Assignment 5: Private Foundations Flashcards
1
Q
Private Foundations Basics
A
- Fund devoted entirely to charitable purposes
- Created, supportted and often managed by an individual or family
- Either created for a specific term of years to accomplish a particular purpose, or “in perpetuity”
- Created in trust or corporate form
- Governed and managed by trustees or directors
- Regulated by: IRS, secretary of state, state attorney general, franchise tax board
- Stringent reporting requirements
- 5% minimum distribution requirement
- AGI deduction limit restrictions as compared to public charities
2
Q
Private Family Foundation
A
- Popular with affluent families
- Provides maximum control over the assets and maximum flexibility
- May be used as a tool to share family values
3
Q
Size of Private Foundations
A
Some are huge (i.e. Gates, Ford, Lily = Billions)
Most are not so big
- of approximately 80,000 PF, two-thirds have endowmments less than $1M (median = $500,000)
- 79% of 987 PF in Foundation Source study have been in existence for fewer than 15 years
4
Q
Foundation share of private giving
A
Giving by Individuals…68% ($75.86B)
Giving by Foundations…18% ($292B)
Giving by Bequest…9% ($39.71B)
Giving by Corporations…5% ($20.05B)
5
Q
PF vs. DAFS
A
- Even though number of DAFs is growing, they still lag behind PF in asset size
DAF charitable assets ($121B in 2018)
v.
PF charitable assets ($872B in 2018) - Also total grant dollars from PF is twice as large as grant dollars from DAFS
DAF total grant dollars ($23B)
PF total grant dollars ($54B)
6
Q
PF Deductions
A
Deduction subject to:
- 30% AGI limitations for cash
- 20% AGI limitations for long-term capital gain property
Gifts of appreciated property to a private foundation (other than operating foundations) are deductive at the lesser of FMV or basis unless the property is “qualified appreciated stock
7
Q
PG Governance Requirements
A
- Succession plan
- Regular meetings of its board with records of board minutes
- Accounting, record-keeping systems
- Solid financial controls
- 990-PF must be filed annually and made available to the public
- Policies concerning conflict of interest, investment, travel and expense, record retention
8
Q
PF Grantmaking
A
- Process may be formal or informal
- Best to have some focus regarding giving so that grant requests can be limited to that focus
- Recipients should agree with grantmaker on “metrics” and reporting
- Impact becomes an issue: “Have we made anything better?”
9
Q
Expenditure Responsibility
A
- Generally, grants are made to public charities
- If a grant is made to an individual, then the foundation must insure that the grant is used appropriately = expenditure responsibility
- Expenditure responsibility requires: a pre-grant inquiry, a written grant agreement, grantee reports, separate account set-up to prevenet comingling of non-charitable and charitable funds. ER grants are reported on the 990-PF
10
Q
Grants to Foreign Organizations
A
- PFs can make grants to foreign organizations but special rules apply
- Equivalent determination: show that the foreign grantee is similar to a U.S. public charity
- Expenditure Responsibility: take steps to ensure funds are used according to grant agreement
- Give to a US-based “friends of” organization
- Give to a US-intermediary organization
11
Q
PFs and the Family
A
- Bring family together in common purpose, or give them something new to fight about
- Instill traditions of giving
- Involve children early
- Open the eyes of succeeding generations about community needs and how others live
- Second and third generation wealthy families have many complex entitities and may involve heirs in many roles, as they mature
- Can be a training ground in which heirs can learn to accept responsibility, gain financial literacy, and become skilled at working well with advisors and others
12
Q
Assets in Common
A
- As wealthy families evolve over generations, more and more of the wealth is in trust, with multiple beneficiaries
- Key assets, like vacation homes, are held in common
- Wealth creators need to be fiercely independent, but their heirs are increasingly inter-dependent
13
Q
PF as a Teaching Tool
A
- Family philanthropy, a family foundation, a DAF, or just giving together is an important way to teach inheritors collaboration, joint decision-making, financial responsibility, good citizenship, and concern for others
- Ideally, the experience should be fun and meaningful
- Great way to involve elders, as mentors of the grandchildren
14
Q
Philanthropy Advisors
A
- Strategic grantmaking
- Facilitate discussions among family members
- Identify/Execute giving opportunities
- Evaluate impact of grants
- Identify like-minded partners
- Coordinate with other advisors
15
Q
PF Rules
- Excise Tax
- Self-Dealing Rules
- Required Distributions
- Excess Business Holdings
- Jeopardy Investments
- Taxable Expenditures
A
- Exist to stem abuses from the past
- Rules make it very hard to use a foundation to hold small business assets or to have dealings back and forth between the donor, the donor family, donor-controlled entities, and the foundation
- This is a complex area of the law and qualified counsel is needed when a situation touches on these rules
16
Q
PF–Excise Tax
A
Section 4940 of the Internal Revenue Code imposes an excise tax on the net investment income (NII) of private foundations
- Previously, it was a complicated two-tiered tax rate
- Now it’s a new flat rate of 1.39% (Taxpayer Certainty and Disaster Tax Relief Act of 2019)
17
Q
PF–Self-Dealing Rules
A
A penalty tax may be levied on DISQUALIFIED PERSONS for engaging in prohibited acts of self-dealing with the foundation.
