Family foundations are an option to consider, even if your name isn’t Rockefeller. Establishing a family or private foundation allows your family to support a charitable cause while integrating your family’s tax and estate planning activities.
The Wisconsin Institute of CPAs points out that although foundations are tax-smart vehicles for making charitable gifts, they can be complex to establish and operate. Following is information on how family foundations work.
When a donor contributes to a family foundation, he or she receives an immediate tax deduction for the contribution. In general, gifts to a private foundation are fully deductible up to 30% of your adjusted gross income (AGI) for gifts of cash and appreciated property held for up to a year.
You can also claim a deduction of up to 20% of AGI for gifts of appreciated property held over a year. Should a donor decide to give more in any one year, the deduction may be carried forward for five years.
Contributing a portion of your assets to a family foundation during your lifetime, or leaving it to your foundation upon your death, reduces your taxable estate and places assets in a private foundation where they can grow in perpetuity, free from income tax and capital gains tax on future appreciation. Because assets can grow faster in a foundation, you will be able to give more money to the causes you care about.
IRS filing requirements – Every private foundation, regardless of income or asset size, must file IRS Form 990-PF. Your gifts cannot remain anonymous because these filings are open to public inspection. Form 990-PF is lengthy, detailed and complex and must list the following:
— All substantial contributors to the foundation;
— Each investment held and all capital gains and losses;
— All officers, directors and trustees, plus their compensation;
— Top-paid staff members and their compensation; and
— All grants distributed, along with the purpose and amount of the grant.
The form is due on the 15th day of the fifth month following the close of the tax year (or May 15 for those using a calendar year). Some states require additional filings.
Rules and regulations – Private family foundations are the most regulated of all tax-exempt organizations. Therefore, complying with all of the rules and restrictions is a daunting task.
First and foremost, the Internal Revenue Code requires a private foundation to distribute a minimum of 5% of the fair market value of its investment assets annually, subject to certain modifications.
That minimum payout is required to prevent foundations from simply receiving gifts, investing the assets and allowing the donors to enjoy the tax benefits without ever benefiting any charitable purpose.
The penalty for failing to meet the annual minimum payout requirement is 15% tax on the income that remains beyond the time it should have been distributed.
If the foundation fails to make the required distribution a second time, the penalty rises to an additional 100% tax – in other words, 5% of the value of the foundation’s investment assets will be confiscated by the IRS.
Although private foundations are exempt from income and estate taxes, they must page a 2% excise tax on net investment income for the tax year. (If the foundation’s distributions exceed the required minimum amount, it may be eligible to pay a reduced rate of 1%.)
Self-dealing is prohibited – Private foundations must also be aware of the prohibition against self-dealing.
Simply stated, a private foundation is prohibited from entering into certain financial or business transactions with individuals defined in the law as "disqualified persons."
In general, disqualified persons include the foundation manager; directors and trustees; substantial contributors to the foundation; specified owners, their families and related business entities; and government officials.
Examples of self-dealing include purchasing items from or selling items to the foundation, using foundation assets or income for personal reasons, lending money and providing monetary payments or property to a government official.
Investments that jeopardize the foundation’s exempt purpose are also prohibited. Violations may lead to substantial taxes and penalties.
April 2, 2004 Small Business Times, Milwaukee