David E. Ormstedt
Lawyer David Ormstedt runs through the pros and cons of setting up a separate foundation to finance your nonprofit.
In general it’s not advisable for a small or medium-sized nonprofit to set up a separate foundation, because of the added costs involved and potential for disagreements down the road between the charity and its created foundation.
501(c)4 organizations, like groups that engage in significant lobbying, really do need to set up a separate foundation to raise money.
There are, however, some advantages even for regular 501(c)3s in establishing a separate foundation.
* Opportunity to acquire new expertise. If a new foundation is able to acquire board members or employees who have specialized skills like a financial background that are not already available to the charity, potential donors may have more confidence in giving to the organization.
* Limiting liability. Creating a separate foundation can also be a small advantage for small to medium-sized nonprofits that operate facilities with some exposure to liability – for example, a day care center where there are risks associated with caring for small children.
That type of organization might feel might feel confident that any claims against the charity itself could not be taken from a foundation holding its assets, since the foundation would be a separate corporation.
That hope may actually be more illusory than real, because under certain conditions a creditor can go after assets of an affiliated organization.
In most cases, there are probably more disadvantages than advantages to establishing a separate foundation.
* Board building. The charity will need to establish a new board. Usually a majority of a charity’s original board members will serve on both boards, but in order to realize the advantages of having people with special skills on this board, you’ll have to spend the time recruiting new members.
* Time and expenses. As a separate corporation, your new foundation will have to incorporate with the Secretary of State, and apply to the Internal Revenue Service for 501c3 status. In some states, a separate registration process is required with some state agencies, such as the Attorney General’s Office or a Consumer Affairs Department.
You’ll need to create bylaws and hold meetings. A separate 990 will need to be prepared and filed each year, and if the amount of money warrants it, there may need to be a separate audit conducted.
Not only are there expenses associated with all that, but the people you recruit to be on the board must be willing to devote ample time to getting the new foundation on its feet.
* Mission impossible. There may come a time when the views of a charity’s board on what direction its programs should go in may conflict with its foundation’s views on the best way to present the charity so that people will give to the foundation.
Such tension between the two boards will be a distraction to the charity and may interfere with the carrying out of its programs.
* Balance-sheet blues. With a foundation fundraising arm, a charity’s balance sheet is going to look less attractive. Instead of contributions showing up on the charity’s income statement, most will now be on the foundation’s income statement.
This may affect its ability to obtain loans and to attract grants from funders like private foundations, United Ways and community foundations.
* Avoiding private foundation status. If the charity intends to largely live off the yield of its endowment and not do much separate fundraising, it’s really not a good idea to put that in a separate foundation.
If a foundation doesn’t actively solicit funds, it may be determined to be a private foundation and incur less favorable taxation policies.
David E. Ormstedt is a lawyer at Wiggin and Dana specializing in tax-exempt organizations and health care.