Berntson Porter Coronavirus Resource Center Details.


LIKE WHAT YOU READ? Share this article :

Private Foundations and Donor-Advised Funds – Creating a Lasting Legacy


Philanthropy in 2020

There is a long-established history of personal and corporate philanthropy in the U.S. with gifting by individuals in 2018 totaling $292.09 billion and gifting by foundations totaling nearly $75.86 billion in 2018, according to the Giving USA Foundation annual report for 2019. Over the past decade, donor-advised funds have also experienced tremendous growth. According to the National Philanthropic Trust, in 2018 contributions to donor-advised funds totaled $37.12 billion (with grant recommendations totaling $23.42 billion), representing a 86% increase in contributions to donor-advised funds over the past five years.

A strong U.S. economy, especially in the Pacific Northwest region, has made charitable gifting top of mind for families along with tax savings and favorable charitable vehicles for long-term generational planning including private foundations, donor-advised funds, and charitable trusts. Private foundations and donor advised funds are explored in more depth below.  Other gifting strategies including charitable trusts and public operating charities are beyond the scope of this article, since those face a different set of tax and legal rules.

The summary below is not intended as a substitute for legal, tax, or investment advice and should be reviewed carefully with your team of advisors, along with your overall charitable gifting goals.

What is a Private Foundation and Donor-Advised Fund?

As defined by the Foundation Center, a private foundation is a nongovernmental, nonprofit organization, with its own funds (usually from a single source, either an individual, family, or corporation) managed by its own trustees and directors, which is established to maintain or aid in educational, social, charitable, religious, or other activities serving the common welfare primarily by making grants to other nonprofit organizations. Most private foundations are initially endowed with a large principal fund and make their annual grants essentially from investment income. Even though foundation assets are derived from private sources, private foundations serve the public and are committed to grant-making that benefits broad public goals.

A private foundation involves forming a separate legal entity (created and organized under state law as either a corporation or trust) and applying for tax-exempt status with the IRS. Private foundations allow donors more control over their gifting and family legacy but also come with more complex tax rules governing the types of investments allowed, grants, and how the foundation is allowed to work with officers, directors, trustees, and family members. Although there are higher operating burdens imposed on establishing a private foundation, those can be balanced with private foundations being a better method to control long-term family gifting goals which is accomplished by appointing a governing board of directors or trustee. Private foundations however may not be the ideal charitable vehicle for all families, and should have enough initial funding and financial resources to cover legal, accounting, and ongoing operating costs as needed (such as director fees, office space, and technology).

A donor-advised fund (DAF) is a giving vehicle established at a public charity allowing donors to make tax-deductible charitable contributions with an immediate tax deduction and then recommend grants from the fund over time.  Donor-advised funds offer the same virtues as a private foundation but involve less cost and complexity to set up, fund, and make recurring gifts from. Both private foundations and DAFs allow donors to take a tax deduction for funding now, while getting the optionality and flexibility of picking future charitable recipients at a later time. Donor-advised funds can also be sponsored by a local manager, such as the Seattle Foundation, or easily set up with wealth manager using a custodian such as Schwab, Fidelity, or Vanguard Charitable.

The chart below shows a side by side comparison of Private Foundations and DAFs:


What Assets are Best to Gift to a Private Foundation or Donor-Advised Fund and When?

For both private foundations and DAFs, generally the best asset to gift is very low-basis highly appreciated stock or real estate, since no capital gains tax is due on charitable gifts and you get an immediate tax deduction, based on the fair market value on the date of the gift. As tax-exempt entities, private foundations and DAFs can then sell the highly appreciated property, often at little or no tax cost, then investing those assets for tax-free growth in a diversified portfolio. In 2020, the tax on capital gains and other sources of portfolio type income to a private foundation is a flat 1.39% and DAFs don’t pay any tax on the sale of gifted stock held by the fund.

Private foundations and donor-advised funds also provide donors with great flexibility in terms of timing charitable gifts. For instance, a donor in a high income tax year in the top income tax bracket (37% in 2020) may decide to take full advantage of the 20% or 30% income limits on donations to their foundation for a meaningful upfront income and estate tax savings without deciding in that same tax year on the ultimate charitable recipients. Gifts can then be scaled back in lower income years.

What are Some of the Tax Reporting Requirements and Nuances Related to Operating a Private Foundation?

