of a
hospital, a parents’ club at a private school or a
university alumni association. Although supporting
organizations are not limited in the number of charities
they can support, the IRS has expressed concern about them
and may closely scrutinize applications from groups that
intend to support multiple charities. One type of
supporting organization names the community foundation as
the supported charity. The foundation provides the
administrative support, while the donor focuses on
grantmaking. The donor can develop the grantmaking program
or the community foundation can do the work. This structure
is as close as possible to the look and feel of a private
foundation, but is more flexible.
Advantages. Some donors choose
supporting organizations because they are not subject to
many of the restrictive tax rules that apply to private
foundations. In addition, supporting organizations
Don’t have to distribute a specific percentage
of assets each year.
Can own an unlimited amount of closely held
stock.
Can engage in economic activity (such as fair
market value rentals) with their donors—provided no private
benefit accrues to the donor and the organization follows
state fiduciary rules regarding the charities’ investments.
Offer donors the same level of tax deductions
as other public charities. This makes a significant
difference to donors with substantially appreciated assets.
Solution. Mrs. F owned appreciated real estate
investment trust units and wanted to use several million
dollars worth to establish a private foundation. Because the
units were not publicly traded stock, her donation deduction
would have been limited to cost. Instead, she established a
supporting organization at her local community foundation.
This allowed her to deduct the current value of the units
and still be involved in disbursing the income to charity.
Disadvantages. The supporting
organization alternative is not without disadvantages. As is
the case with many tax code provisions, the freedom from the
excess business holdings, self-dealing and minimum
distribution rules this option brings comes at a
price—supported charities control or closely supervise the
supporting organization. Although the IRS prefers that the
“supported” charity assert control by appointing a majority
of the board, technically the supported charity can be
limited to one board member if the organization is closely
integrated with the supported charity. The supporting
organization board cannot be controlled by anyone who would
be a “disqualified person”—the donor, his or her close
relatives and some employees—if the organization were a
private foundation. A supporting organization is a
separate legal entity. As such, it must have board meetings,
file tax returns that are subject to public inspection and
apply for its own tax exemption.
When to consider a supporting organization.
CPAs should recommend establishing a
supporting organization if a client wants to establish a
foundation but has assets other than publicly traded stock,
has closely held stock that will not be sold in the near
future or wishes to benefit a charity that may not be ready
to handle a significant endowment.
Solution. Mrs. G wanted to support the opera in her
hometown. Because the previous opera board had spent its
endowment and went bankrupt, she established a supporting
organization, affiliated with the community foundation, for
the opera’s benefit. This technique prevents the new opera
from spending the principal. If the opera dissolves again,
even after her death, the community foundation can redirect
the funds to a similar cultural enterprise. Donors
should consider a different alternative if
Control is more important than the tax
advantages of a supporting organization. (Consider a private
foundation.)
The assets to be donated do not justify a
separate entity. (Consider a community foundation or a gift
fund—a $500,000 donation may be the minimum for a supporting
organization to a community foundation, although many
require $1 million to $2 million.)
The donor wants no involvement in running the
organization. (Consider a restricted donation directly to
the charity or a field-of-interest fund at a community
foundation.)
PROPRIETARY FUNDS
Proprietary funds (also
known as gift funds) are essentially charitable mutual
funds. For tax purposes, the law treats proprietary funds as
public charities rather than private foundations. Once
assets are donated, the sponsoring mutual fund manages them.
Advantages. Proprietary funds are an
efficient way to centralize charitable giving and recommend
grants to not-for-profit organizations. Grants are limited
to U.S. charities but otherwise have no geographic
restrictions. In addition
The fund handles all administration and
recordkeeping.
The fund can be established at the last minute.
Donors receive all tax benefits associated with
donations to public charities.
A donor may authorize another party to
recommend grants from his or her account.
Gifts from the fund can be made anonymously.
The arrangement is convenient for a donor who
wants to fund a particular program over a period of time but
take the tax deduction early.
Disadvantages. Proprietary funds
have some disadvantages. Terms are standardized by each
fund, generally nonnegotiable and, because the fund controls
the assets, investment options are limited to certain mutual
funds. In addition
Although funds are donor advised, donors do not
have total control over giving.
Grants cannot be used to fulfill an existing
pledge, for private benefit or for lobbying/political
contributions.
Certain assets may not be acceptable if the
fund is designed to handle only marketable securities.
Some funds have agreements with the IRS that
voluntarily impose certain private foundation rules.
A donor must do his or her own due diligence on
donee charities.
Some proprietary funds are paid out to other
charities upon the death of the donor or fund adviser.
When to consider a proprietary fund.
CPAs and their clients should consider a
proprietary fund if
The donor wants an immediate income tax
deduction but has no time to consider contribution
recipients before yearend.
Gift amounts are too small to justify other
options.
They like the income tax attributes of a public
charity.
They seek professional investment of principal.
The donor has a specific philanthropic vision
that can be fulfilled without help from a professional
adviser. Steer clients away from this type of fund
if
The donor’s desire for control or publicity
outweighs the tax and administrative advantages of a
proprietary fund. (Consider a private foundation.)
S corporation stock, closely held stock that
will not be redeemed promptly, real estate, timber property
or similar assets are involved.
The donor wants help learning how to be an
effective philanthropist in his or her community. (Consider
a community foundation.)
The donor is interested in a family foundation
that will have a lasting impact on his or her family and
community. (Consider a private foundation.)
Limits on Charitable Contributions by
Individuals |
| | Contributions to
30%-type organizations
| | Contributions to
50%-type organizations |
Private
foundations | Other 30%-type
organizations |
Type of contribution
| Amount deductible
| Percentage
limitation |
Amount deductible
| Percentage
limitation |
Amount deductible
| Percentage
limitation |
Ordinary income property—
inventory, depreciable property,
agricultural products, oil and gas
property, Section 306 stock, OID debt
instruments, market discount bonds,
artwork by its creator and other property.
| Cost | 50% | Cost
| 30% | Cost | 30%
| Short-term capital
gain property —stocks, bonds and
other capital assets. | Cost |
50% | Cost | 30% |
Cost | 30% |
Long-term capital gain property—
stocks, bonds and other capital
assets. | | |
| | |
| —In general | Fair
market value | 30% | Cost
| 20% | Fair market value
| 20% | —If
election is made to reduce the amount of
the deduction. | Cost |
50% | | |
| |
—Qualified appreciated stock. |
| | Fair market
value | 20% | |
| —Tangible
personal property, if donee’s use of
property is unrelated to donee’s exempt
purpose. | Cost | 50%
| Cost | 20% | Cost
| 20%
| |
WHICH IS BEST?
There are very few
absolute answers when selecting a philanthropic entity. In
some situations, only a private foundation will do. In
others—on December 31, for example—a donor-advised fund at a
community foundation or a proprietary gift fund are the only
available choices. In the final analysis a CPA must work
closely with a client to decide which entity is best for
that donor, the family and the community. As with many
important decisions, timing is important, so CPAs should
encourage clients to make charitable giving decisions now
before yearend pressures force them into making a less than
desirable choice.
Expert Help Additional
information on issues related to this article is
available from Melissa M. Cliett, staff attorney
and director, philanthropic advisors services,
Council on Foundations, 1828 L Street, N.W., Suite
300, Washington, D.C. 20036-5168. She can be
reached at 202-467-0446 or cliem@cof.org. Also
visit the council’s Web site at www.cof.org . | |