Charitable giving is one of the best ways for people to support the causes that matter to them. These types of contributions can take many forms, so it’s relatively easy to not only make a direct impact, but also do so in a way that makes the most sense for the donor from a tax, flexibility, control, and legacy standpoint.
What is more — charitable giving is often conducted as a group enterprise. By pooling resources, people and entities can broaden the scope of their contributions as well as the decision-making process that goes into them. This allows them to maximize their efforts, doing more together than they could have done alone.
Private family foundations in particular are a powerful way to direct charitable contributions and foster inter-generational involvement in charitable giving, focused on a particular area of interest. But before diving into why that is, it’s important to understand the value of shared perspectives as your family works toward its charitable goals.
The Power Of Family Philanthropy
Some of the appeal of family-based giving is obvious — family members often have similar values, a shared stake in financial commitments, and collective benefits from the social capital that so often comes with charitable giving. But much of its real power is beneath the surface — and that makes it important for families to take their philanthropy seriously.
First and foremost, everyone needs to be on the same page. Who will be involved, what are their roles, and how much time and money are they willing to commit? Establishing some baseline expectations can lay the foundation for the decisions that follow.
Next comes the task of developing a vision. What are your shared values and what does the family hope to achieve through charitable giving? For example, does the family want to focus on conservation, education, medical research, or some other charitable mission? Will the mission be focused or broad; created with strict controls based on the founder’s vision, or made highly flexible for future generations? This is often where talk of your legacy comes into play. Having a clear sense of how you want your family to be remembered can inform how you approach the process of charitable giving.
Communicate To Create Unity
Consider the situation in which family members do not share values, or that they agree about the problem but not the solution. This can muddy the waters about which organizations should receive your family’s charity and how much should be allotted to each.
Communication is essential so that everyone is on the same page about the impact you want to make together. Charitable giving is deeply personal, and people with a stake in the organizations championing their causes need to be able to voice their opinions — and listen to the opinions of others — about how the group directs its contributions. A best practice is to schedule an annual family meeting or retreat devoted to discussing the family’s charitable legacy and sharing specific ideas for giving in the year ahead.
Invite Young Relatives To Participate
Many of us cherish the example set by our parents and grandparents in giving generously to charity. In the same way your parents might have influenced your desire to practice philanthropy, you might influence your children as well. That’s why it’s important to invite your kids into the process.
The younger generation is an especially strong partner in the process. Screening charitable applicants can be a daunting task, and for larger family foundations there may be layers of management that are difficult for more seasoned family members to handle on their own. Giving children and grandchildren an ownership stake over the process — whether large or small — provides them with hands-on experience and helps keep the overall foundation running smoothly.
The values you share and the goals you work toward have the potential to span several generations, and that can extend the reach of your contributions well into the future — a perpetual legacy that reaches further than you might have thought was possible!
Private Family Foundations
A private family foundation is a charitable organization that is organized as a nonprofit corporation or a trust and is created either by a single individual or family. Those family members are the sole contributors to the fund, rather than having it receive public donations from a broad base of supporters.
The primary function of a private foundation is to make grants to charities that provide services, rather than providing those services themselves (that type of entity is called a private operating foundation). A private foundation maintains 501(c)(3) tax-exempt status, while simultaneously affording the family a high degree of control over how funds are used.
Although the most famous family foundations are massive and complex organizations (like the Bill and Melinda Gates Foundation), they can actually start much smaller and develop into prominence over time as more family members contribute. It’s a misconception that private foundations have to be complex, time-consuming, and expensive! They can begin relatively modestly, with one or two decision-makers, and then grow in scope and size over the years as family members make lifetime donations, estates provide legacy gifts, and new generations join in the charitable giving discussions.
Setting Up Private Family Foundations
To set up a private family foundation, start with these steps: Develop A Mission. This will inform the direction of giving and establish the foundation as a charitable organization.
