Wednesday, 28 August 2019

One of the most rewarding aspects of accumulating wealth is being able to share it with others.

Establishing your own charitable foundation can be an efficient way to give back when there's a specific cause you're committed to. Before diving in, however, it's important to understand what's involved in running a foundation of your own.

What is a private foundation?

Generally speaking, a private foundation is any organization that meets the Internal Revenue Code requirements for 501(c)(3) status but doesn't qualify as a public charity. The funding for a private foundation typically comes from the individual, family, or business that sets it up. The kinds of assets that can be held in a private foundation include cash, real estate, antiques, artwork, or life insurance.

Types of private foundations

Charitable foundations can take different forms, depending on their purpose. The Internal Revenue Service categorizes private foundations in one of three ways:

  • Private operating foundations: A private operating foundation is an organization that spends at least 85 percent of its income on its own exempt activities. Examples of private operating foundations include zoos, libraries, and museums.
  • Exempt operating foundations: Generally, an exempt operating foundation is a foundation that's been publicly supported for at least 10 years.
  • Grant-making foundations: Grant-making foundations are the most common type of private foundation and they offer financial support to other charities or individuals. For example, a grant-making foundation could provide funding to animal welfare groups or offer grants to local artists.

In terms of taxation, all private foundations are required to file a Form 990-F, Return of Private Foundation annually. Private operating foundations and grant-making foundations (also known as private non-operating foundations) are subject to a 1 percent or 2 percent excise tax on net investment income. Exempt operating foundations don't pay this tax.

Establishing a charitable foundation

The process of setting up a private foundation begins with enlisting trusted advisors such as your attorney or CPA to help along the way and then deciding what legal form the foundation will take. Typically, private foundations operate as a trust or corporation.

Setting up a charitable trust may less time-consuming, but it can be difficult to make changes to the trust's structure later on. Incorporation requires a bit more paperwork but you'll have more flexibility as well as an added layer of personal liability protection for the foundation's activities.

Now that your foundation is a legal entity, the next step is applying for an Employer Identification Number (EIN) with the IRS. You'll need this number for tax purposes even if the foundation won't have any employees. You can apply online using your Social Security number.

You'll also have to apply for 501(c)(3) status with the IRS. For that, you'll need to complete Form 1023 and provide certain documents, including:

  • A financial statement for the current year
  • A proposed budget for the next two years
  • A copy of your articles of incorporation if applicable
  • A copy of your signed trust agreement if applicable
  • A copy of your bylaws if applicable

Once you've been granted 501(c)(3) status you can wrap things up by registering your foundation with the appropriate state agency.

Understand the risks and rewards

Setting up a private foundation has both advantages and disadvantages. On the plus side, a foundation can be a good way to create a legacy of giving that can be carried over into future generations. Besides that, there can be numerous tax benefits.

With the exception of the excise tax mentioned earlier, the foundation's investment income is tax-exempt. Donations you make to the foundation are tax-deductible, which offers the opportunity to minimize your personal tax liability.

In terms of the downsides, the two biggest things to keep in mind are the time and expense involved. Setting up a foundation can cost several thousand dollars and there are also the ongoing operating costs to factor in.

Running a foundation is similar to running a business when it comes to things like reporting taxes, tracking expenses, managing employees if there are any, and record-keeping. Thinking about how much time you're able to commit to managing a foundation can help you decide whether it's a good fit for furthering your philanthropic efforts.

The content provided is for informational purposes only. Neither BBVA USA, nor any of its affiliates, is providing legal, tax, or financial advice. You should consult your legal, tax, or financial consultant about your personal situation. Opinions expressed are those of the author(s) and do not necessarily represent the opinions of BBVA USA or any of its affiliates. 

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