private foundations and donor advised funds
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A review of private foundations and donor advised funds taken from the book Visual Planned Giving (2014)TRANSCRIPT
Private Foundations & Donor Advised Funds
Professor Russell JamesTexas Tech University
Private Foundations & Donor Advised Funds
1: What are PFs & DAFs?
Private foundations (non-operating)and donor advised funds hold money and distribute grants
78%
14%
5% 3%
Assets
81%
3% 14%
2%
Charitable Distributions PrivateFoundations(non-operating)
CharitableRemainderTrusts
Donor AdvisedFunds
Charitable LeadTrusts
Private Foundations are the Dominant Charitable Planning Vehicles
Combining 2010 data from IRS Statistics of Income (PF, CRT & CLT) and National Philanthropic Trust (DAF)
Psychology’s “terror management theory” suggests a defense to mortality reminders
is to create symbolic immortality (one’s name, impact, story will live on)
Dead
• Josiah K. Lilly (1948)
• Edsel Ford (1943)
• Robert Wood Johnson II (1968)
• W.K. Kellog (1951)
• Andrew W. Mellon (1937)
• John D. Rockefeller (1937)
Alive
• Lilly Endowment
• Ford Foundation
• Robert Wood Johnson Foundation
• W.K. Kellog Foundation
• Andrew W. Mellon Foundation
• The Rockefeller Foundation
The rules of a private foundation can be permanent
This differs from leaving an inheritance or
company where later generations make all rules
A private foundation allows donor and descendents to control the foundation
assets and charitable payouts indefinitely
A private foundation can transmit values by involving descendents in specific charitable causes for many generations
or Charitable Trust
Under state law create a…
Obtain federal tax exempt status Initial Application
1023 Annual filing
990-PF
Create a Private Foundation
Flexible; lower UBIT rates
More founder control; foreign operations eliminate deductibility for corporate donors
Nonprofit Corporation
1.
2.
Private foundations can be large, but most aren’t
26%
39%
28%
4% 3%
Asset Size: Non-Operating Private Foundations
$1 under $100,000
$100,000 under $1MM
$1MM under $10MM
$10MM under $25MM
$25MM or more
Source: IRS Statistics of Income for 2010. Domestic Private Foundations: Number and Selected Financial Data, by Type of Foundation and Size of End-of-year Fair Market. Excluding those not reporting any assets
Foundation board• Often the donor and close family members
• Can establish rules for succession
– Descendents who meet certain criteria
– Unequal voting rights allowable
– Junior board for minors advising on small gifts
Private Foundations & Donor Advised Funds
1: What are PFs & DAFs?
Private Foundations
2: PFs v. Public charities
Three types of charitable organizations
Public charity
Supporting organization
Private foundation
Public Charity
• Publicly supported
OR
• Operates ongoing traditional charitable activity (e.g., hospital, church, school)
Private Foundation
• Default if charity not a public charity or supporting organization
Typical private foundation
• Funded by one person, family, or corporation
• Makes grants, rather than directly running charitable activity
• Expenditures funded by investment income
Typical private foundation
• Funded by one person, family, or corporation
• Makes grants, rather than directly running charitable activity
• Expenditures funded by investment income
Traditional charity (e.g., operates church, hospital,
school)
Typical private foundation
• Funded by one person, family, or corporation
• Makes grants, rather than directly running charitable activity
• Expenditures funded by investment income
Publicly-supported
charity
At least 1/3 of total support1
from small donors2
1 Includes gifts and investment income over last 4 years. Large unusual gifts from outsiders can be excluded. 2 Gifts from those giving ≤ 2% of total support and any support from government
At least 1/10 of total support1
from small donors2
Typical private foundation
• Funded by one person, family, or corporation
• Makes grants, rather than directly running charitable activity
• Expenditures funded by investment income
operated to attract new
public or government
support
Smells like public charity
“facts and circumstances”
that it is a public charity
1 Includes gifts and investment income over last 4 years. Large unusual gifts from outsiders can be excluded. 2 Gifts from those giving ≤ 2% of total support and any support from government
Typical private foundation
• Funded by one person, family, or corporation
• Makes grants, rather than directly running charitable activity
• Expenditures funded by investment income
At least 1/3 of total support1 from memberships + charitable operations + small donors2
No more than 1/3 of total support1 from investment income
1 Includes gifts and investment income. Large unusual gifts from outsiders can be excluded 2 Includes support from government
Public charity by receipts
Private Foundations
2: PFs v. Public charities