18
Q
Disqualified Persons
A
- Substantial Contributor (one who gives 2% or more of the total contributed gift to the foundation)
- Foundation manager
- Anyone owning 20% or more of an entity that is a substantial contributor
- A family member of any of the above
- An entity, 35% or more of which is owned by any of the above
19
Q
Self-Dealing Acts
A
- Any sale, exchange, or lease, regardless of price
- Lending money other than interest-free to the foundation (for its exempt purpose)
- Furnishing goods, services, or facilities to the foundation, unless done so without charge and for exempt purpose or furnished by the foundation under terms no more favorable than those offered to the general public
- Transferring income or assets to a disqualified person for his or her benefit
20
Q
Self-Dealing Acts–Examples
A
- A foundation pays rent to a disqualified person, even at or below market rates
- The trustees of the foundation holds a 3-day retreat to discuss future plans for the foundation. Spouses of trustees attend the dinners hosted by the foundation.
- Trustee and their spouses attend a fundraising gala and sit at a table sponsored (purchased) by the foundation
- Individual makes a personal pledge and fulfills teh pledge via a grant from the foundation
- Payment of compensation or reimbursement of expenses other than in reasonable amounts and for exempt purpose (what is reasonable? Comparable to what other enterprises would pay under like circumstances, consult salary surveys)
21
Q
Self-Dealing Penalties
A
- 10% initially, based on the amount involved
- Can rise to 200%
- Foundation manager may also be fined 5% if knowingly involved; that increases to 50% if he or she refuses to correct the issue
22
Q
Required Distributions
A
- Salaries of employees (tests for reasonableness; ill-advised to use foundation at “gravy train”; IRS and the press are vigilant)
- Investment expenses (investment management fees, brokerage fees, custodial fees, etc.) incurred in managing the endowment is not included in the minimum payout requirement
23
Q
Excess Business Holdings
A
- Triggered by foundation ownership of more than 20% of voting stock of a business (the 20% allowable is reduced by the amount owned by disqualified persons)
- Tax is 10% of the excess holding, increasing to 200% if the excess holding is not disposed of in a timely manner
24
Q
5-Year Rule
A
- If the PF or SO received closely held stock by gift or bequest, tax is not imposed until 5 years (10 years with an IRS extension) after receipt
- Offer a limited planning opportunity; one should also beware of a “buyer waiting in the wings”
25
Q
Jeopardizing Investments
A
- Jeopardizing investments generally are investments that show a lack of reasonable business care and prudence in providing for the long- and short- term financial needs of the foundation
- 10% tax increasing to 25% if not corrected in a timely fashion on investments deemed to jeopardize the foundation
Examples:
Per the IRS, no category of investments is treated as intrinsically jeopardizing but careful scrutiny is applied to:
- Trading in securities on margin, commodity futures, investing in working interests in oil and gas wells, buying puts, calls, and straddles, buying warrants, selling short
26
Q
Taxable Expenditures: Excise Tax
A
- If a private foundation makes a taxable expenditure, then it must pay an excise tax
- Excise tax increases drastically if not corrected in a timely manner
- Foundation managers may also have to pay a tax if they knowingly permit taxable expenditures
27
Q
Taxable Expenditures–Examples
A
- Payments to influence legislation
- Intervention in political campaigns or activities
- Grants to individuals other than for travel, study and similar educational purposes, under rules approved in advance by the IRS
- Certain grants to other private foundations, certain grants to nonexempt organizations
28
Q
Not Taxable Expenditures
A
- Foundations are legally used to influence political change via, for example, “nonpartisan” research
- Foundations can lobby, but only within limits allowed by the IRS
- Foundations can offer, say, scholarships under rules approved in advance by the IRS
THIS IS A COMPLEX AREA–BEST TO FLAG THE ISSUE AND SEEK QUALIFIED COUNSEL!
29
Q
When to consider a PF?
A
- Client has publicly traded stock or cash to contribute
- Has significant value to contribute
- High planning tolerance
- High fee tolerance
- Wants perpetuity
- Demands complete control
- Wants involvement in grant-making
- Considers it a benefit to involve family
- Wants to pay staff
30
Q
PF–Potential Issues
A
- Difficult or impossible to use a foundation to hold a family business interest for more than a short time (5 years); even then, deduction is only for basis
- Dangerous to “sell” foundations as offering salaries, junkets, expense accounts, etc.
