Philanthropy is a vital part of Houston’s culture. According to a 2017 Charity Navigator report on the top 30 markets in the U.S., the largest 108 charities in Houston have a median total of $9.1 million in assets and made $4.3 million in contributions, about one-third more than the national average. Despite the abundance of philanthropy in the region, many generous members of the community may not understand the distinction between a public charity and a private foundation.
The word “foundation” is commonly incorporated into the names of several types of nonprofits. Most people are familiar with The Susan G. Komen Foundation, The Bill and Melinda Gates Foundation, or The Make-A-Wish Foundation. All of these organizations are charitable, but not all of these are private foundations.
So, what exactly is a private foundation, and how is it different? Both public charities and private foundations are classified as tax-exempt, 501(c)(3) organizations by the IRS. The major difference between a private foundation, like The Bill and Melinda Gates Foundation, and a public charity, like the Make-A-Wish Foundation, is where they derive their financial support. Whereas a public charity solicits funds from the general public, a private foundation, which is an independent legal entity, usually has one source of funding, typically an individual, family, or corporation. Private foundations can make charitable grants in support of public charities, which in turn provide services or conduct other tax-exempt activities, such as feeding the homeless.
Houston boasts several large and well-known private foundations, such as The Laura and John Arnold Foundation and The Brown Foundation. However, most foundations are nowhere near as big or complicated. In fact, private foundations can be started with as little as $250,000 in initial funding, and they needn’t be professionally staffed. Many are run by families whose “boardroom” consists of the kitchen table. In addition to the ability to fund many good works, when the foundation is funded, the donor gets a tax deduction up front, and then makes charitable gifts over time. The only requirement is that the foundation make “qualifying distributions” each year of at least 5 percent of the previous year’s average net assets. Distributions that count toward this requirement include grants to charities, certain related expenses, and, with the exception of investment expenses, necessary and reasonable administrative costs.
In exchange for complying with these requirements, private foundation donors maintain full control over how the foundation’s assets are invested and charitable funds are granted (and can pass this control to subsequent generations in perpetuity).
Although a private foundation can be set up at any point during one’s lifetime — or even after death — there are certain times and occasions when establishing a private foundation can be especially advantageous, such as:
- Selling a business: Donating shares of a business to a private foundation can be a means of reducing income and/or estate tax liabilities, and private foundations may be funded with both privately held and publicly traded stock.
- Liquidity event: An inheritance, court judgment, or other payout can be used to fund a private foundation, providing both an ideal way to give back while reducing tax liabilities. Private foundations may also be funded with donations of tangible or intangible property, including real estate, art work, and intellectual property (e.g., patents, royalties).
- Retirement: With retirement, starting a private foundation opens the door to a new and rewarding “second act” as a philanthropist. For high-net-worth individuals who have a strong charitable interest, private foundations offer an opportunity to save on estate taxes while simultaneously creating a lasting philanthropic legacy.
Source: Houston Business Journal