Foundation basics

What are the benefits of establishing a private foundation?

Benefits of a private foundation

The paramount reason people start foundations is to make the world a better place. But launching a private foundation has some benefits for the founder as well. Here are some of the most compelling advantages for the families that establish private foundations.

Tax advantages

The most direct benefits for the founders and funders of private foundations relate to the U.S. tax system. Please click here for our discussion of the tax benefits of private foundations.

The family retains a great deal of control over the assets

The board of directors of a foundation controls how the endowment is invested as well as the timing and character of charitable grants. The foundation's founder typically chooses family members to serve on the board of ditectors; as such, the family controls the foundation and its assets. As time goes on, new board members are selected only from the succeeding generations thereby allowing the family to retain control of the foundation.

The ability of family members to retain control of private foundations is different from regular public charities which must have an independent board of directors. Although the foundation, as a charitable entity, must use its assets for an exempt charitable purpose, the family decides exactly how the charitable mission is carried out and what causes receive support.

It is possible to build a substantive organization

With a private foundation, it is possible to create a substantive organization of skilled professionals all working together to carry out the foundation’s mission. Foundations can hire qualified staff and consult with paid third-party experts to build expertise, skill, infrastructure, and the connections needed to move a cause forward. The foundation can even hire family members as paid staff if the wages are “reasonable compensation” for the services rendered. Of course, paying family members is purely optional, and it is common for family members to volunteer their time to manage the foundation to keep administrative costs low.

Beyond staffing, foundations can pay all reasonable and necessary expenses needed to advance the foundation’s mission. Reasonable and necessary expenses include items like office supplies, mailing expense, accounting and tax preparation, professional fees, board meeting expense (including food), conferences, site visits, and travel expense. If some of these expenses are inadvertently paid for on a personal credit card, the foundation can make reimbursement payments.

The crux of the matter is that a foundation has considerable autonomy to build up an organizational structure to carry out its mission. Foundation directors can “work on the foundation” to make it more consequential and transformative just like an entrepreneur can “work on his business” in order to make the business more efficient and profitable. A foundation that has been built up and strengthened can endure long after the original founder has passed on; there are many foundations operating today that are over 100 years old.

Familial benefits

A well-run private foundation can provide familial benefits that may not be that obvious but nonetheless are very real. Perhaps the most straightforward familial benefit is that the charitable activity of the foundation increases the family’s reputation and cultivates goodwill. Some foundations support a regional area such as a home state or a hometown, which fosters a positive local reputation. The good works of the foundation add an almost palpable dimension to the family legacy that can live on for generations.

Additionally, foundations provide other familial benefits such as:

Develop practical skills in the younger generations:

A private foundation can be an excellent training ground for young family members to learn practical life and business skills. If the foundation builds out a substantive organization with business like infrastructure (e.g., it has employees, etc.), then the transmittable skill set is virtually endless. But small and lean foundations can be edifying for the younger generation as well. When young people perform simple actions like speaking in front of a group or contributing to a brainstorming session, they are building valuable skills like leadership and teamwork. Moreover, seeing that a foundation’s endowment is almost always invested in public securities markets, helping with a foundation can be a great way to expose the younger generation to investment management.

By participating in the investment committee, young people can learn the academic principles of investing but also gain the real-life experience of seeing how a portfolio is managed in real time—this benefit has even greater importance seeing that investing and money management is rarely taught in schools.

Pass along important family values:

Family philanthropy in the form of a private foundation sets a very strong example to the younger generation about what the elder generation truly values. Naturally, the very existence of the foundation is a testament to the charitable spirit of the founder and serves as a example to the younger generation about the importance of giving back.

Simply put, foundations are a vehicle for expressing values. The principles of the elder generation are self-evident by examining the pattern of charitable grants and the foundation’s mission statement. By virtue of simple exposure to the foundation, the younger generation customarily becomes rooted in the values of the family. The propagation of family values can be even more robust when family members are included in the foundation’s work from a young age.

The cycle completes itself when the young family members are added to the board of directors and the older generation steps away or passes on. In this way, private foundations can be handed down from one generation to the next, sustaining the spirit of charity into the future.

Bolster family ties:

The list of forces in the modern world pulling families apart seems almost endless. An additional familial benefit of private foundations is that they give families a reason to stick together.

