Charitable Planning: Donor Advised Funds vs. Private Foundations

When you give $100 to your favorite charity, you are probably not overly concerned about how your donation is spent, as long as it advances the mission of the charity. On the other hand, if you are making a large donation, it is likely that you have more specific goals in mind for the use of your money, whether its to fund a particular program or to support another endeavor. This desire to specify exactly where your donation dollars will go may jeopardize your ability to claim an income tax deduction. Therefore, proper planning is essential.

If you want more control over how your donation is used, consider either donor advised funds or private foundations.

Donor Advised Funds

Many larger public charities, particularly those that support a variety of different charitable activities and organizations, offer donor advised funds. This type of charitable giving vehicle is based upon an agreement between the donor and the charity stating that the charity will consider the donors wishes with respect to the ultimate use of the donated funds. However, the agreement is non-binding, and the charity will exercise final control over the disposition of the funds, consistent with the charitable purposes of the organization. In some cases, the donor can designate someone to oversee the funds in the event of death or incompetence. 

Private Foundations

A private foundation, on the other hand, is a nonprofit organization that is usually created via a single donation from an individual or a business, whose funds and programs are managed by its own trustees or directors. Through the choice of directors or trustees, the donor has greater control over the specific use of funds, rather than relying on a public charity. Private foundations generally fit into two categories: private operating foundations and private non-operating foundations. Private operating foundations actually run the charitable activities or organizations they fund, while private non-operating foundations simply disburse funds to other charitable organizations. A private foundation can also serve as a family enterprise, where members of the family can work together in supporting charitable causes over the long term. 

However, the benefit of increased donor control through the use of a private foundation comes at a price. The following rules are designed to ensure that private foundations serve charitable interests and not private interests:

  • Private foundations are generally required to pay out for charitable causes at least 5% of their asset value annually or be subject to a penalty.
  • Substantial penalties are imposed on transactions between the foundation and its donors or managers, although payment of reasonable salaries is permitted.
  • Private foundations are generally prohibited from benefiting a private individual.
  • A private foundation is responsible for ensuring that the funds it distributes to a private charity are expended properly. (Schools, hospitals, and churches are examples of public charities, to which this does not apply.)
  • An excise tax of up to 2% of investment income is imposed annually on investments.
  • There are restrictions on the types of investments made by private foundations. 

The deductibility of contributions to private foundations is more limited than for contributions to public charities. Depending upon whether cash or property is being donated, deductions to private foundations are limited to 20% to 30% of adjusted gross income, whereas deductions to public charities have higher limits of 30% to 50%. Finally, the administrative and legal costs of creating and managing a private foundation must be considered. 

Under the appropriate circumstances, a private foundation might be just what you are seeking to obtain greater control over how your charitable donation is spent, and it can be highly rewarding to be involved in charitable endeavors. For more information, consult your tax and legal professionals.

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