Volunteer Legal Handbook - Law - Private Foundations

Any charitable corporation can call itself a "foundation," but for purposes of the Handbook, a foundation is defined by the tax definition, as discussed below. Additionally, to thoroughly discuss private foundations would require doubling the size of these materials. Please see the Supplemental Materials section for additional resources on private foundations.

The main advantage of a private foundation is to the donor and can be summarized in one word: control. Simplifying things a great deal, there is a tradeoff for the donor. As the donor surrenders control, he or she gains tax advantages and reduces administrative costs; as he or she exercises control over the use the private foundation makes of the monies, strict prohibitions on self-dealing are imposed, tax advantages may be reduced or disappear altogether and the administrative costs ñ the portion of the endowment lost to taxes and overhead ñ will increase.

The cost of creating and obtaining exempt status for a private foundation is significant. The operating costs, and in particular complying with all of the rules and restrictions that surround private foundations, is another very significant issue. But for the right kind of donor, those prices may be reasonable for the greater control a donor can have over the use made of his, her or its donated funds.

Because private foundations are largely creations of the tax code, discussion of them tends to focus overwhelmingly on fairly obscure income tax concepts. You really need the help of a qualified certified public accountant to work your way through these issues. This is only a much simplified introduction.

First and foremost, the advantage of a private foundation is control. A donor who gives money to a private foundation they control has the ability to direct the use of monies. The private foundation is not answerable to any broader group of donors and, subject to the requirements of the Internal Revenue Code, can manage the monies as they see fit.

The disadvantage is another tax. Federal tax law subjects private foundations to an annual excise tax of two percent (2.0%) on annual investment income. In addition, there are more limits on the amount of deductible contributions that may be made to foundations than there are for charitable corporations. These and other limits are intended to prevent private foundations from abusing their greater control and flexibility.

Very generally, a donor to a charitable corporation may deduct the full fair market value of in-kind donations. Also very generally, a donor may deduct only his or her basis in in-kind donations to a private foundation. If the in-kind property were fully depreciated the donor to the private foundation would not get any deduction. However, Congress has on an annual basis been allowing a fair market value deduction to donors to private foundations under 26 U.S.C. Section 170(e)(5). The latest word is that this privilege has now been made permanent.

In addition, there are other constraints on the deductibility of donations to private foundations:

Cash - Generally, a donor may not deduct cash donations in any given year that amount to more than fifty percent (50.0%) of the donor's adjusted gross income. It's thirty (30.0%) in the case of certain sub-types of private foundations.

Appreciated Property - Generally, a donor may not deduct gifts of appreciated property in any given year that amount to more than thirty percent (30.0%) of the donor's adjusted gross income. It's twenty percent (20.0%) in the case of certain sub-types of private foundations. Excess donations of appreciated property may be carried forward for the next five (5) years.

Stock - (We're talking corporate shares here, not livestock.) The rules here are hopelessly complex, and in transition. Be aware that there are complex limits on stock donations, with serious tax implications for the donor, and talk to a certified public accountant.

Under the tax laws, and especially 26 U.S.C. Section 509(a), a "foundation" is characterized by three things, which operate as a kind of negative definition. In application, however, these tests can be terrifically difficult to administer or apply.

A private foundation typically has a single primary source of funds; a corporation or a family contributes essentially all of the money to it, as opposed to having a broad base of contributors.

A private foundation usually makes grants to charitable corporations who administer programs, as opposed to operating programs itself. Generally, all distributions must be to charitable corporations. The specific rules are at 26 U.S.C. Section 4942(g).

Monies disbursed from the private foundation come from the endowment or investment income of the endowment, as opposed to a fund-raising program.

Taxes. Congress has perceived private foundations as carrying a high risk of abuse, and has closely regulated them. In addition to the two percent (2.0%) excise tax on investment income, there are other excise taxes imposed on private foundations that are penal and intended to regulate their behavior as opposed to generating revenue. They are avoidable only if you operate the private foundation in strictly the way Congress wants.

There is an excise tax imposed on transactions tainted with self-dealing that is similar, but not identical, to the excise tax on excess benefits transactions described above.

There is an excise tax imposed if the private foundation fails to make qualifying distributions at a high enough level under a complex definition. Generally, the private foundation must distribute at least five percent (5.0%) of the aggregate fair market value of its assets that are not used directly to carry out the private foundation's exempt purposes.

There is an excise tax on excess business holdings. Generally, a private foundation may not own more than twenty percent (20.0%) of the voting stock of a business. Any voting stock owned by the persons who control the private foundation are subtracted from that total.

There is an excise tax on jeopardy investments. A private foundation cannot invest its funds in ways that jeopardize its ability to perform its mission.

There is an excise tax on taxable expenditures. An extremely difficult area, generally a private foundation can't make distributions which would be forbidden to a charitable corporation; i.e., political contributions or lobbying expenses.

The IRS's view of private foundations' duties and risks is set out in IRS Publication 578, "Tax Information for Private Foundations and Foundation Managers," available by phone at 1-800-TAX-FORM or on the Internet at

Chapter 7. Private Foundations and Donor Advised Funds