This handout is designed to illustrate the use of a Private Foundation (“Foundation”) and answer some questions you may have with regard to its use.

1.0 WHAT IS A PRIVATE FOUNDATION?

A tax-exempt charitable entity (corporation or trust) controlled by you or whomever you designate.

2.0 WHAT ARE THE BENEFITS OF A PRIVATE FOUNDATION?

2.1 Control Charitable Distributions. You contribute cash or property to your Foundation and claim an income tax deduction for the contribution. However, unlike other gifts to charity, you continue to control the investment of such contribution and how the funds are disbursed for years after the contribution. This is especially helpful if you make charitable contributions at year-end. Without a Foundation, you must decide who will receive the funds before the end of each year. With a Foundation, you need only make the contribution to your Foundation and will have additional time to decide who gets the contributions, and in what amounts.

2.2 Greater Deductions. Your ability to offset your income with any charitable deductions is limited to a percentage of your net income. For years in which your income is abnormally high, you may want to take advantage of the increased charitable giving opportunity. However, as discussed above, if you have not yet chosen particular charities to receive the funds, using a Foundation allows you to obtain the increased charitable deduction now and make the charitable distributions later. Additionally, through your Foundation, you can provide scholarships or grants to individual recipients, make contributions to non-charitable entities for charitable purposes, and potentially make contributions to foreign charities. If you made these types of contributions individually, you would not be permitted a tax deduction for them.

2.3 Intangible Benefits. A Foundation provides you the opportunity to grant intangible benefits to your family. Specifically, by serving on the Foundation’s Board or as one of its officers, your children and grandchildren can become involved in worthwhile causes and cultivate contacts with the people associated with them. In addition, your Foundation can perpetuate your family name after you are gone. Lastly, your family can even receive reasonable salaries and other compensation for services rendered to the Foundation.

2.4 Transfer Tax Benefits. By allocating assets to your Foundation during life or at your death, you avoid imposition of gift and estate tax and reduce your taxes by as much as 45% of the contribution. If you have a taxable estate, allocating assets to your Foundation allows you to effectively transfer nearly twice as much to charity as you could to your heirs.

3.0 IS RUNNING A PRIVATE FOUNDATION DIFFICULT?

As with other entities (like corporations or partnerships), Foundations must file certain tax returns on an annual basis. There is also a requirement to publish a notification each year that the Foundation’s tax returns are available for public inspection. However, the Foundation’s operations themselves do not need to be complicated at all. In fact, your Foundation can do nothing other than give contributions to other established charities.

4.0 WHEN SHOULD I ESTABLISH MY PRIVATE FOUNDATION?

You can establish the Foundation during life, which allows you to take an income tax deduction for the amount of the transfer. Alternatively, you can establish a Foundation at the time of your death under the terms of your Will or Living Trust to avoid estate tax on the contribution.

5.0 WHO IS A GOOD CANDIDATE FOR A PRIVATE FOUNDATION?

Good candidates for a Foundation include:

5.1 Seller of Highly-Appreciated Marketable Securities. If you intend to sell highly appreciated securities, you should consider contributing the securities to the Foundation prior to the sale. This will allow you to not only obtain a charitable tax deduction for the contribution but avoid the capital gains on the sale of the asset.

5.2 Create Charitable Legacy. If you have a large estate, and have already transferred significant wealth to your heirs, you can use a Foundation to provide intangible benefits to your heirs, while simultaneously benefiting charities.

5.3 Combine with other Estate Planning. Foundations can also be used to receive funds from Charitable Remainder Trusts and Charitable Lead Trusts. These techniques let you claim current tax deductions while still controlling the funds.

6.0 WHAT TYPES OF ASSETS CAN BE CONTRIBUTED TO A PRIVATE FOUNDATION?

A Foundation can hold a wide variety of assets, including cash, marketable securities, and real property. However, if property other than cash or marketable securities is contributed to the Foundation, then your income tax deduction will be limited to your basis in the property. Additionally, special considerations and limits apply to contributions of closely held businesses, non-income producing property, and debt-encumbered property that often make them not ideal assets for contribution to a Foundation.

