The Life Cycle of a Private Foundation

The Life Cycle of a Private Foundation

The private foundation (PF) is a great tool for an individual or family that wants to be in the “business of philanthropy.” It provides a tax exempt shell within which to house assets to operate the business of philanthropy. It is a structure that survives the grantor and establishes the family as philanthropists for the ages.
It can also be a royal pain in the neck in terms of its care and feeding, with tedious initial and ongoing filings and returns, meetings and other documentation.
Today, we are going to outline the life cycle of a PF so that you can see a bit of what is involved and why I always say that PF’s are appropriate for those who want to be in the “business of philanthropy” rather than those who are looking to fund a charitable pocketbook. It is not meant to be exhaustive by any means. (Warning: Don’t attempt to implement any of this on your own!) Thank you to www.irs.gov for its great article “Life Cycle of a Private Foundation.” Check it out for more detailed information including sample documents.
Starting Out and Applying to the IRS

1. As basic as it sounds, the first thing to do is determine the type of foundation you want to establish: “private operating,” “exempt operating,” or “grant making.” Hint: most folks use “grant making” a/k/a “private non-operating” foundations.
2. Draft and execute the proper organizing documents and bylaws so that the foundation will qualify as a §501(c)(3) organization. Typically, a PF is structured as a trust, corporation or association. Your attorney should be sure to include certain provisions that prohibit the foundation from engaging in behavior that could trigger the PF excise taxes under §§4941, 4942, 4943, 4944, and 4945.
3. Obtain an employer identification number (EIN). Note that entity must be in existence first before applying for the EIN.
4. Determine the registration requirements for the state(s) in which your foundation may be required to file. For more information, including how to determine in which states a foundation may be required to register, see the website of the National Association of State Charity Officials.
5. Submit an application (form 1023) along with the user fee ($850) to the IRS to establish your tax exempt status. Such application should be filed within 27 months after the end of the month of legal formation and tax exempt status, if warranted, will be retroactively applied back to the date of formation.

Required Annual Filings & Ongoing Compliance

1. Form 990PF – an onerous return in which, in my humble opinion, the required disclosures about the activity of the PF are primary and the numbers and excise tax calculation are clearly secondary. It is very important to note that, unlike virtually any other return with which you are familiar, the 990PF is a PUBLIC DOCUMENT which means that “private” foundations are anything but private.
   • Excise tax on net investment income – a basic 2% tax which can be reduced to 1% if certain conditions are met.
   • Possible excise taxes related to self-dealing, failure to distribute income, excess business holdings, jeopardizing investments, and taxable expenditures.
2. Form 990-T – Unrelated Business Income Tax (UBTI) return, if required
3. Employment tax forms, if the PF has employees
4. State Filing Requirements – Example – in New York, Form CHAR500 must be filed annually along with a copy of the foundation’s Federal Form 990PF plus a filing fee.
5. Substantiation and disclosure of charitable contributions – All grants are disclosed on the 990PF, giving potential readers (which can be anyone since the 990PF is a public document) full knowledge of what the PF has supported during the year.

Other Significant Events

1. IRS audits may be field, office, or correspondence audits. As with audits of taxable entities, the results are subject to administrative and judicial appeal. They are about as pleasant as root canal without anesthesia.
2. Termination of a PF
   • Voluntary termination by notifying the IRS and paying a termination tax.
     • The termination tax is equal to the lesser of the combined tax benefit resulting from the 501(c)(3) status of the organization or the value of the net assets of the organization
     • A foundation may also transfer its assets to another private foundation, commence voluntary termination, and pay no termination tax because it has no assets. In this case, the transferee acquires all of the aggregate tax benefits of the transferor associated with the transferred assets.
   • Involuntary termination for either willful repeated violations or a willful and flagrant violation of the private foundation excise tax provisions and becoming subject to the termination tax.
   • Transfer of assets to certain public charities
   • Operating as a public charity for a continuous period of 60 months after giving appropriate notice.

• Administrative Headaches
  1. Trustee/directors’ meetings – to review performance, set policy, and approve grants. Minutes should be kept.
  2. Responding to requests for copies of the 990PF – Again, a public document that has to be provided to those who request it.
  3. Maintenance of a Website – optional
  4. Responding to requests for grants – even if the PF “opts out” of entertaining such requests, they still, somehow, find their way to the PF office and need to be addressed.

Again, this short outline is by no means exhaustive but it illustrates a few basic points. Here are the takeaways:

• Starting a private foundation is like starting a for-profit business. There are ground rules and boundaries that must be understood and respected. It is best to go in with your eyes open.
• A PF requires thought and ongoing attention. It is best used to advance a philanthropic agenda that is clearly stated and generally accepted by the founder and the governing board.
• Because philanthropic agendas will change over time, it is best for founders to go in with an open mind and remain flexible, not tying up the PF with too many restrictions. If this is not possible, perhaps a shorter term, specific gift to charity may be more to the liking of the donor.
• A PF should not be viewed as a charitable pocketbook. Its highest and best use is to engage in the business of philanthropy, the same way a private, for-profit company engages in the family business.