1. What is a Private Foundation or Family Foundation?

A private foundation, often called a family foundation, is a nonprofit entity that can be managed by an individual, family, or business. These foundations are established for charitable, educational, religious, scientific, and literary purposes under Section 501(c)(3) of the IRS Code. To ensure contributions are tax-deductible, the foundation must be recognized by the IRS. Essentially, a private foundation is a planned giving tool that encourages family participation, offers significant control over assets and donations, and allows donors to receive immediate tax deductions for future charitable contributions.

2. Benefits of a Private Foundation

Family Legacy: Establishes a lasting legacy of giving, supporting causes important to your family and promoting charitable activities for future generations.

Control: Provides maximum control over which charities to support and how assets are invested. You can also donate a wide range of assets to the foundation. 

Family Involvement: Enables family participation in philanthropy, passing on values to future generations. 

Tax Benefits: Offers immediate tax deductions for contributed assets, even if grants are made later. It also helps remove taxable assets from your estate without incurring capital gains taxes.

33. Private Foundation vs. Donor Advised Fund

The main differences lie in control and flexibility. With a private foundation, donors retain control over donations and disbursements, can hire staff, reimburse expenses, set up structured giving programs, and make direct grants to individuals. Donors can also contribute a wider variety of assets. In contrast, contributions to a donor advised fund are irrevocable, and the nonprofit administering the fund makes investment decisions. Donors can recommend charities for grants, but the fund’s governing body has the final say.

4. Private Foundation vs. Public Charity

A private foundation is a nonprofit organization managed by its own trustees or directors, primarily making grants to other nonprofits. In contrast, public charities receive funding from the general public, including individuals, government, and private foundations, and often engage in direct service activities. Private foundations typically derive their funds from a single source and do not solicit public donations.

5. Use of Foundation Assets

Donations to a private foundation must be used for charitable purposes and certain administrative expenses.

6. Employment of Family Members

Family members can be employed by the foundation as officers or directors, making it a family affair. However, paying family members requires adherence to IRS rules, so consulting an attorney is essential.

7. Transactions with the Foundation

The IRS prohibits self-dealing. Disqualified individuals (donors, their descendants, and employees) cannot engage in transactions with the foundation, except for making donations or receiving fair market value compensation for services. Examples of prohibited transactions include: 

      - Buying or selling items to the foundation. 

      - Personal use of foundation assets or income. 

      - Borrowing money from the foundation. 

      - Keeping foundation assets on private premises.

8. Grant Recipients

Private foundations typically make grants to recognized public charities, including religious institutions, educational and cultural organizations, and poverty relief agencies. They can also provide scholarships or project-specific grants to individuals but cannot fund political campaigns or organizations influencing legislation.

9. Minimum and Maximum Giving Requirements

The IRS mandates that private foundations distribute at least 5% of their previous year’s average net assets for charitable purposes annually. There is no maximum limit on giving.

10. Eligible Grant Recipients

Private foundations can grant funds to any organization recognized by the IRS as a public charity, including religious institutions, educational and cultural organizations, and poverty relief agencies.

11. How Does a Nonprofit Supporting Organization Compare to a Private Foundation?

A supporting organization is technically a private foundation but is treated as a public charity for tax purposes. This is because it is closely connected to at least one public charity, almost functioning as part of it. This connection can be established by having a majority of the foundation’s board appointed by the public charity or by supporting specific projects of the public charity to ensure oversight. The special tax status is granted because Congress trusts that public oversight will protect the public interest. However, the IRS has been increasingly scrutinizing both new supporting organizations and their operations to ensure active oversight and control.

12. Penalties for Failing to Meet the 5% Payout Requirement

If a private foundation fails to meet the 5% minimum payout requirement, it faces a penalty of 15% of the undistributed amount. Note that this requirement does not apply during the foundation’s first year of operation; grants can be deferred to the second year, but not beyond, except under special set-aside rules.

13. Compensation for Trustees/Board Members

It is legal to compensate trustees or board members of a charitable foundation. While the charity cannot exist for the significant benefit of a private individual, board service involves time and expertise, which can be reasonably compensated. Determining what constitutes reasonable compensation can be guided by what similar foundations in your area pay their officers, as this information is publicly available and federally mandated.

14. What is Self-Dealing and Why is it Illegal?

Self-dealing involves direct or indirect transactions between the foundation and a “disqualified person,” even if the transaction benefits the foundation. It also includes any use of foundation income or assets for the benefit of a disqualified person. The rules against self-dealing, outlined in Internal Revenue Code Section 4941, are designed to prevent misuse of foundation funds and assets for personal gain. 

       Disqualified persons include:  

      - Foundation trustees, directors, managers, or officers 

      - Substantial contributors to the foundation 

      - Owners of more than 20% of a business that is a substantial contributor

      - Family members of the above, including spouses, children, grandchildren, great-grandchildren, parents, other ancestors, or spouses of children, grandchildren, or great-grandchildren

      - Corporations where more than 35% of the voting power is owned by disqualified persons 

      -  Certain government officials

      Prohibited transactions include: 

      - Sale, exchange, or leasing of property (e.g., purchasing office supplies from a disqualified person)  

      - Lending money or extending credit 

      - Furnishing goods, services, or facilities for money  

       - Using foundation income or assets for the benefit of a disqualified person  

       - Paying money or property to a government official