A family foundation can serve as a kind of mortar helping to bind individuals together into a more unified and connected family. It is not uncommon for modern families to disperse geographically, especially as new generations grow up, pursue higher education, or start new careers across the country. However, the regular meetings and teamwork required to operate a foundation provide a good reason for family members to connect outside of family celebrations and holidays.

Achieve increased self-fulfillment:

Study after study shows that donating to charity and participating in philanthropy is a proven happiness booster and source of fulfillment. Lending credence to the saying “it is better to give than to receive,” research demonstrates an identifiable link between making donations to charity and increased activity in the brain regions associated with pleasure. Helping others has been shown to have a stronger and more lasting impact on well-being than “fun” activities like going to the movies or playing video games. Family philanthropy creates a stronger bond between the family and the community at large which can be very satisfying.  

Flexible giving options

Private foundations have very flexible giving options and are considered more flexible than other charitable vehicles. The primary method foundations carry out their charitable mission is by funding operating charities with grants. They can give to any organization recognized by the IRS as an operating charity with the 501(c)(3) moniker and to religious organizations like churches, synagogues, and mosques.  

A foundation has the option of accepting grant proposals or it can select the charities to fund through a purely internal process. Aside from making grants to IRS-recognized operating charities and religious organizations, foundations have several additional giving options, such as:

Direct grants to individuals and families in need:

Private foundations have the option of providing grants directly to individuals and families in need. The most common kind of support that foundations provide to individuals is in the form of emergency assistance and disaster relief. In general, foundations can provide direct economic hardship assistance as long as it furthers the foundation’s charitable mission and the recipient is needy or distressed.

One important point is that the foundation provides individuals with a grant using endowment dollars that have already provided the original donor with a tax deduction. The key point here is that a tax deduction is allowable for the original donor only if the funds are first channeled into a foundation. No tax deduction would be allowable if the original donor gave funds directly to the person in need. For example, if Johnny B. Good, a private person, gives money directly to help Hard-Knock Harry by writing a personal check, then Johnny cannot claim a tax deduction. However, if Johnny instead contributes the money to a private foundation, which in turn provides a grant to Harry, then Johnny can claim a deduction.

Scholarship programs:

The law allows foundations to petition the government for permission to create and administer scholarship programs. Setting up scholarship programs is an option for all foundations, not just those foundations focused on education. Once the program is approved, the foundation has the authority to choose individual recipients provided that the eligibility criteria is non-discriminatory and does not unfairly benefit foundation insiders and their families.

Prize and award programs:

Private foundations have the legal right to set up prize and award programs and grant them to individual recipients. A well-known example is the MacArthur Fellows Program, sometimes informally called “the genius grants,” which are typically awarded annually to individuals ages 20 to 30 in diverse fields who have shown “extraordinary originality and dedication in their creative pursuits and a marked capacity for self-direction.”

As of 2022, the MacArthur Fellows award is a $625,000 stipend paid out over five years. Awards like the genius grant program can help raise awareness of a given field, influence other people to launch their own innovative pursuits, and spur creativity and problem solving.

Foundations should be cautious when setting up such a program because the rules are quite complex and there are numerous legal pitfalls for the unwary. Nonetheless, prize and award programs are a powerful and often underutilized tool available to private foundations.

International giving:

Private foundations can make grants to international charities even when there is no IRS recognized 501(c)(3) entity to receive the grant. These grants simply require additional due diligence either in the form of an “equivalency determination” or via “expenditure responsibility.”

Both due diligence options require effort and expense over and above standard grants to U.S.-based nonprofits. Any foreign giving of this kind should be of sufficient size to make it worth the expenditure of additional resources. There is a small cottage industry of certified tax practitioners available to help foundations meet the requirements to give to foreign charities.

Make qualifying loans and investments in for-profit companies instead of grants:

Private foundations have the option of making loans and equity investments in for-profit companies if the primary purpose of the financing is to further the foundation’s stated charitable goals and the production of income is of secondary importance. Loans and investments of this nature are called Program-Related Investments (PRIs) and can take the place of grants in meeting the 5% distribution requirement.

There is, however, a substantial difference between grants and PRIs. With PRIs, the foundation expects to get the money back in the future which can then be recycled as philanthropic capital for another charitable cause.

Additionally, private foundations have another option of simply guaranteeing the loans of other organizations that otherwise would not meet a bank’s lending criteria. With loan guarantees, the foundation can work towards its philanthropic goals without a spending a single penny from its endowment.  

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