Private foundations face a complex set of tax rules meant to ensure that foundations are meeting charitable gifting goals, avoid becoming a mere holding company for investments or family business interests, and prevent self-dealing between foundation insiders. Below are a few of the more salient tax rules and tax filing requirements for private foundations.

  • Require an annual tax filing (Form 990-PF) due on May 15th each year (without filing for an extension), and also may require additional bookkeeping services.
  • Private foundations need to distribute out at-least 5% of prior year average values of non-charitable related assets (investments) each year to avoid an excise tax.Private foundations that make a large donation in one year, may carryover that donation to the next five tax years to reduce future grants. There are special rules related to valuations of real estate held by a private foundation.
  • Set-Asides – The IRS also realizes that foundations in the early stages may be saving investment returns and contributions for a larger goal (for example purchasing a building) and makes exceptions to the 5% annual distribution rule for certain cases, in what are called set-asides.
  • Grants from the foundation should also be reviewed carefully to ensure they are going to a qualified public charity (generally a 501(1)(c)(3) organization); if not, the foundation could be subject to penalty and the grant would not count toward the annual distribution requirements. The foundation should have a formal grant review process in place regarding accepting proposals, types of causes to support, gifting focus, and overall strategy. Grants to individuals may be acceptable under certain circumstances, such as for scholarships or emergency needs, but should be reviewed carefully.
  • Private foundations are subject to an annual investment income tax ranging from 1-2% of foundation investment income (interest, dividends, rents, capital gains, passive income, etc). For tax years beginning after December, 20, 2019, the excise tax is a flat 1.39% of foundation net investment income. This is important to budget for from a cash-flow standpoint, since foundations also need to make quarterly estimated tax payments (similar to individuals and trusts).
  • Foundation directors should be aware of the self-dealing rules especially related to paying family members or close friends to be an officer/director of the foundation and as related to real estate leases. If self-dealing occurs, the tax code imposes a 10% excise tax on the violation and a 5% excise tax on the foundation manager. If self-dealing continues without being corrected, those penalty taxes can rise to 200% and 50%, respectively.
  • There may be additional state/local tax and legal filings to complete.
  • There are special rules related to excess business holdings and K-1 type investments may created a separate tax related to Unrelated Business Taxable Income (UBTI).
  • Officer compensation is allowed for directors, officers, and trustees of a private foundation (including family members), provided the compensation is reasonable in regard to the efforts made, including factors such as qualifications, experience, job responsibilities, duties, full-time or part-time commitment, etc. Officer compensation should be clearly documented and reviewed on a regular basis to determine it is both reasonable and necessary and not excessive. Foundation insiders include managers (directors, officers, and trustees), substantial contributors, family members, and certain entities (for example an operating business) owned wholly or partially by the above individuals.

How can Private Foundations and DAFs Create a Family Gifting Legacy for the Next Generation?

Private foundations and DAFs are a great way to get children (and even grandchildren) involved with both family governance and philanthropy. Serving on the foundation board or being involved in quarterly or annual foundation meetings can be a great way for the younger generation to get a first step into family finances and may include choosing causes or charities to support, setting gifting budgets, or reviewing investments held by the foundation. One area to look at may be choosing investments in companies that are great social stewards using Socially Responsible Investing (SRI) methodologies. Picking investments for a private foundation is a good discussion to have with both your wealth manager, CPA, and estate planning attorney.

Next Steps

If you are interested in exploring how a private foundation or DAF may fit into your estate and income tax planning, please reach out to your CPA at Berntson Porter & Company PLLC or speak directly with a team member in our estate and transition planning services group below.

Cyndi Hertzog, Senior Tax Manager | p: 425.454.7990 | d: 425.289.7607

Matthew Goodwin, CPA, CFP®, MPAcc (Tax), Senior Manager | p: 425.454.7990 | d: 425.289.7666


New Name, Same People and Service You’ve Known for Years.

Berntson Porter is excited to announce that we are now part of CBIZ & MHM (Mayer Hoffman McCann P.C.). Together, CBIZ & MHM are one of the nation’s Top Ten accounting providers, and Berntson Porter is honored to be joining them. We are pleased to be able to offer the same people and the same service you’ve known for years under a new name: CBIZ Berntson Porter. Please click here for more information.