- Dangerous to encourage client to consider business dealings with the foundation
- Be cautious in using for political purposes
- Tax law requires special expertise not only in knowing the rules but also in applying them in complex circumstances
- Foundations are powerful tools that require top-notch legal advice, particularly when business interests are involved
- CAPs should play talent scout in this area rather than have the “answers”
31
Q
Aligned Investments
A
Private foundations provide grants to further their charitable mission. Grants are never repaid.
Leverage the foundation’s assets to also accomplish charitable goals.
- Intention to provide positive social impact and provide some level of financial return
- Program related investments (PRIs)
- Mission related investments (MRIs)
32
Q
Program Related Investments (PRIs)
A
- Mission-driven; meet charitable standards
- PRIs can be made to noncharitable, non-exempt entities but it must exercise expenditure responsibility
- PRIs do not have to satisfy the prudent investment standard
- PRIs count towards the five percent payout requirement
Exception for PRIs if it meets the three-part test:
- Primary purpose of the investment must be to further the exempt purposes of the foundation
- Income-producing or appreciation of the property may not be a significant purpose of the investment; and
- no electioneering and very limited lobbying purposes
33
Q
Mission Related Investments (MRIs)
A
- No legal definition
- Not a charitable activity
- “Other 95%” of a private foundation’s assets
- Made from investments and not program assets
- Does not count towards 5 percent payout
- Must meet prudent investor standards
- IRS permits growing practice of “impact investing” or “Mission-related investing” by private foundations
- It’s like adding a filter or lens to your investing (e.g. a socially responsible portfolio–not investing in things like tobacco, etc)
34
Q
When a Foundation Sunsets
A
- Most foundations exist in perpetuity
- Trend: of larger foundations, 1 in 10 plan to limit the foundation’s life
- Example: Bill & Melinda Gates Foundation’s 20-year spend down will begin at the death of Bill and Melinda Gates
35
Q
Issues of Limited-Life Foundations
A
- Why spend down?
- How do we align investment practices with spend-down plans?
- Staffing?
- Grantmaking focus?
- What do foundations owe grantees?
- With whom do we collaborate?
- How, and with whom, should we communicate our plans?
- How should we evaluate our impact?
- How do we archive and share our knowledge?
36
Q
Supporting Organizations
A
- A family may set up a SO under the wing of a public charity, which can be desirable if a close relationship is needed for programming, etc.
- A “hybrid” foundation, with some of the “ego features” of a private foundation, with public charity tax status
- Governance is conducted by nonfamily members, with decisions made by numerical majority, “veto,” or through “operation in conjuntion with” one or more public charities
- A public charity may itself decide to establish a SO, almost like a subsidiary or partner (e.g. university endowment held in a SO, Hospital with a SO to fund services for the poor)
37
Q
IRS.Gov definitions of SOs
A
- Supporting organizations are charities that carry out their exempt purposes by supporting other exempt organizations, usually other public charities.
- The classification is important because it is one means by which a charity can avoid classification as a private foundation, a status that is subject to a much more restrictive regulatory regime.
- Key feature of a SO is a strong relationship with an organization it supports
- Strong relationship enables the supported org oversee the operations of the SO
- Therefore, the SO is classified as a public charity, even though it may be funded by a small number of persons in a manner similar to a PF
38
Q
Type 1–SO
A
Type 1 SOs are operated, supervised, or controlled by the supported organization
39
Q
Type 2–SO
A
Type II SOs are supervised or controlled in connection with the SO
40
Q
Type 3–SO (Eliminated by the 2006 Pension Protection Act)
A
Operated in connection with a public charity. Were once touted as having the benefits of a public charity with private control. They were abused, so they are no longer a live planning option.
41
Q
When to consider a SO
A
- Donor wants higher deduction limits of a public charity
- Wants to name the organization
- Wants it to have (potentially) perpetual life
- Donor wants to give something other than cash or publicly traded stock
- Donor welcomes a nonprofit as a partner in managing the organization and is willing to cede control
42
Q
Conduit or Pass-Through Foundation
A
- A PF by which its own terms, must distribute each year all its net assets for charitable purposes
- May pay reasonable administrative expenses from assets
- Receives public charity tax treatment for income tax purposes
43
Q
Private Operating Foundation
A
Generally, a POF provides the charitable services itself
- Museum
- Orphanage
- Counseling for populations at risk
Qualifies for public charity status, so gets higher deduction limits
44
Q
PF Rules Apply to Private Operating Foundations
A
- In general, a POF is a PF that devotes most of its resources to the active conduct of its exempt activities
- POFs remain subject to the rules related to self-dealing, excess business holdings, jeopardizing investments, and taxable expenditures and to the excise tax on investment income
- Engage experienced tax counsel!
45
Q
Reasons to consider a POF
A
- Donor wants to be hands on
- Wants to be engaged directly with the community served
- Wants public charity status for contributions
- May also want to solicit donors to give to the operating foundation
