How to Start a Private Foundation
A private foundation is established for charitable purposes to provide its donors with a tax deduction for their charitable contributions. It is typically funded in the form of an endowment from a single entity, either an individual, family, or corporation. Most private foundations make their donations in the form of grants.
How to Start and Protect Your Private Foundation
You can establish your private foundation as either a charitable trust or a nonprofit corporation. While a charitable trust is easier to operate, a nonprofit corporation limits personal liability, offering more significant legal protection to the trustees. This article will provide you with the information needed for establishing your foundation as a nonprofit corporation.
Starting a private foundation requires a substantial commitment of both time and money. It is essential that you seek an estate planning attorney throughout forming and running your foundation, and we are here to help. Meet the Hess-Verdon attorneys.
How to Start a Foundation
There is a significant amount of documentation required to start a private foundation. Throughout the lifetime of the foundation, you will be answering to both state and federal authorities.
Your first step will be to register with the IRS. You need to have an employer identification number (EIN) whether you intend to hire employees or not. The IRS will assign you an EIN at no charge. Your EIN will also allow you to open a corporate bank account.
You will then need to form your corporation by filing articles of incorporation and the required state filing fee with the Secretary of State.
Articles of incorporation traditionally include:
- Name of the foundation. Always do a name search to ensure that the name you choose for your foundation does not already exist.
- Type of corporate structure. In the case of a private foundation, you will be registering it as a nonprofit corporation.
- Specific purpose statement. Keep your purpose statement broad enough to evolve yet narrow enough to focus on your ultimate goals for the foundation.
- Your designated registered agent. It is a requirement that you designate a specific contact to receive official correspondence and lawsuits.
- Contact information for your board of directors and their authority.
You will need to qualify for tax exemption at both the state and federal levels. IRS Form 1023 is the application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. This form must be completed carefully, and there are several pertinent sections to it.
It usually takes three to four months for the IRS to process this documentation, and there will be a necessary filing fee. Once you have received your federal determination letter from the IRS, you must also apply for tax exemption with the California Franchise Tax Board using form 3500A. The State will supply you with an affirmation of exemption upon approval.
Advantages of a Private Foundation
The advantages of a private foundation include:
- Organized philanthropy
- Expansion of opportunities to donate
- Tax-deductible donations
- Double the capital gains benefits
- Reduction in estate tax
- Public relations
- Protects your privacy
- Travel and other related expenses are deductible
Disadvantages of a Private Foundation
There are some disadvantages of a private foundation. They are:
- An extensive commitment of time and costs
- Extensive recordkeeping requirements
- Extensive regulatory requirements
- Annual reporting requirements
- There may be lower caps on deductibility
How to Keep the Foundation
To keep your foundation running in compliance with federal and state regulations, you will be required to keep meticulous records of all foundation operations. When you first formed your corporation, you appointed a board of directors. Make sure that each board member knows their duties and the level of authority for making foundation decisions. Every major decision should be made as a group, with no one individual able to act in the name of the foundation in a manner that could be construed as against the best interests of the foundation.
You will want to make sure that you meet every deadline set by governing authorities. It is not only easy to lose your nonprofit status, but the government has the power to punish individuals who don’t abide by the strict government regulations every foundation must operate under.
When it comes to private foundations, some activities are strictly prohibited. Your foundation could be heavily taxed and fined if it participates in:
- Activities related to political campaigns
- Activities related to legislation
- Making a grant to individuals who do not meet regulatory criteria
- Payments for activities that are non-charitable unless there is a specific exception allowed by government oversight
- Completing grants to other private foundations that do not meet strict regulatory requirements
- Making risky investments with foundation funds
- Participates in activities considered to be a conflict of interest of the foundation
Note: Some investments are considered program-related investments. These investments can only be made if they can be proven to further the charitable purposes of the foundation.
Private Foundation Distribution Rules
The federal government requires all private foundations to follow strict rules when distributing funds to qualified recipients. Minimum distribution requirements are closely monitored. A foundation is required to distribute an amount that meets or exceeds a certain percentage of the net assets each year. These funds must follow strict qualifying distribution rules.
Qualifying distributions include all amounts paid in grants or other charitable distributions and reasonable and necessary administrative expenses associated with these distributions.
Private foundations are prohibited from disbursing funds to disqualified persons. This category includes:
- Substantial contributors to the fund
- Foundation officers and directors
- Family members of disqualified persons
- Any corporation, partnership, or trust in which a disqualified person has 35% ownership
Private foundations are prohibited from participating in self-dealing transactions with disqualified persons even if that transaction would be considered beneficial to the foundation. Self-dealing transactions can be either direct or indirect and include:
- Sale, exchange, or lease of property which would provide a disqualified person financial gain. A disqualified person can donate property as long as there is no debt attached to it.