7.0 HOW MUCH IS DISTRIBUTED TO CHARITY EACH YEAR?

There is no maximum on the amount of the Foundation that you may distribute to charity in any year. The only requirement is that you distribute at least 5% of the value of the Foundation to charities annually.

8.0 HOW MUCH CONTROL WILL I HAVE OVER THE PRIVATE FOUNDATION?

8.1 Complete Control. With a Foundation, you and your family have complete control over the Foundation’s operations, including investment choices and all charitable distributions.

8.2 Special Rules for Grants. If you want to give money to private individuals, such as in the form of grants or scholarships, you must first obtain permission from the IRS. However, as long as the IRS is assured that the money will go for the stated purposes, permission is routinely granted.

8.3 No Self-Dealing. Foundations must comply with restrictions on “self-dealing” which includes situations where you or your family members enter into sales or loans with the Foundation. However, as noted above, you can take salaries from the Foundation, as long as those salaries are reasonable.

8.4 Other Restrictions. Foundations also have other investment restrictions designed to protect the charitable interest in the assets. Specifically, the “jeopardy investments” rule prevents the Foundation from making highly risky investments that threaten its long-term and short-term financial needs. Additionally, the Foundation is prevented from holding long-term more than 20% of any one company or making distributions for non-charitable purposes. However, if the Foundation invests in a well- diversified portfolio, such restrictions should not be an issue.

9.0 ARE PRIVATE FOUNDATIONS THE ONLY WAY TO BENEFIT CHARITY AND SAVE TAXES?

No. There are a variety of techniques, including Charitable Remainder Trusts, Charitable Lead Trusts, and Donor Advised Funds that provide you and your family with important income and estate tax advantages, while simultaneously benefiting charities.

9.1 Charitable Remainder Trust. A Charitable Remainder Trust is a form of irrevocable trust in which you transfer cash or property and retain the right to receive payments for life, or for a selected term, and where any remaining amount of the trust passes to a charity you select after death or at the end of the selected term. Because the charity is the ultimate remainderman, the IRS treats the trust as income tax- exempt. This is a powerful technique that can result in elimination of capital gains tax, increased cash flow, and the elimination of estate taxes. Additionally, the remainderman selected can be a Foundation.

9.2 Charitable Lead Trust. A Charitable Lead Trust is a form of irrevocable trust in which you transfer cash or property, grant a charity (including your Foundation) the right to receive payments for a selected term, and where any remaining amount of the trust passes to your heirs at the end of the term. This technique can provide an immediate income tax deduction for the present value of all future payments to charity and allow you to transfer assets to your heirs at substantially discounted values.

9.3 Donor Advised Fund. Donor Advised Funds are “mini” foundations typically created at public charities whereby the donor contributes property to the Donor Advised Fund and retains the right to “direct” such charity to make distributions to other public charities in the future. The public charity does all the administration on the gift and controls all the investment decisions. These are often used when a donor wants to maximize their current charitable deduction, but does not want to undertake the administration of managing a Foundation or the amount being transferred is too small to justify the creation of a Foundation. The main detriment to the Donor Advised Fund (as compared to the Foundation) is the lack of control over the investment decisions, the additional fees charged to manage the assets by the public charity, and the loss of some control over the charitable distributions.

9.4 Supporting Organization. Supporting organizations are similar to Foundations in that you can retain control over the investments and create distribution policies for the assets. However, they incorporate even more favorable income tax rules, in exchange for a lower degree of control by your family.

10.0 HOW DO I CREATE A PRIVATE FOUNDATION?

If you want to create a Foundation during your lifetime, a non-profit corporation or trust is formed, and federal and state exemption application forms are filed with the IRS and the Franchise Tax Board or other appropriate state tax authority. If you are contributing appreciated non-marketable property, you will need to obtain a “qualified appraisal” of such property to substantiate your income tax deduction. If instead you would like to create the Foundation at your death, you need only direct your Executors or Trustees to create the tax-exempt entity in your Will or Living Trust.

Clay R. Stevens © 2010