Charitable giving can be motivated by any number of forces: religious convictions, social aspirations, or even fashion sense. What is certain is that big charitable giving has become the ultimate sign of success.
Several of the best-known billionaires have announced their intentions to give most of their fortunes away. Bill Gates won't be leaving more than 5 percent of his fortune to his heirs; Warren Buffett probably even less than that; Ted Turner has earmarked billions to be donated to charitable ends during his lifetime. It is unlikely that any of them will simply be writing checks to their favorite causes.
Private foundations are prime vehicles for large-scale charitable giving. Beyond the desire to help others, the use of private foundations can further two practical impulses associated with charitable giving: income and estate tax savings; and maintaining control after the money or property is donated or set aside for donation.
However, private foundations cannot be established or run casually. There are administrative complications involved, and careful consideration and preparation should be given before establishing one. The bare minimum for funding a private foundation is $1 million.
The estate tax rules for charitable giving are simple: The amount of money or the fair market value of property that is donated to a public charity or a private foundation is deducted from the taxable estate. Accordingly, testamentary or lifetime gifts to a private foundation move money or property out of a person's taxable estate.
The key income tax rules are trickier. Private foundations are themselves income-tax-exempt (but are subject to a 2 percent excise tax on net investment income). Within limits, lifetime donations to a private foundation also generate an income tax deduction to the donor. The basic rule is that the amount of money or the fair market value of long-term capital gain property is deductible from adjusted gross income (AGI). However, if long-term capital gain property is contributed to a typical private foundation, only the "basis" (generally, the cost) is deductible, unless the property is publicly traded stock.
Complex percentage-of-income limitations may limit deductibility of major charitable gifts. Where the donor's AGI exceeds $100,000, charitable deductions are allowed (along with other itemized deductions) only if they exceed a floor of 3 percent of AGI. Other specific percentage limitations also could apply. For example, the income tax deduction for a gift of cash to a private foundation is limited to 30 percent of an individual donor's AGI (with a 5-year carry-forward available for any excess). For gifts of property to a private foundation, the limit is 20 percent. Other limitations apply to public charities and so-called operating foundations. These limitations often come into play where highly appreciated founder stock, artworks or non-recurring cash items (such as business-sale, stock-option or lawsuit proceeds) are involved. Planning around these limitations is advised.
Tax matters aside, a well-funded private foundation can be the centerpiece of an ongoing family legacy of good works. Family members (in the current generation and beyond) can be employed by the foundation and paid a reasonable salary for their services. Family members who are suffering from "affluenza" may find a purpose through their involvement in the family foundation.
For people with very large stakes in public companies, a private foundation can provide a vehicle for an orderly sale of these holdings over time. A sale of a large stake all at once (as might otherwise be necessitated by estate taxes) could have a disastrous impact on the market.
The lifetime of the foundation can be indefinite, depending upon its funding. Over this course, foundation board members can consider various charitable projects and cause disbursements that they consider worthy (within any limits of the foundation charter). As society changes (or as the board changes), the foundation can redirect its charitable goals.
In essence, a private foundation is a vehicle to get the tax benefit of a charitable contribution up-front, with time to decide how to disburse the funds for charitable purposes later.
These benefits of private foundations come at the price of compliance with a complex set of rules designed to ensure fiduciary responsibility and ongoing charitable activities. These rules are mainly enforced through a system of excise taxes that essentially act as penalties.
The excise tax system is a minefield for foundation managers. Treatises are devoted to the details. In broadest strokes, punitive excise taxes are imposed on the following: "Self-dealing" transactions (for example, a sale or lease of property to the foundation by the founder or a related person, even if fair to the foundation); failure to distribute foundation income; excess business holdings; risky investments (there are no per se violations, but certain investments are subject to strict scrutiny); and prohibited expenditures (such as legislative lobbying). If these matters are not corrected by the foundation manager, punitive excise taxes also can be imposed on the manager.
Foundation charter documents must prohibit any acts that are barred by the excise tax provisions. In addition, private foundation tax-exemption requests and tax returns are subject to public disclosure requirements. In California, the Probate Code incorporates the excise tax provisions and gives the Attorney General authority to compel corrections of the foundation or even the authority to terminate it.
It is common knowledge that it isn't easy to make a fortune. Fewer grasp how complicated it can be to give a fortune (or a piece of it) away. With some planning and careful compliance, a private foundation offers a means of perpetuating a charitable gift for generations.
Menasche Nass and Andrew Bernknopf are attorneys with De Castro, West, Chodorow, Glickfeld & Nass Inc. The authors can be reached at firstname.lastname@example.org and email@example.com.
Entrepreneur's Notebook is a regular column contributed by EC2, The Annenberg Incubator Project, a center for multimedia and electronic communications at the University of Southern California. Contact James Klein at (213) 743-1759 with feedback and topic suggestions.
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