Are you considering making a significant charitable legacy gift? What type of vehicle should you use? Donors often have similar goals in mind — helping a charity dear to their heart and saving on taxes. However, donors may differ in their objectives regarding family involvement, control of grant making and investing, and costs to administer the legacy gift.
To help address different needs, private foundations and philanthropic funds are two of the primary donor vehicles often used. Each vehicle has special nuances to consider. Which one is right for you will depend upon your specific tax situation, philanthropic goals and other non-charitable considerations, which are as important in the decision-making process as the legacy gift itself. Consider some of the following key points regarding each vehicle when making your decision.
The Cost of a Good Deed
Costs associated with a charitable legacy gift can vary greatly. Establishing a private foundation can take up to several months and will involve professional fees for items such as incorporating the entity and filing an application with the IRS. There will also be ongoing professional costs for income taxes, accounting services, professional investment advice, recordkeeping and administrative costs to review grant requests and grant making. While one benefit of private foundations is that they are not limited to gifting only to 501(c)(3) public charities, giving foundations a broader base of eligible charities from which to choose, there will be due diligence costs to ensure an organization is a qualified recipient.
On the other hand, starting a philanthropic fund involves very little time with no professional fee costs to the donor. There are no ongoing professional fees for filing tax returns, recordkeeping or administrative costs. Eligible grant recipients are, however, typically limited to 501(c)(3) public charities. Verifying the organization is a 501(c)(3) and all associated expenses are the responsibility of the sponsoring philanthropic fund organization.
The level of control over the vehicle used to make a charitable legacy gift is a key component for many donors. With a private foundation, you can manage the investments yourself or obtain professional investment advice if you wish. Many times the donor is a sophisticated investor or already has trusted advisors and does not want to use unknown third-party advisors to manage legacy gift assets. For a private foundation, a legal entity is established by the donor who then controls the board and grant-making decisions. You also have unlimited succession for control of the foundation to ensure that your legacy can live on indefinitely.
With a philanthropic fund, you have no control over how the assets are invested. The funds typically go into an investment pool, which means there will be a charge for investment management fees that comes out of your fund. However, typically these equal 1% or less of the fund principle. The philanthropic fund acts as a “giving account,” where the advisory board is selected by the sponsoring philanthropic fund organization. You don’t have control over grant making and must make recommendations to the sponsoring organization for a gift to the charity of your choice. There may also be some limitations on succession and allocation of funds to successor family funds, which could impact the donor’s initial legacy intentions.
And, of course, the tax deduction limit for charitable contributions varies slightly depending on which vehicle you use. For private foundations, the deduction limit for contributions of cash are subject to 30% of adjusted gross income (AGI), while the deduction limit for contributions of appreciated assets are subject to 20% of AGI. For a philanthropic fund, cash contributions are subject to 50% of AGI, and gifts of appreciated assets are subject to 30% of AGI.
There are also distinctions between the two vehicles as to what can be gifted and what can be deducted. For a private foundation, contributions may be funded with wide array of donor assets; however, the deduction is limited to cost basis for all appreciated property gifts, except for publicly traded stock. For a philanthropic fund, contributions may be limited to cash or publicly traded stock; therefore, the deduction is fair market value for all appreciated property gifts.
Keep in mind if you use a private foundation, you will be required to make annual donations to other organizations in the amount of 5% of the foundation’s net asset value. In a year marked by poor investment performance, you may have to use some of the foundation’s principle to meet the annual requirement. There is no such requirement for a philanthropic fund; you can park the assets in the philanthropic fund until you are ready to distribute out to a charitable organization. For a private foundation there is also an annual net investment income (NII) tax calculated on the annual federal tax return, so some of the assets will be paid to the government in the form of a tax. There is no tax for a philanthropic fund, so all of the assets are used for charitable purposes.
When deciding which vehicle to use, remember that there are additional legacy items to consider. A private foundation, ironically, has limited privacy, since the annual tax returns are required to be made available to the public. With a philanthropic fund, you can keep donors’ names confidential, and grants to other charitable organizations can be made anonymously. But only with a private foundation can you employ family members to run the foundation, allowing the next generation to get more involved in philanthropy, the grant-making-decision process, and to continue the family legacy for generations to come.
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This communication is published by Cohen & Company for our clients and professional associates. Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this publication should be taken only after a detailed review of the specific facts and circumstances.