Private foundations have grown in popularity in recent years and go hand-in-hand with estate planning. For individuals who are charity driven, adding a private foundation to an estate plan can be a rewarding experience on several levels. Not only will creating a private foundation afford you the ability to give back and do honorable deeds but it can also reduce income tax liability and eliminate certain assets from your taxable estate. When integrated into your estate planning, starting a private foundation can offer you control of gifts or bequests to charities, giving you, the donor, more control over where how funds are distributed.

Private Foundations Explained

Private foundations are specially recognized charitable organizations by the Internal Revenue Service (IRS). The Internal Revenue Code (IRC), defines private foundations as:

“a corporation or community chest, fund or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition. Or for the prevention of cruelty to children or animals.”

Every charitable organization is considered a private foundation unless specifically distinguished as such with the IRS. For tax purposes, private foundations are divided into three categories: 1) private operating foundations, 2) exempt operating foundations, and 3) private non-operating foundations.

Considerations When Starting Foundation

Control, family considerations, taxes, and administration are all primary considerations that should be taken into account when making the decision to start a foundation.

Control: Would your estate and charity benefit more from ongoing support through annual distributions versus a one-time gift? Do you wish to have a trustee evaluate how money is spent?

Family: Do you want to have your family members become more engaged in civic/philanthropic activities? Is it important to you that your family members have a greater appreciation or knowledge of your cause? Could they themselves benefit from a strengthened social impact within their community?

Taxes: Does a private foundation help you meet your tax planning and estate tax goals? Are you certain of the tax benefits associated with funding and ongoing administration? Even though private foundations, when properly set up, are tax exempt, the IRS does impose a 2% tax on investment income. Additionally, a private foundation must file an annual tax return outlining assets, liabilities, managers, and activities.

Administrative: There is a multitude of statutes and regulations that adhere to certain benefits of a private foundation. Complexity and compliance costs associated with the creation and administration a private foundation should certainly be taken into consideration. Some costs that will contribute to the administrative considerations are attorney fees to draft trust documentation and accountant fees to prepare and file IRS forms both at the onset of the charitable foundation and annually thereafter.

Benefits of Creating a Private Foundation

There is an abundance of tangible and nontangible benefits associated with creating a private foundation. Tax liability benefits aside, adding a private foundation to an estate plan can help you create a legacy dedicated to your philanthropic interest, encourage others to take up the same cause, and hopefully allow you to help solve social issues such as poverty, hunger, or lack of education. Financially speaking, beginning a foundation can help lower your estate taxes if applicable, in addition to helping you oversee charitable funds over time and pass on wealth management tips to your younger family members.

How to Start a Private Foundation

So, you have weighed the costs and complexity of operating your private foundation and discussed the implications with your estate planning attorney and tax accountant. Next, how do you start a private foundation? If you have already employed the assistance of a trusted lawyer and accountant, these two individuals will be instrumental in beginning and maintaining your private foundation. Both professionals should have a solid understanding of federal laws regarding the qualifications and requirements for tax-exempt charitable organizations, as well as state law governing the creation and management of trusts.

While you have the option to create a private foundation as a corporation or a trust, for estate planning purposes, you’ll want to focus on establishing the trust form of a private foundation. Not only are private foundation trusts easier to create and administer, you also avoid additional work involved with private foundation corporations.

For many individuals with a desire to start a private foundation during their lifetime, a trust may have already been established. In these instances, individuals can set up a separate inter “vivos trust.” Alternatively, if you desire to establish a trust following death, you can utilize a revocable living trust or a last will that establishes the private foundation. If you have already created a living trust, an amendment can be drafted that directs the trustee or executor to create and fund the private foundation. A private foundation, like any trust, will include that certain provisions be outlined, such as trustee powers, successor trustee provisions, distribution guidelines, and governing law provisions.

In addition, private foundation trust documents must include the charitable purpose of the trust and other private foundation rules, as required by the IRS. Finally, once the trust documents are filed and the private foundation has been funded, the trustee must then apply for tax-exempt status by completing the necessary IRS forms.

Professional Help: Private Foundations

Setting up a private foundation certainly has advantages; however, the benefits may not be as tremendous as other charitable giving strategies. Therefore, you should certainly consult your tax professional in order to determine if starting a private foundation has the tax benefits that you are looking for and that overall cost and complexity considerations of administering a private foundation are taken into account.  To learn more or to find out if establishing a private foundation is best for you, contact Lawhorn CPA Group, LLC at 865-212-4867 or online HERE.