No one will argue that making charitable contributions is a great way to create a legacy and minimize the impact of income taxes. It’s a win-win. But what vehicles can you as a donor use to efficiently and effectively leave your footprint?
Traditionally, the answer has been to start a private foundation. This is one of the primary tools used to accumulate significant funds to contribute to the greater good. Private foundations can be very effective in maximizing charitable contributions and managing the tax implications of capital gains. The most attractive feature is that you maintain almost complete control over where your money goes. You still need to have selection criteria and a process for distributions, but you and your designated board can evaluate public charity candidates and award funds accordingly. This is often a key selling point for those with significant wealth to invest.
Tax-exempt in nature, a private foundation requires working with the secretary of state to set up the entity and the IRS to obtain tax-exempt status. Other important attributes include ongoing tax filing requirements and the excise tax on net investment income of up to 2%. Additionally, the foundation must give away 5% of its assets each year, regardless if it wants to. If the foundation fails to do so, it may suffer a 15% excise tax on the undistributed amount each year until the foundation complies.
Compare the private foundation to the donor-advised fund, an option that has become more popular in recent years and that often achieves the same charitable impact with low maintenance and low cost. A donor-advised fund can be set up almost immediately through a public charity with only a custodian fee that is paid out of the fund. There is no initial business filing, minimal (if any) annual federal or state tax filings and no minimum annual payout. If any tax filings are needed, they are handled by the custodian of the fund’s assets.
The negative is that while you have a strong voice in establishing parameters — such as ‘this money will be used for college scholarships for students at ABC High School’ and helping to develop application questions, selection criteria, etc. — as part of a larger selection committee led by the charity holding the funds, you may only have one vote, and therefore less of a say regarding who ultimately is awarded a grant.
Additional key points to consider include anonymity of the donor — which a donor-advised fund allows for but a private foundation cannot due to required public tax filings for distributions — and even succession planning. In the case of a foundation, if the next generation of the family isn’t interested in leading the charge, it may be difficult to keep it running for the long term. A donor-advised fund, with its management function generally dispersed among a broader board of people, often is easier to carry on.
It really comes down to what’s right for you as a donor. How important is maintaining control over the funds versus the infrastructure and cost it may require? If you are looking to keep significant control of your wealth, particularly if you have administrative support such as a family office, you may want to consider a private foundation. If you are looking to create a legacy without as many steps in the process, you may want to consider the donor-advised route. There are many questions to address with your advisors to help ensure you choose the charitable vehicle that’s right for you.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.