You may be considering starting a private foundation for several reasons, such as selling a business, donating a large asset or preparing for retirement. Perhaps you and your family are ready to invest in social causes you care about and leave a lasting legacy.
San Diego’s vibrant philanthropic community offers many opportunities for impactful giving.
Understanding how to start a foundation and alternative giving options are vital to accomplishing your philanthropic goals.
What is a Private Foundation?
According to the Council on Foundations, “private foundation” is the umbrella term that includes corporate, independent, family and operating foundations. These independent legal entities make grants from their charitable investments, consisting of funds from one source or a small list of sources, such as an individual, family or corporation.
The fund is managed by the foundation’s own appointed trustees or directors.
Like public charities, a private foundation is classified as a tax-exempt 501(c)(3) organization by the IRS. However, private foundations do not raise funds or seek financial support from the public.
There are many benefits to starting a private foundation. They provide significant funding for charitable causes, allow you to have a significant impact, and provide a way to leave a lasting legacy.
For San Diego donors, this means addressing the unique needs and opportunities within our region.
However, there are also challenges with starting a private foundation. For example, private foundations are subject to a number of regulations, which can be complex and time-consuming. Additionally, private foundations must make grants to qualified charitable organizations, which can be a challenge if you have a specific cause in mind.
Download our Private Foundation Solution Brochure
Private Foundation FAQs
Below are some of the frequently asked question our team hears from donors about private foundations.
1. What is a private foundation?
A private foundation is a tax-exempt 501(c)(3) organization funded by a single source, such as an individual, family, or corporation, and primarily makes grants to other charities.
2. How do I start a private foundation?
Starting a private foundation generally involves 12 steps (outlined below) that include defining a philanthropic objective, creating a mission statement, and following legal and tax steps to establish and maintain the foundation.
3. What are the benefits of a private foundation?
Benefits include significant tax advantages, control over grantmaking, the ability to support specific causes, and creating a lasting legacy for you, your family and your community.
4. What are the challenges of maintaining a private foundation?
Challenges include regulatory compliance, administrative burdens, ongoing operational costs and more.
5. How does a private foundation differ from a public charity?
Unlike public charities, private foundations do not raise funds from the public and are funded by a single source or a small group of donors.
6. What is the minimum annual distribution requirement for a private foundation?
7. Private foundations must distribute at least 5% of their investment assets annually to charitable purposes.
8. Can a private foundation employ family members?
Yes, but compensation must be reasonable and comply with IRS regulations to avoid self-dealing penalties.
9. What is a donor-advised fund (DAF), and how does it compare to a private foundation?
A DAF is a simpler, cost-effective alternative to a private foundation, offering similar benefits with less administrative burden and higher tax-deductibility limits for donations.
Setting Up a Private Foundation: 12 Essential Steps
Starting a private foundation involves the following 12 steps:
- Define your philanthropic objective(s)
- Create a clear mission statement
- Establish grantmaking guidelines
- Hire a legal team and financial advisors for planning, compliance, recordkeeping and tax returns
- Establish a board structure and appoint board members or trustees
- Consider your personal time investment vs. hiring a staff to manage the foundation
- Determine if your foundation should continue after your lifespan
- Form your foundation as a trust or corporation under state law
- Apply for an Employer Identification Number (EIN)
- Apply to the Internal Revenue Service (IRS) for recognition as a tax-exempt 501(c)(3) charity and to receive tax-deductible contributions
- File any additional required paperwork for tax-exempt status from your state
- Follow IRS foundation guidelines, including:
- Make grants worth at least 5% of your foundation’s investment assets each year
- Grant only to other nonprofits or for educational scholarships
- MPay up top 2% excise tax on your foundation’s investment assets
With many steps involved, starting a foundation can be more complicated than it looks. Beginning at square one requires exhaustive time and resources, not to mention expertise.
Many find that maintenance costs are prohibitive, with resources quickly diluted by overhead and red tape, resulting in fewer funds for grantmaking than planned.
Private Foundation Alternative: Donor-Advised Fund
A donor-advised fund (DAF) can be your private foundation solution. DAFs offer a streamlined way to support local nonprofits and initiatives in San Diego or causes that matter to you outside of our region.
A DAF is a charitable giving account that allows you and/or your family to make tax-deductible donations to a sponsoring charitable organization. DAFs offer similar benefits to private foundations but with less administrative burden and cost.
As a bonus, you can deduct your DAF gifts up to 50% of your Adjusted Gross Income (AGI) compared to 30% for private foundation gifts.
Other benefits include privacy and peace of mind.
Unlike an IRS foundation, a family foundation through a donor-advised fund is not required to disclose certain financial information, including tax returns. Beyond that, strict and complex legal requirements of a private foundation disappear – no worries about compensation rules, expenses, grant expenditure responsibility, tax filings, or any possibility of inadvertent self-dealing.
When you add up all the benefits, it’s no surprise that many of our funds at San Diego Foundation were originally private foundations before families decided to simplify their lives by moving to a DAF at hosted at community foundation for their philanthropy.
If you are considering starting a private foundation, you may want to consider a DAF instead. San Diego residents can benefit greatly from the simplicity and flexibility of DAFs.
Learn more about how donor-advised funds can be a simpler alternative.
Download the Private Foundation Brochure
The Private Foundation Solution Brochure helps you better understand donor-advised funds and the benefits they provide for you or your family.