Giving Back to the Community Series:
The Giving Back to the Community Series examines the benefits of charitable giving from the donor and their family’s perspective and sheds light on three common strategies. The series will include five separate articles dealing with:
Now, more than ever, we need all of us to expand our charitable giving, and Dunham hopes this series helps.
Subscribe to the Dunham Blog to receive each new installation of the Giving Back to The Community Series!
The ability to do good for others – to make an impact in this world during our lifetime is exceptional. To continue that good long after we depart from this world is extraordinary.
A Private Family Foundation is one way to help you establish your charitable giving during your lifetime. Furthermore, because you generally establish a Private Family Foundation to exist in perpetuity, it is the framework for your philanthropic legacy, perhaps for centuries after you are gone.
Compared to a charitable gift you may make in your life that benefits your favorite charity on the one occasion, a private family foundation perpetuates generosity in your name. Moreover, it does so in your name well beyond your lifetime. For many donors, the legacy aspect of a Family Foundation is one of the attractive features of this giving strategy.
What is a Private Family Foundation?
As the name suggests, a Private Family Foundation is a type of foundation set up by your family. It is funded with your family’s money, guided by your family’s charitable focus, and often run by family members.
One of the main advantages of a Private Family Foundation is that the family controls the investments in their foundation and how they will bestow their good. How they will bestow their good refers to the selecting of what charities and causes they would like to support.
There are various types of foundations. This article only examines Private Family Foundations, not Supporting Organizations, Independent Foundations, Corporate Foundations, international Foundations, or Private Operating Foundations.
Enhanced Flexibility on How and When to Bestow Your Good
While Private Family Foundations will make grants to public charities, they do not have to limit their charitable giving to 501C(3). This flexibility gives a Family Foundation an advantage - you can donate to various types of organizations and cause you believe will do the most good. Some examples are:
· With advance approval from the IRS, family foundations may run scholarship programs and choose the recipients, perhaps assisting underprivileged children.
· The family foundation can develop a program to offer awards and prizes to spur innovation in your field of expertise. These incentives are particularly effective and rewarding when you want to specify the innovation and create a community of potential innovators.
· A Private Family Foundation allows you to provide emergency assistance to individuals and families. You are permitted to provide funds to individuals with hardship assistance such as illness, loss of employment, or the passing away of the primary wage earner.
· Family Foundations can grant to overseas charitable organizations when there is no IRS-recognized 501(c)(3) entity to serve as an intermediary.
· With a Private Family Foundation, you can run your charitable programs without setting up a separate 501c3. IRS allows direct charitable activities (DCAs) that permit a family foundation to fund and carry out their projects directly.
· Program related Investments are an exciting aspect of a Private Family Foundation. Your family Foundation can make loans instead of only grants to impact companies through program related investments. Program-related investments aim to make inexpensive capital available to impact companies and organizations addressing social or environmental concerns. Program related Investments are generally made in the form of loans or equity investments later returned to the foundation.
However, program related investments must meet three criteria:
1. The investment’s primary purpose must be to advance the family foundation’s charitable objectives;
2. Neither the production of income nor the appreciation of property can be a significant purpose;
3. You cannot use the funds directly or indirectly to lobby or for political purposes. (1)
The Tax Aspects of a Private Family Foundation
From a tax aspect, giving to your Family Foundation may make it possible for you to:
1. Reduce your income tax for each year in which you make a contribution;
2. Avoid capital gains taxes depending on the property contributed;
3. Reduce or potentially eliminate estate taxes;
4. Grow your charitable funds in a tax-advantaged structure which could lead to more assets to give if the family foundation’s account grows.
It is important to briefly review the income tax aspects of a Private Family Foundation. While 100% of your gift is deductible, the amount you can use in any tax year will be limited to a percentage of your Adjusted Gross Income (AGI). These limits will differ between donations to private charities, Donor-Advised Funds, and Private Family Foundations.
