By Philip C. Hunt, Esq., Androscoggin Foundation Trustee, Perkins Thompson

For families that have a strong commitment to good works and charitable activities, the use of a private family charitable foundation is worth consideration. Such a foundation can provide for the ongoing support of good causes supported by family members in perpetuity, assure a continuing commitment to charitable activities, provide for the family to play a continuing role in overseeing the family’s philanthropic activities, promote a family commitment to philanthropy and assure continuing family control over the assets as well as providing potential income and estate tax benefits through the charitable deduction.

A private charitable organization is a form of tax exempt charitable organization recognized under the Internal Revenue Code, Section 501(c)(3), usually formed as a non-profit corporation or charitable trust. The organization must apply to the Internal Revenue Service for recognition as a tax exempt charitable organization by filing IRS Form 1023 and must file annual reports with the Internal Revenue Service on Form 990-PF to demonstrate that the organization is carrying out its charitable purposes and using its resources for charitable purposes. Charitable foundations are also subject to oversight by the State of Maine to assure that the foundation’s funds are used exclusively for charitable purposes.

The organization may be and typically is governed by a board of directors or trustees who may be family members. The family members control the investment of the foundation’s assets and decide how best to use the foundation’s assets and income to carry out the charitable missions which the family supports. The family may employ a professional manager to manage operations and investments. Organizational documents– articles of incorporation and by laws in the case of a non-profit corporation or the trust agreement in a charitable trust—determine when annual meetings are held, expectations for time commitments to the foundation, a time line for processing grant applications, procedures for approving grant applications, and procedures for overseeing the implementation of charitable grants.

Subject to IRS rules and restrictions, the charitable foundation typically carries out its charitable mission by making grants to charitable organizations or qualified individuals for specific approved charitable purposes under IRS rules for grant making or making program related investments to carry out qualified exempt charitable purposes. There are a number of IRS rules and regulations to consider. For example, the private foundation is subject to a modest excise tax (currently 1.39%) on its investment income. The private foundation is required to disburse at least 5% of the value of its countable assets for qualified charitable purposes annually. The foundation cannot invest its funds in a way that will jeopardize the charitable purposes of the foundation, may not engage in a trade or business or exercise control over any unrelated trade or business and may not engage in a variety of prohibited transactions which involve conflicts of interest or self dealing transactions.

A private foundation can be established and funded on an ongoing basis with assets that can include cash, publicly traded securities, privately held stock or investment securities, real estate or other family-controlled assets.

There are a number of tax advantages that can be derived from the operation of a private charitable family foundation.

Income Tax Savings
A donor may receive an income tax deduction for any amount he or she contributes to a private foundation up to 30% of the donor’s adjusted gross income (AGI) annually. This income tax advantage, however, may be subject to limitations on itemized charitable deductions at both the federal and state level.

Capital Gains Tax Savings
Donors may also be able to avoid or reduce capital gains taxes by donating appreciated assets to a private foundation. For example, if a donor were to give appreciated stock to a foundation, the donor would be entitled to receive an income tax deduction for the full, fair-market value of the stock. When the foundation decides to sell the stock in the future, it will pay only a modest investment excise tax on the recognized gain.

Estate Tax Savings
When assets are contributed to a private foundation, they are excluded from the donor’s estate and, as a result, are not subject to either federal or state estate taxes. At the moment, the applicable federal and State of Maine estate tax exclusion limit this benefit to persons whose estates exceed the applicable estate tax credit shelter exemptions, $11.58 million (inflation adjusted) for individuals under the federal estate tax and $5.8 million (inflation adjusted) for individuals under the Maine estate tax. These exemption amounts are subject to change, however. For high-net-worth individuals who have a strong charitable interest, private foundations offer an opportunity to avoid paying estate taxes while simultaneously creating a lasting philanthropic legacy.

Tax-Advantaged Growth
Because assets contributed to a private foundation grow in a tax-advantaged environment, over the years, the foundation’s value will likely grow to exceed the total amount of contributions—despite making regular charitable grants. The result will be a significant charitable legacy that family members may continue to control and pass down to future generations in perpetuity.

Family foundations are not for everyone and are most valuable to individuals with high net worth and significant exposure to income and estate tax and who have appreciated assets which would be subject to capital gains tax on disposition. Such foundations may also be of interest to individuals who have substantial retirement accounts that might be potentially subject to substantial income taxes if disbursed to individual beneficiaries.

There are costs to set up a foundation, including legal and accounting costs to set up the foundation, draft and file its organizational documents, obtain the foundation’s tax identification number from the IRS and obtain IRS recognition of tax exempt status, and transferring assets to the foundation. A family foundation is also subject to all of the same ongoing administrative requirements including filing annual exempt organization tax returns as any other private foundation.

There are alternative approaches which may be desirable for persons who do not wish to undertake the complexity of establishing and administering a private foundation.

One alternative is a contribution to a community foundation such as the Maine Community Foundation or other form of qualified donor advised fund. A donor-advised fund is essentially a charitable investment account used for the sole purpose of supporting charitable organizations designated by the donor. The fund can be named after the donor’s family to provide recognition of the contribution. After making an irrevocable contribution to the fund, the donating family can make recommendations to the fund sponsor to make grants to any IRS-qualified public charity over time; there are no mandatory annual disbursements.

The organization sponsoring the donor-advised fund handles the fund’s management and all necessary recordkeeping. If the donor wishes to remain anonymous, a donor-advised fund can provide that option as well—unlike a foundation where all grants are required to be reported publicly.

A donor-advised fund can also be more attractive than a private family foundation because the applicable charitable deductions may be greater. With a donor-advised fund, a contribution is eligible for an immediate tax deduction in the current tax year (subject to the usual limitations on itemized charitable deductions). The deduction for contributing to a donor-advised fund can be up to 60 percent of adjusted gross income for cash and 30 percent of adjusted gross income for long-term publicly traded appreciated securities. That compares with a deduction limit of 30 percent and 20 percent, respectively, for a private foundation. There is also no tax on investment income when you use a donor-advised fund. Although private foundations are exempt from federal income tax, their investment income is subject to an excise tax of 1.39 percent.

A donor-advised fund can also be an option for those who may not have the assets needed to establish a private foundation. The donor advised fund may be a more attractive approach for donors who are not subject to federal or state estate taxes but are interested in charitable income tax deductions.

As in all tax matters, there are complexities that need to be discussed with appropriate legal and accounting advisors to assure compliance with applicable rules and regulations.