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Size Considerations
Unless a certain principal is available to generate
funds for grantmaking, it may not be worthwhile to incur the
costs of forming and operating a private foundation. Although
there is no legal minimum and no firm consensus on the amount
that justifies establishing a foundation, there are some general
guidelines.
One rule of thumb is that an annual minimum of $25,000 should be available for grantmaking. This amount may be generated by
endowment, annual contributions, or a combination of the two. Another factor that is relevant to start-up size is whether or
not future gifts to the corpus are anticipated. To a large degree the amount necessary to justify a foundation depends on the
donor's interests. Many small foundations have been established, for example, in order to provide modest academic
scholarships.
Two types of foundations are widely recognized exceptions to the rules governing size. One is the "stand-by" foundation, which
is set up to receive lifetime contributions and which stands by to receive a major bequest at death or on termination of a
trust. In the interim, the donor gains experience with management and grantmaking procedures. The second is the "flow-through"
foundation, which converts appreciated and/or real property into cash and distributes the proceeds to publicly supported
charities, without building up an endowment.
The types of assets available to an individual or family who is considering establishing a private foundation play a part in
determining what kind of foundation should be set up and whether a private foundation is an appropriate charitable outlet.
- Cash
Lifetime gifts of cash to a private foundation afford the donor a deduction of up to 30 percent of his or
her adjusted gross income, with a five-year carry-over privilege for amounts in excess of 30 percent.
- Appreciated Property
Lifetime gifts of appreciated property, such as closely held stock and real estate, may be
deducted at cost. Publicly traded stock may be deducted at its fair market value. All these gifts of appreciated property to
private foundations may be deducted up to 20 percent of the donor's adjusted gross income, with five-year carry-over
privileges for amounts in excess of the 20 percent limit.
The above limitations apply only to lifetime gifts. Bequests are all deductible from the estate of the donor at full value.
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Types of Foundations
There are a number of organizations whose names include
the word "foundation" that are not technically foundations at
all. They may use the word to describe efforts to raise funds
to combat a particular disease or to support a particular educational
institution. Generally, these "foundations" are actually publicly
supported charities themselves, which exist to raise funds and
distribute them to other public charities. They are often called
"public foundations."
On the other hand, private foundations, the subject of this booklet, are privately supported by an individual, a group of
individuals, a family, or a company. They exist for the sole purpose of making grants for charitable, educational, or
religious purposes or, in some cases, of carrying out such activities themselves. The major types of grantmaking foundations
are discussed below.
- Private non-operating foundations
are usually incorporated under state law as nonprofit corporations
or organized as charitable trusts. They are recognized by
the Internal Revenue Service as tax-exempt organizations.
As the largest category of private foundations they vary
greatly in size and purpose. A non-operating foundation
may have derived the bulk of its income-producing corpus
from a single bequest, or it may receive annual contributions
from an individual, group of individuals, or members of
a family. Some non-operating foundations are "flow-through"
or "conduit" foundations that distribute their assets soon
after they are received. Others have substantial and long-lasting
endowments. The primary purpose of a non-operating foundation
is to make grants.
Grantmaking decisions are usually made by a board of
directors or trustees, and this board may be autonomous
or controlled by the donor or donor family. While grantmaking
is the sole activity of some foundations, others participate
actively in conferences, publications, and research related
to their field of interest.
All private foundations must set forth exempt purposes
in their charters. Major non-operating foundations such
as the Ford, Rockefeller, and Sloan are general
purpose foundations whose broadly framed purposes
allow them to make grants in virtually any field of endeavor.
Special purpose foundations
set forth a specific area of interest within which they
will make grants. This may be a broad aim, such as the
promotion of international peace, or a narrow one, such
as providing scholarships to the daughters of Lutheran
ministers residing in Nashville.
- Private operating foundations,
as the name suggests, are not primarily grantmaking entities.
They operate facilities or institutions devoted to a specific
charitable activity spelled out in their charters. Some
conduct research while others provide a direct service by
operating museums, facilities for the handicapped, historical
sites, etc.
- Corporate foundations are
usually private non-operating foundations with close ties
to the corporations that provide their funding. They are
often "flow through" foundations that use funds received
last year to make grants this year. Philanthropic priorities
are usually set by the chief executive officer of the corporation
or by a committee appointed by the foundation's board of
directors. Other corporate officers may serve as directors
or trustees for the foundation.
- Community foundations are
public charities, supported not by any one donor or donor
family, but by the pooled contributions of a large number
of donors. Although they are not the subject of this book,
they deserve mention as a viable philanthropic outlet for
donors who wish to serve the good of a particular community.