- Extension of credit to a disqualified person
- Payment of expenses of disqualified persons except for personal services that are necessary to carry out the purpose of the foundation. These expenses must never be excessive.
- Transferring or using foundation income and assets for the benefit of a disqualified person’s personal gain.
- Payments to a government official.
The IRS imposes penalties on self-dealing in the form of an annual excise tax. A self-dealer will be required to pay a first-tier excise tax in the amount of 10 percent of the amount involved for each act of self-dealing. Further, a foundation manager who knowingly participates in acts of self-dealing can be required to pay a first-tier excise tax of 5 percent of the amount involved, up to $20,000 for each act of self-dealing. If the foundation manager participated in these activities unwillingly or for a reasonable cause, that manager could be found exempt from this fine.
If these fines are not paid within a reasonable time, the self-dealer will be required to pay a second-tier excise tax in an amount equal to 200 percent of the amount involved. An involved foundation manager may also be taxed in the amount of 50 percent of the amount involved up to a maximum of $20,000. The IRS can impose additional penalties in amounts equal to both the first-tier and second-tier taxes if individuals who have been previously subject to these payments willfully and flagrantly continue to participate in self-dealing acts.
For a private foundation to comply with government regulations associated with exempt foundations, it is vital that the foundation seek financial advice from an experienced professional. Private foundations must submit detailed reporting to the governing authorities, including the state where the foundation resides and the IRS, on an annual and, in some cases, biannual basis. Contact us today for guidance in starting and running your private foundation.
TYPES OF CHARITABLE REMAINDER TRUSTS
- Charitable Remainder Trust (CRT)
- Charitable Remainder Lead Trust (CLT)
- Charitable Lead Annuity Trust (CLAT)
- Charity remainder-annuity trusts (CRATs): The income beneficiaries are guaranteed a fixed amount from all assets in the trust as yearly income for their lifetime or 20 years. With a CRAT, the income earned from the trust is constant and immune to fluctuations in the economy or changes due to the performance of the investments.
- Charitable remainder-unitrusts (CRUTs): If the CRT is created as CRUT, the income beneficiaries receive a specific percentage (at least 5 %) of the assets in the trust. The amount received by the grantor or named beneficiaries during their lifetime varies based on the performance of the trust’s assets.
Charitable remainder trust distribution rules
· Payments must be set as a fixed annual amount or as a fixed percentage of the yearly trust value as in a CRUT.
· The CRT can have inflation adjustments for payments, but this benefit eliminates charitable deductions
· The IRS rules demand that CRT payments be between 5-50% of the trust’s assets
· As the grantor, you receive an instant income tax deduction that is equal to the current value of the projected remainder interest that goes to the charity
Key considerations for a CRAT:
· The Charitable Remainder Annuity Trust or CRAT pays a fixed income stream
· The income is a percentage of the CRAT asset’s market value
· This payment doesn’t change in the term of the trust; thus, the term annuity
· If you fund the CRAT with $2 million and you choose a 5% annuity payment, this trust will pay you a fixed $100,000 every year
· The CRAT payments rarely surpass 15%
· You cannot add new assets to the CRAT after you create it
Key considerations for a CRUT:
· The payments are a fixed ratio of the dynamic market value of the assets
· The yearly income stream fluctuates as the current value of the assets change
· You receive more pay when the assets grow and less money when the CRUT investments dive
· If you funded the CRUT with $2 million, and you choose 10 % as the payout, in the first ear, you would get $200K
· If in the second year the CRUT assets appreciate to $3 million, the payout will be $300K
· If in the fourth-year assets fair market value dropped to $1million, the payout will be $100K
The CRT is good for you if you wish to preserve the value of your appreciated assets. This trust empowers you to turn long-term trusts into an income-generating property. When the trust sells the assets that are put into it, the sale is exempt from taxes. By avoiding capital gains taxes, more money goes to the income and charitable beneficiaries.
The CRT investments are exempt from tax. That makes the CRT a worthwhile vehicle for asset diversification. You can also use it to take care of your hairs for their entire life -it helps you prevent the risk of spendthrift heirs running down your estate. Contact a trust attorney for help with all issues relating to a charity remainder trust. Call (949) 706 -7300.
- Charitable Remainder Trust (CRT)
- Grantor Retained Annuity Trust (GRAT)
- Qualified Personal Residence Trust (QTIP)
- Learn more on estate planning.
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