A private foundation can seem like the perfect answer to your family’s philanthropic goals, but you should be wary of issues that could jeopardize its tax exempt status. I discuss the most common issues below:
Each year, a family usually determines how it will distribute the annual required minimum distribution from its private foundation. The foundation receives charitable requests from non-profit organizations which are carefully considered by the family. If the family chooses to grant a request, they need to first make sure that they are not paying off a ‘personal pledge.’ If a personal pledge is made to a charity and paid for by the foundation, the IRS considers it a benefit to an insider and may give the individual involved in this type of activity (often referred to as self-dealing) a personal 10% penalty. Put simply, a foundation can make a pledge to a charity only if it is initiated by the foundation.
IRS Publication 78
A family should make sure that the charitable organization their foundation supports, or is considering supporting, is tax exempt. On occasion, an organization that had tax exempt status may no longer be tax exempt. The IRS lists most tax-exempt organizations in a searchable database called Publication 78.* If the organization is not listed, the foundation might still be able to make a distribution by exercising ‘expenditure responsibility’ to document the use of grant funds. Although this extra step is time-consuming, it ensures the funds are used only for charitable purposes. *Schools, religious organizations and governmental departments, such as a park, are not listed in Publication 78.
While schools are generally considered public charities, scholarships given to individual students to attend school by a foundation are not allowed unless the foundation received advance approval from the IRS to provide scholarships. However, a foundation may gift to the school’s general scholarship fund without advance IRS approval.
We have all been invited to ‘buy’ a table at a charitable event. If a foundation buys a table at an event and the friends and family of the organizers of the event sit at the table, some believe this is in violation of the self-dealing rules. Others argue that their attendance only promotes donations to the charitable organization. As such, it is prudent to limit table attendance to only the board members of the foundation.
Often, a foundation aims to support a global charity that is not recognized by the IRS as a public charity. When this happens, the foundation should seek a legal opinion to document the process of determining whether or not the charity would be granted tax exempt status in the U.S. The IRS also provides guidelines on how to make this determination. In addition to these avenues, the foundation also should make certain that their grants are used for charitable purposes by following the IRS’ reporting requirements.
The IRS issues outlined above are only a few of the many that a family should be aware of when running a private foundation. For more information about the IRS’ rules and regulations for foundations, or for help making your own foundation IRS-compliant, please contact your client advisor.