Donations to public charities and Donor-Advised Funds are 60% of AGI for cash and 30% for non-cash donations. Donations to your Family Foundation are generally limited to 30% of AGI for cash donations and 20% AGI limitation for all other asset types.(2)
If you cannot use the entire deduction in the tax year you made the gift, you have five additional years to use it. It generally does not go to waste.
A Private Family Foundation must meet a minimum distribution requirement or be subject to an excise tax. They are also subject to a net investment income tax of 1.39% for the tax year 2020 and beyond. IRS levies this tax to help defray some of the cost IRS has in monitoring Private Family Foundations.(2)
Minimum 5% Expenditure Rule(3)
A private family foundation must pay out an amount equal to 5% of its net investment assets in what is known as “qualifying distributions” each year. IRS defines Qualifying distributions as:
· Actual grants to qualified charities;
· Necessary and reasonable administrative costs to make those grants;
· Costs to provide direct charitable activities; and,
· Costs to acquire assets used in the conduct of the private family foundation’s exempt activities.
Failure to meet the minimum distribution requirement will result in a penalty tax assessed on the undistributed amount, and the family foundation could be accessed:
· An excise tax of 30% of the undistributed amount;
· An additional excise tax of 100% of the undistributed amount is imposed if the family foundation does not make up the deficiency within 90 days of receiving notification about the deficiency from the IRS .
Under the 5% expenditure rule, a Private Family Foundation can pay charitable expenses and hire staff—even family members. The compensation to family members and others hired to run the foundation must be “reasonable compensation.”
All legitimate and reasonable expenses incurred by your family foundation count toward your foundation’s minimum distribution requirement. These expense could include but are not limited to advisors such as CPAs, travel expenses for site visits, board meetings, conferences, and office supplies.
Properly Working With the IRS (4)
As we have discussed, a Private Family Foundation is a wonderful way to leave your philanthropic legacy. However, they tend to be highly scrutinized by the IRS. For this reason, it is essential to understand how to avoid potential conflicts of interest that can lead to trouble if you are unaware. The use of professional guidance is critical.
You must understand the terms “self-dealing” and “disqualified persons.” When hiring family members or disqualified persons, you need to give special consideration to their roles being deemed reasonable and necessary. The pay should be in line with comparable positions.
You need to seek professional advice if you are selling or leasing equipment to the foundation, granting loans, and providing facilities, goods, and services.
Leaving Your Legacy with a Private Family Foundation
Now is an excellent time to begin your family’s philanthropic journey if you are ready. With your family, start discussing the goals and objectives of the family foundation. Discuss the roles of each family member. Explore as a family the options you have, who you want to support, and consider program related investments for impact organization.
Engage your professional team and the experts you need to make those goals a reality. Your family foundation could create a legacy of good, in your name, for many years to come.
A Private Family Foundation allows you and your family to be continually generous, compared to making a one-time charitable donation.
This communication is general in nature and provided for educational and informational purposes only. It should not be considered or relied upon as legal, tax or investment advice or an investment recommendation, or as a substitute for legal or tax counsel. Any investment products or services named herein are for illustrative purposes only and should not be considered an offer to buy or sell, or an investment recommendation for, any specific security, strategy or investment product or service. Always consult a qualified professional or your own independent financial professional for personalized advice or investment recommendations tailored to your specific goals, individual situation, and risk tolerance.
Dunham does not provide legal or tax advice. Federal and state laws and regulations are complex and subject to change, which can materially impact your results. Dunham cannot guarantee that such information is accurate, complete or timely; and disclaims any liability arising out of your use of, or any tax position taken in reliance on, such information. All financial decisions and investments involve risk, including possible loss of principal.
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Past results are not indicative of future performance and are no guarantee that losses will not occur in the future. Future returns are not guaranteed, and a loss of principal may occur.
Dunham & Associates Investment Counsel, Inc. is a Registered Investment Adviser and Broker/ Dealer. Member FINRA/ SIPC.
Advisory services and securities offered through Dunham & Associates Investment Counsel, Inc