What is a Private Foundation?
A private foundation is a type of 501(c)(3) tax-exempt organization typically established for the purpose of grantmaking. Private foundations are usually funded by an endowment, a single donor (whether an individual or corporation), or a small group of donors. This is in contrast to public charities which must be supported by a broader source of donations or revenue such as gifts from the general public, government grants or other public sources.
Private foundations generally operate by using the income generated by their investments to fund grantmaking and other charitable activities. Except in certain circumstances, private foundations may only make grants to public charities or government entities.
Since they are less open to public scrutiny, private foundations are subject to quite a few regulations and restrictions, including prohibitions on self-dealing, lobbying and political activity. Additionally, they are required to distribute a minimum percentage of their assets each year to maintain their valuable tax-exempt status (see more on this below) and are also subject to excise taxes on their net investment income and certain other activities.
Who Benefits from a Private Foundation?
Private foundations directly benefit public charities through their grantmaking programs which typically have one or more focus areas such as education, social services, research, health care, arts, culture, or environmental protection. The public thereby indirectly benefits from the foundation’s support of those charitable endeavors. With advance approval from the IRS, private foundations may also provide scholarships and grants to support individuals pursuing specific areas of study or artistic activities.
In short, private foundations can support any number of causes through grantmaking, so long as the objectives of the grant recipients are consistent with the tax-exempt purposes of the foundation. Thus, the impact of a private foundation depends initially on its founder’s goals and the guidelines established by its governing documents.
What Do I Need to Start My Own Private Foundation?
Anyone can start a private foundation with the proper purposes, documents, and procedures in place. The process starts with forming a nonprofit corporation and appointing a group of individuals to serve as the board. The purpose of the private foundation will be reflected in the corporation’s organizing documents. Once the corporation is formed, it will need to apply for tax-exempt status with the IRS and obtain the required state exemptions and registrations.
While the formation process is fairly straightforward, substantial infrastructure may be needed to support the foundation over time. Before starting a private foundation, the founder should carefully consider whether a foundation is the best vehicle for their charitable goals by first developing a strong business plan and assembling a team of advisors to assist with grantmaking, accounting, and administration.
Don’t Forget About the 5% Minimum Distribution Rule
Private foundations are generally required to distribute at least 5% of their assets each year for charitable purposes (many distribute more than that, see this article contending that 5% is perhaps too modest of a requirement). The underlying reason behind the distribution requirement is to ensure that private foundations are actively engaged in philanthropic activities and use their resources to benefit the public. Failure to comply with this requirement can lead to excise taxes and, in extreme cases, the loss of tax-exempt status.
Helping You to Create a Private Foundation
The Law Firm for Non-Profits frequently advises founders of private foundations and would be delighted to discuss whether doing so may be right for you.
