30 May 2012

Many wealthy philanthropic people establish private family foundations in order to make a positive impact on the community, to educate their children and future generations about the importance of giving back to the community to make the world a better place, and to obtain charitable income, gift and estate tax deductions. You may have seen the names of family foundations prominently listed as donors around town on walls of honor and in brochures at the Disney Concert Hall, the Los Angeles Zoo, City of Hope, the Hollywood Bowl, and other venues. It is important to understand before you establish a private foundation how it works and whether it is the right vehicle to meet your charitable goals.

What is a private foundation? A private foundation is a private non-profit tax exempt entity, either a corporation or an irrevocable trust, whose funds and charitable gift giving programs are managed by directors or trustees. A private foundation is established to make gifts (primarily through grants) on an annual basis for social, educational, religious and other charitable purposes.

Initially, the donor will have to incur the expense of hiring legal counsel to establish the charitable entity (whether it be a corporation or an irrevocable trust) and also to prepare detailed applications to submit to the IRS and the State of California to obtain its tax exempt status. If the foundation is established as a corporation, Articles of Incorporation must be prepared and filed with the California Secretary of State. In addition, if the foundation is a corporation, Bylaws must be prepared and the rules of corporate governance will apply to its operation, which includes the requirement for annual meetings and annual filings with the California Secretary of State.

The donor receives an income tax deduction for lifetime contributions to the private foundation and an unlimited estate tax deduction for contributions to the foundation at death. For income tax purposes, a donor may deduct gifts of cash to the foundation up to thirty percent (30%) of his or her adjusted gross income. The donor may deduct gifts of appreciated property to the foundation (such as stock or real estate) up to twenty percent (20%) of his or her adjusted gross income. If the donor has charitable income tax deductions in excess of the foregoing percentage limitations, those deductions may be carried forward for a five-year period following the year the contribution was made to the foundation.

What are the advantages of establishing a private foundation?

1.         The donor establishes a family legacy by naming the private foundation after the family, which may continue to exist following the donor’s death.

2.         The donor’s children may be given a role in the charitable giving process that serves to unify the family and make the children socially aware of their responsibility to the community. Essentially, the foundation serves as a family philanthropic training program.

3.         Family members may receive reasonable compensation for services provided to the foundation (with certain limitations).

4.         The donor has a vehicle to implement an organized planned giving program.

5.         The donor may make tax deductible gifts to his or her family foundation and, as a trustee or director of the foundation, may control the investment of these assets and the ultimate distribution of the gifts.

6.         The investment income generated by assets held in the foundation may be exempt from income tax (with the exception of the 1-2% excise tax).

7.         The donor will not recognize capital gains when appreciated assets are contributed to the foundation.

What are the disadvantages of establishing a private foundation?

1.         Legal and accounting fees to establish and maintain the foundation could be significant.

2.         An annual excise tax of 1 – 2% on net investment income is imposed on private foundations.

3.         The directors or trustees of the foundation must keep detailed records regarding its grant-making activities and foundation meetings.

4.         Private foundations must annually distribute a minimum of five percent (5%) of the fair market value of its net investment assets. Failure to meet this requirement results in an excise tax on the foundation.

5.         An excise tax is imposed if a disqualified person engages in an act of self-dealing.

6.         The Internal Revenue Service (IRS) may assess excise taxes on:

a.         Certain foundation holdings in private businesses;

b.         Foundation investments that jeopardize the carrying out of the foundation’s tax-exempt purposes;

c.         Expenditures for certain activities not furthering exempt purposes.

7.         The foundation must annually prepare and file returns with the IRS and the state of California.

8.         The percentage limitations for charitable income tax deductions for gifts made to a private foundation are significantly less than the percentage limitations for gifts made to a public charity (which includes a donor advised fund).

9.         Gifts of appreciated property to public charities are deductible for income tax purposes based on the property’s fair market value. In contrast, gifts of appreciated property to private foundations are limited to the property’s cost basis (with the exception of publicly traded stock held for more than one year that is not subject to any resale restrictions).

A private family foundation may be the right choice for your family to fulfill its charitable goals and to promote family involvement in the community. Please do not hesitate to call us if you are interested in discussing whether this is the right choice for you.

If you would like to discuss this or other trusts and estates issues, please contact the attorneys at Drucker Law Offices, 468 North Camden Drive, 2nd Floor, Beverly Hills, CA 90210, 310.285.5375 Tel, 310.444.9754 Fax, www.druckerlaw.com

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