Targeting gifts through a family foundation

[Editor’s note: The following article was prepared by Wachovia Trust Nonprofit and Philanthropic Services.]

A growing number of charity-minded individuals want to exercise more control over how their donated dollars are being used. Many of them are taking a close look at establishing private family foundations. The total number of private foundations in the United States has tripled in the past 25 years, with annual funding by high net worth individuals exceeding $22 billion in every year since 2001 (according to the Foundation Center).

Neither of those statistics is surprising, given such foundations’ flexibility and their numerous tax and non-tax advantages. The growing interest in family foundations has also been fueled partially by the recent high-profile activities of some well-known foundations, most notably the Bill and Melinda Gates Foundation.

Essentially, a family foundation is created by an individual (or by a family) who wants to help fund the work of favorite charities, but also wishes to have more of a say in how those gifts are managed and used. This ability to direct charitable gifts with a high degree of precision through grants to specific causes, institutions, or groups appeals to many. And the fact that a family foundation can be used to encourage a continuing interest in philanthropy among younger generation family members is often seen as an additional benefit.

Though complex to administer, the actual operating mechanism of a family foundation is relatively straightforward: The person who establishes the foundation contributes the initial funding and may make additional donations to the foundation over time. Other family members may also contribute. The creator of the foundation, acting through a board of trustees or directors, determines how the foundation’s assets will be spent and how long the foundation will be in existence.

If you are thinking about establishing a private family foundation, we recommend you investigate the following issues in more detail.

What Do You Want Your Foundation to Achieve?

Before you embark on the journey to create a family foundation, you have to decide first what exactly you want your foundation to achieve.

Often, that requires an examination of your values and your charitable interests. Some foundations focus on a narrow niche, funding wildlife rehabilitation organizations or music education for schoolchildren in a specific state or region, for example. Other foundations operate with a broader mandate – providing grants to organizations that, for instance, support research into various illnesses or disabilities. Your work as a grantmaker will be more effective if you have a clearly defined set of philanthropic goals.

Once you are certain of what your foundation’s goals are, you’ll want to formalize them in a mission statement. A mission statement alerts potential grant applicants to the types of organizations and activities your foundation will fund. A mission statement should include:

  • Grantmaking priorities
  • Types of organizations that will receive funding
  • Geographic focus/restrictions on organizations supported by the foundation
  • Projects that may be eligible for funding

In fact, a separate, publicly available set of grantmaking guidelines will provide additional assistance to grant applicants and can also help reduce the number of ineligible or inappropriate proposals and inquiries. In addition, you may find it helpful to craft a “Statement of Donor Intent,” a message from you as the creator of the foundation outlining your grantmaking values and your charitable interests.

The Tax Benefits of a Family Foundation

The personal rewards of supporting your favorite charities through a private foundation are immeasurable. The tax benefits of your charitable giving are measurable and quantifiable.

Income Tax: A gift to a private foundation may entitle you to an immediate income-tax deduction. Your deduction will be limited to a percentage of your adjusted gross income. Contributions that are not deductible because of the tax law’s income limitations may be carried forward for up to five tax years.

Gifts of qualified appreciated stock are deductible at full fair market value. By donating such stock to your foundation, you avoid capital gains tax on the appreciation. In general, qualified stock is publicly traded stock that you’ve held more than one year.

Estate Tax: Without proper planning, estate taxes could significantly reduce the size of your estate. A private family foundation can help to reduce the potential bite of estate taxes. By contributing assets to your family foundation, you will be effectively removing their value and any future appreciation from your taxable estate. The impact is twofold: Your estate’s potential tax liability is reduced, and your family will be able to oversee the distribution of the assets from your foundation.

The Nuts and Bolts of Overseeing a Family Foundation

A foundation’s board is responsible for establishing policies and procedures for the foundation and for selecting and supervising the foundation’s employees and officers. Your advisors can work with you to help determine how your foundation’s board will be structured, how often it will meet, and what its responsibilities will be. Since one of the board’s primary responsibilities will be to review grant applications and to select the organizations the foundation will support, the composition of the board is critical.

Responsibility for day-to-day operations will rest with your foundation’s officers and staff. Most family foundations are run by the founder and his or her family members. It’s best to decide on management responsibilities early on in the process.

Keep in mind that if directors and officers are compensated for their services, the amount of the compensation must be reasonable. When determining compensation, you will want to consult with your professional advisors regarding tax law restrictions on private inurement and self dealing.

The Financial Side of Your Foundation

Since a private family foundation enjoys federal tax-exempt status, it is required by law to engage in grantmaking activities that equal or exceed approximately 5% of the value of its endowment each year. These expenditures include grants and necessary and reasonable administrative expenses.

Given that your family foundation is spending 5% or more of its endowment annually, the goal from an investment perspective would be to realize an  investment return equal to or greater than the minimum required 5% minimum annual distribution. When annual returns are greater than the annual payout, the foundation can continue growing.

Other financial issues that may be of concern include federal tax law provisions that impose an excise tax (generally, 2%) on a foundation’s net investment income, as well as excise taxes on self-dealing transactions, any investments that jeopardize the tax-exempt purposes of the foundation, excess business holdings, or taxable expenditures made by the foundation.

Working with Professionals

A private family foundation can be an effective way to ensure that your philanthropic intentions will endure. A foundation can be an immensely satisfying undertaking that benefits both the giver of the gift and the recipients. However, it’s important that you consult carefully with asset management, tax, estate, and legal professionals who can help ensure that your private family foundation will achieve your philanthropic goals.

For more information on how Wachovia Nonprofit and Philanthropic Services can help you develop and implement a private family foundation, please contact your Wachovia Philanthropic Consultant.

Trust services are offered through Wachovia Bank, N.A. (Wachovia), a national banking association and subsidiary of Wachovia Corporation, or Delaware Trust Company, N.A., a subsidiary of Wachovia. Trusts that have their situs in and are governed by the law of Delaware use Delaware Trust Company as the trustee. Wachovia does not provide legal or tax advice.

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