Formalize The Foundation. File the appropriate paperwork to set up the organization (either as a trust or a corporation) that is right for your family. You’ll also need to file for a 501(c)(3) status with the IRS.
Choose A Trustee. You can appoint yourself as the trustee of your own foundation. This way, you maintain control over the assets contained in the foundation. You may arrange for your heirs and descendants to receive salaries as “employees” of your foundation. Foundations have strict rules prohibiting self-dealing, so salaries must be earned, with enough documentation to show that work was actually performed. These family members can then be named as replacement trustees to succeed you after death or resignation.
Hire Experienced Professionals. While family members are the sole contributors, they’re not expected to shoulder every responsibility themselves. Attorneys, tax advisors, investment professionals, managers, and staff should be brought on board as necessary. Specifically, an experienced corporate fiduciary, such as First Business Bank, can help with the administration of a private family foundation and assist the family in meeting their fiduciary and regulatory responsibilities and allow family members or the management team to focus more on strategy, grantmaking, and policy. First Business Bank routinely helps private family foundations with investment management, recordkeeping, tax filings, grant administration, charitable distributions, and even facilitates annual family planning sessions.
From here, the foundation will be able to start managing its charitable giving.
Next Phase Of Private Family Foundations
Donors receive an immediate income tax1 deduction for each year they contribute to the foundation. They avoid capital gains tax on contributions of appreciated property and simultaneously reduce their taxable estates. Tax deductions for these contributions are determined by what type of property has been contributed. For example, contributions of cash and nonappreciated property are limited to 30% adjusted growth income(AGI), whereas long-term capital gain property and real property are capped at 20%.
Many donors to foundations do not reach AGI limits on income tax deductions. If they do reach AGI limits, contributions that exceed annual AGI limits may be carried forward for five subsequent years. Note that contributions may be made both to a private foundation and a public charity, effectively “stacking” charitable contributions in a particular year.
The foundation’s investments must also be conducted in a prudent manner. Speculative or otherwise risky investments that might jeopardize the foundation’s charitable status can lead the IRS to levy a 10% tax unless the facts and circumstances justify the investment.
As for the actual awarding of grants, the foundation must distribute an equivalent of 5% of the organization’s nonoperational net annual income.
All bank accounts, books, records, meeting minutes, and other documents must be meticulously maintained to avoid levying tax penalties and ensuring respect for the foundation’s legal form. Spending that goes against the mission statement, self-dealing, lobbying for legislation, and attempting to affect the outcome of an election are all prohibited.
Donor-Advised Funds Vs. Private Foundations
Like private foundations, donor-advised funds accept gifts of appreciated assets, avoid recognition of capital gains by the donor, and allow for an immediate charitable deduction of the fair market value of the gift, up to applicable AGI limits. But for all their similarities, there are some key differences between private family foundations and donor-advised funds. In particular, private foundations are their own separate entities, whereas donoradvised funds are operated at the account level. While private foundations exist solely to manage the investment from a single source, donor-advised funds may comprise multiple accounts from multiple sources.
Donor-advised funds offer ease of administration and can be established with small donations whereas private foundations have more recordkeeping and tax filing requirements, and generally are funded at about $1.0-$2.0 million in initial family contributions.
Restrictions and responsibilities differ as well. As mentioned, private foundations are required to distribute a minimum of 5% of their assets annually. Donor-advised funds have no such minimum in place. Foundations also have more reporting requirements, which can be expensive and time-consuming. Since donor-advised funds are owned and managed by their host organization, donors don’t have to do this legwork themselves.
When it comes to charitable giving, it’s not always easy to decide on the best way to structure your gifts to maximize your charitable impact and family legacy. The Private Wealth team at First Business Bank offers simple, clear advice on the creation, administration, and investment requirements of private foundations, charitable trusts, and other charitable planning vehicles. Whether it’s through a private family foundation or another structure, our advisors will guide you through the planning process so that you and your family can make an impact that matters for generations to come.
1. Please consult a tax professional about your own specific circumstances.