Private Foundations
3: Tax rules
Tax rules for private foundations
Tax on net investment income
• 2% tax on net investment income
• Drops to 1% If charitable grants ≥ assets X (avg. % payout in the last five years) + 1% of net investment income
Gifts to private foundations also have lower income-based deductibility limits
Current Value: $25
1990 Paid $1
Long-term capital gain (special election)
Tangible personal property
(“unrelated” use)
CashOrdinary income
property
Inventory Short-term capital gain Public
Charity
Public Charity
Current Value: $25
1990 Paid $1
Long-term capital gain (no special election)
Tangible personal property
(“related” use)
CashOrdinary income
property
Inventory Short-term capital gain
Public Charity
Private Foundation (non-operating)
Current Value: $25
1990 Paid $1
Long-term capital gain (any)
Tangible personal property (“related” or “unrelated” use)
Current Value: $25
1990 Paid $1
Private Foundation (non-operating)
Private Foundation (non-operating)
Private Foundations
3: Tax rules
Private Foundations
4: Insider benefits
Charitable Purposes
To protect charitable distributions, many transactions are prohibited or penalized
Insider Benefits
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
IRS punishments for transactions that break the rules include:
• Initial tax (10%-30%)
• Additional tax if transaction not corrected (25%-200%)
• Revoking exemption
Who is an insider (A.K.A. a “disqualified person”)?
Insider Benefits Charitable Purposes
Insider or “Disqualified Person”• Officer, director, trustee, or any employee with
responsibility for the act
• Ancestor, spouse, descendent, or spouse of descendent of above
• Corporation, trust, or partnership owned 35% or more by above
• Substantial contributor >2% of all
contributions from foundation startto end of tax year (+>5K total contributions)
Grantors of a charitable trust automatically qualify
• Self-dealing• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
Self-Dealing
• Sell, exchange, lease, transfer or loan money, goods, services, property, or facilities to a disqualified person
• Paying a government official
Bargain sale
Suppose a disqualified person is willing to sell a $200,000 property to the foundation for $10,000?
Bargain saleSuppose a disqualified person gives a $200,000 property (with a recent $12,000 mortgage) to the foundation?
(Payment of the insider’s debt is a benefit, but allowed if debt is 10+ years old)
Self-Dealing Penalty• Disqualified person taxed 10% of transaction (+5% tax
on foundation manager who knowingly participates)
• Must correct in 90 days of IRS notice else disqualified person taxed 200% (+50% tax on foundation manager)
Free gifts to the foundation of money, property, or use of money or property are allowed
Foundation can hire an insider to perform necessary professional or managerial services (called “personal services”) if compensation is reasonable• Investment advice• Legal work• Accounting/tax services• Banking• Administrative assistance
The Council on Foundations’ Foundation Management Report contains compensation information for various positions
Reimbursements of reasonable and necessary expenses such as meals and travel• Travel to foundation board meetings for board
members (and junior board members who perform some functions in that role)
• Travel to grantees or potential grantees sites to investigate current or potential awards
Private foundations allow for unlimited multi-generational,
nearly tax-free (1%-2%) control of wealth,
with ongoing ability to provide insider
travel and employment for
professional/ management
services, and limiting charitable activities to founder’s desires
Private Foundations
4: Insider benefits
Private Foundations
5: Distributing income
• Self-dealing
• Failure to distribute income• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
The foundation must distribute at least 5% of non-charitable net assets under its control by the end of the following tax year
Non-charitable net assets excludes charitable assets and assets not yet
under foundations’ control
No charitable assets:used for charitable purposes,
such as paintings on loan to a museum, or office
furniture used to manage the foundation
No assets not yet under foundation’s control: a right to receive property after death, after
estate administration, or after payment of a pledge
5% payout is reduced by investment
tax and unrelated business
income tax
Administrative expenses for grant-making or fundraising (but not
investment management) also count as charitable
expenditures towards the 5% minimum required
payout
5% can be spent on grants to charity including designated purpose funds, but NOT to
• Another non-operating foundation
• Charity controlled by the foundation or disqualified persons
• Donor advised funds
Buying or improving assets used directly in charitable purposes also
count towards 5%
Can the foundation postpone payouts to save up for a big gift?