Community foundations usually confine their grantmaking
to a specific locale, and decisions are made by trustees
who represent a broad spectrum of the community's residents.
The Cleveland Foundation and the Community Foundation of
Greater Atlanta are examples of such foundations. Donors
may find that a gift to a community foundation, with instructions
for its use, will serve their philanthropic goals.
- Support foundations or named funds
within a larger public charity or institution are attractive
alternatives for donors whose philanthropic activity of
choice is already being served by a large public charity,
institution, or community foundation. Support foundations
or named funds are less administratively complex than independent,
grantmaking foundations because the public charity that
they benefit can assume many of the ongoing management responsibilities.
Such foundations enable donors or donor families to maintain
a continuing relationship with their chosen charitable enterprises.
Although much grantmaking discretion is lost, the donors
can recommend to the publicly supported organization or
institution how their gifts should be used.
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Provisions of the Tax
Code Affecting Private Foundations
What follows is a brief description of the major
features of the Tax Code that affect the formation and operation
of private foundations.
Excise Tax A tax now set at 2 percent must be estimated and paid quarterly in advance on the net
investment income of a
private foundation. "Net investment income" includes dividends, interest, and capital gains less the foundation's expenses
related directly to the production of such income. The excise tax may be reduced to one percent if charitable distributions
for the year equal or exceed the average of the previous five years' payout percent plus one percent of net investment income.
In effect, the one percent tax saving must be added to the required payout for the current year, but is not considered a part
of that year's total payout when figuring the next five-year average.
Self-Dealing Transactions between a private foundation and its "disqualified persons" are
called self-dealing. Disqualified
persons include foundation managers; donors; owners of more than 20 percent of a corporation, trust, or partnership that is a
substantial contributor to the foundation; and the family members of any of these persons. The foundation is also forbidden to
deal with a corporation, trust, or partnership in which any disqualified person holds an interest of 35 percent or more.
Certain government officials are also considered disqualified persons.
Acts of self-dealing that are specifically prohibited by the Tax Reform Act include:
- A private foundation and a disqualified person may not engage in any direct or indirect sale, exchange, or leasing of
property, regardless of how competitive the price.
- A private foundation may not lend money or extend any other form of credit to a disqualified person. However, a
disqualified person may lend money to a foundation, although there must be no interest or other charge, so long as the
proceeds are used strictly for charitable purposes.
- A disqualified person may be paid only for limited personal services provided and for expenses incurred in carrying out
the exempt purposes of the private foundation. The total amount of compensation and reimbursement for expenses must be
reasonable.
Acts of self-dealing are subject to heavy penalties in the form of additional taxes.
Payout Requirements A private foundation must distribute for its charitable purpose an amount
equal to its "minimum investment return." The minimum investment return is defined by law as 5 percent of the average fair
market value of all the foundation's assets, as determined by periodic appraisal. Failure to make charitable distributions at
the required level will result in tax liability.
Limit on Stock Holding A private foundation may not hold more than 20 percent of the voting
shares of any corporation, public or private. This limitation was imposed because of past abuses that involved using
foundations to hold large blocks of stock in family-run corporations in "friendly hands."
Speculative Investments A private foundation may not invest in a manner that jeopardizes the
security of its principal. The Internal Revenue Service pays special attention to foundation investments in highly speculative
securities or futures. Foundations that invest according to generally accepted and prudent practices experience no difficulty
in complying with this requirement.
Public Reporting Private foundations have been required for many years to file informational tax
returns. The Tax Reform Act of 1969 expanded the required forms and reaffirmed the rule that such returns must be available for public inspection. When
fully implemented, recent changes in the law also will require foundations to provide copies of their annual returns to anyone
who asks for them. In addition, copies of the returns generally must be filed with the state in which the foundation operates.
Grants to Individuals Individuals are frequently the recipients of foundation grants. Grants made for scholarship or
fellowship purposes must be made on an objective and non-discriminatory basis according to procedures approved in advance by
the Internal Revenue Service.
Advocacy and Lobbying Private foundations are prohibited from attempting to influence the
outcome of any election, but they may carry out voter registration drives under certain limited circumstances. With
some important exceptions, private foundations are also prohibited from lobbying or attempting to influence legislation
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Reprinted with permission from the Forum of Regional Associations of
Grantmakers
©2003 Indiana Grantmakers Alliance, Inc.
32 East Washington Street, Suite 1100
Indianapolis, Indiana, 46204
Phone: (317) 630-5200 | Fax: (317) 630-5210
Email: info@indianagrantmakers.org
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