Yes. If…
• It is for a project better accomplished through set aside than by immediate payout (e.g., constructing a building)
• Pay out within 60 months of first set-aside
If the foundation makes a big gift, will the amount above 5% carry over to future
years?
Yes. Gifts above 5%
can carry forward for up to
5 years.
• Foundation pays a tax of 30% of required amount not distributed
• Additional 100% if not corrected in 90 days of IRS notice
Penalty for Failure to Distribute
Private Foundations
5: Distributing Income
Private Foundations
6: Investments
• Self-dealing
• Failure to distribute income
• Excess business holding• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
What’s the problem with excess business holdings?
• Donor still controls the business even though he has taken a charitable deduction
• Donor decides if any profit is distributed to the foundation
• Donor controls his (and other’s) compensation at the business
Foundation
Foundation + Insiders
20%
Add If Another Has Effective
Control15%Others
65%
A private foundation cannot own more than 2% if the foundation and all disqualified persons combined own more than 20% of a company (35% if someone else has effective control)
• Charitable function such as a school or hospital
• Business run by unpaid volunteers or selling donated items
• Business for beneficiaries /employees such as a museum cafeteria
Full ownership of a charitable business is allowed
Full ownership is allowed if business is passive – simply collecting dividends, interests, royalties, or real estate rent without leverage
Time to dispose of excess business holdings• 90 days if foundation buys• 5 years if foundation
receives as a gift [and can request extension for another 5 years if unusual circumstances]
• Foundation pays a tax of 10% of highest business holdings above maximum
• Up to 200% if not corrected in 90 days of IRS notice
Excess Business Holding Penalty
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose• Taxable expenditures
Insider Benefits Charitable Purposes
Crazy investment gambles can
jeopardize the charitable purpose
Nothing is automatically
disqualified, but special attention given to options, margin trading,
short selling, commodity
futures, oil/gas interests
Jeopardizing investments are excessively risky in the context of entire portfolio
(“fails to exercise ordinary
business care and prudence”)
High risk investments are allowed if they are primarily charitable •Needy student loans
• Low-income housing
•Urban renewal
• Foundation pays a tax of 10% of the jeopardizing investment (manager pays 5%, up to $10k)
• Another 25% if not corrected within 90 days of IRS notice (manager pays another 5%, up to $20k)
Jeopardizing Investment Penalty
• Self-dealing
• Failure to distribute income
• Excess business holding
• Investments that jeopardize charitable purpose
• Taxable expenditures
Insider Benefits Charitable Purposes
Taxable expenditures
• Non-charitable purposes
• Political campaigning or lobbying (except non-partisan research)
• Grants to individuals except – Travel, study, or similar if IRS
approves non-discriminatory award process
– Grants to impoverished persons or disaster victims
– Prizes/awards to recognize achievement with no restrictions on use of funds
• 20% of the taxable expenditure (manager pays 5% up to $10k if no reasonable cause)
• Another 100% if not corrected within 90 days of IRS notice (manager pays another 50%, up to $20k)
Taxable Expenditures Penalty
Private Foundations
6: Investments
Private Foundations
7: v. Donor Advised Funds
What if creating a private foundation is just too much hassle?
Donor Charities
The Donor Advised Fund
Donor’s DAF
$
$
Sponsoring charity has legal ownership of DAFs
$
Gifts are to a public charity, because charity
has legal ownership
Charity follows donor advice, otherwise no one would give again
$
Donor advised fund• No minimum payout• Minimal setup &
administrative expense• Expected control of grants• Investment management
sometimes allowed• Legislatively new• High income limits &
valuations• No tax on earnings
Private foundation• 5% minimum payout• Significant setup &
administrative expense• Legal control of grants• Investment management
always allowed• Legislatively stable• Low income limits &
valuations• 1% or 2% tax on earnings
End of year DAF contributions pull forward deductions
Many use DAFs as a short-term conduit to take an earlier tax deduction for expected future gifting to charities
DAF Limitations• No benefits (grants, loans, compensation, or indirect benefit) to
donor, family, or organizations 35%+ controlled by these. Ex: no major donor event tickets
• No excess business holdings (same rule as private foundations)
• No distributions to private foundations (rare exceptions) or individuals
Private Foundations
7: v. Donor Advised Funds
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All slides are taken from the
book Visual Planned Giving
Available from Amazon.com
Private Foundations & Donor Advised Funds
Professor Russell JamesTexas Tech University