How to Start a Private Foundation PRIMER SERIES TAX AND LEGAL

Transcription

How to Start a
Private Foundation
TAX AND LEGAL
PRIMER SERIES
BRIEF PAPERS ON KEY TOPICS
by Sara Beggs, Exponent Philanthropy
Legal Review by Andras Kosaras, Andrew & Porter, LLC
Edited by Andy Carroll, Exponent Philanthropy, & Joseph Foote
Table of Contents
l.
EDUCATE YOURSELF ABOUT VARIOUS
CHARITABLE VEHICLES
ll.
DETERMINE THE TYPE OF PRIVATE FOUNDATION
lll.
STRUCTURE THE FOUNDATION AS EITHER A CHARITABLE
TRUST OR A NONPROFIT CORPORATION
lV.
ESTABLISH YOUR FOUNDATION WITH THE STATE
V.
OBTAIN AN EMPLOYER IDENTIFICATION NUMBER
Vl.
APPLY TO THE IRS FOR TAX-EXEMPT STATUS
Vll.
REGISTER AND APPLY FOR EXEMPTION WITH THE STATE
Vlll.
OPERATE YOUR PRIVATE FOUNDATION ACCORDING
TO THE LAWS
lX.
CONCLUSION
DISCLAIMER: Exponent Philanthropy cannot be held liable for the information
provided in this primer. We strongly encourage you to consult your attorney to
ensure compliance with federal and state laws and regulations.
I. Educate Yourself About
Various Charitable Vehicles
Generally, a private foundation has four characteristics:
• It is a charitable organization;
• It is initially funded from one source (usually
an individual, a married couple, a family or a
business);
• Its ongoing income derives from investments (in
the nature of an endowment fund); and
• It makes grants to other charitable organizations
rather than operating its own program (except in
the case of a private operating foundation).
If you have not identified a funding source for your
endowment but have a great program idea, you
may actually be more interested in forming a public
charity rather than a private foundation. You can find
information on forming public charities in Starting a
Nonprofit Organization at www.boardsource.org. Visit
the E-Books section of their Bookstore to view and
download the publication.
Even if you have funds to put toward a charitable
purpose, you should consider the advantages and
disadvantages of starting a private foundation versus
using some other giving vehicle. First Steps in Starting
a Foundation, by John Edie and published by the
Council on Foundations is an excellent resource to
help you think through these various options. We also
strongly recommend consulting an estate planning
attorney or an attorney concentrating in tax-exempt
organizations.
HOW TO START A PRIVATE FOUNDATION: TAX AND LEGAL
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II. Determine the Type of Private Foundation
If you determine that a private foundation is the appropriate charitable vehicle for you, you must
then consider the type of private foundation that most appropriately matches your long-term goals
and capabilities. The Internal Revenue Service (IRS) distinguishes among three different types of
private foundations, which are further described below. The descriptions below, however, are simply
overviews and not comprehensive analyses of the regulations governing these entities. Although
the initial foundation structure can be changed, it can be a complicated process and should only be
done with the aid of an attorney and accountant.
A. STANDARD PRIVATE FOUNDATIONS
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Standard private foundations, also referred to as private non-operating foundations, are the most
common form of private foundation. Standard private foundations vary in size and purpose. They
typically obtain funding from a single bequest, or may receive annual contributions from an individual,
group of individuals, members of a family, or a company. The primary purpose of standard private
foundations is to make grants to public charities, rather than operate any substantial programs.
Standard private foundations must spend an amount equal to at least 5% of their net investment
assets on qualifying grants and administrative expenditures annually. Company foundations
follow the same regulations as standard private foundations, but the funding source of a company
foundation is a business, rather than a family or individual.
1. Tax Deductibility of Gifts to a Standard Private Foundation
a) Cash Gifts. When a donor makes a cash gift to a standard private foundation, his or her tax
deduction is limited to 30% of the donor’s adjusted gross income, with a 5-year carryover of
amounts in excess of the 30% limit.
b) Gifts of Appreciated Property. A donor’s deduction for gifts of appreciated property, such
as closely held stock and real estate, to a standard private foundation is limited to the property’s
adjusted basis, which is generally the cost of the property. A donor’s contribution of most publicly
traded stock to a standard private foundation, however, is deductible up to the stock’s fair market
value. In addition, a donor’s deduction for all gifts of appreciated property is further limited to 20%
of his or her adjusted gross income, with a 5-year carryover of amounts in excess of the 20% limit.
2. Tax Deductibility of Gifts to a Standard Private Foundation
Compared with Tax Deductibility of Gifts to a Public Charity
Donors are entitled to more liberal tax deductions for gifts to public charities than for gifts to
private foundations.
a) Cash Gifts. A donor’s tax deduction is limited to 50% (rather than 30%) of the donor’s adjusted
gross income for cash gifts to a public charity, with a 5-year carryover of amounts in excess of the
50% limit.
b) Gifts of Appreciated Property. Contributions of appreciated property to a public charity are
deductible at their full fair market value, except that contributions of appreciated tangible personal
property must be related to the public charity’s exempt purpose, or else the donor is limited to
deducting his or her basis in the property. A donor’s tax deduction is limited to 30% (rather than
20%) of the donor’s adjusted gross income for gifts of appreciated property to a public charity,
with a 5-year carryover of amounts in excess of the 30% limit.
Please note that the above limitations apply only to lifetime gifts. Bequests, whether to a private
foundation or a public charity, are fully deductible from the donor’s estate.
B. PRIVATE OPERATING FOUNDATIONS
Private operating foundations, although still usually funded primarily by one source, use the bulk
of their resources to carry out their own charitable programs, rather than making grants to other
charitable organizations. To qualify as an operating foundation, the organization must spend at
least 85% of its annual adjusted net income or its minimum investment return for the operation of
its charitable activities and meet certain tests set forth in the Internal Revenue Code of 1986, as
amended (Code).
Although a private operating foundation is subject to most of the excise tax rules to which a
standard private foundation is subject (further described below), a major benefit is that donors to
a private operating foundation may take advantage of the more liberal income tax deduction rules
generally applicable to gifts to publicly supported charities. In other words:
a) Cash Gifts. A donor’s deduction is limited to 50% (rather than 30%) of his or her adjusted gross
income for cash gifts to an operating foundation, with a 5-year carryover of amounts in excess of
the 50% limit.
b) Gifts of Appreciated Property. A donor’s deduction is limited to 30% (rather than 20%) of his or
her adjusted gross income for gifts of appreciated property to a private operating foundation, with
a 5-year carryover of amounts in excess of the 30% limit. Perhaps more importantly, contributions
of appreciated property to a private operating foundation are deductible at their full fair market
value, except that contributions of appreciated tangible personal property must be related to the
foundation’s exempt purpose, or else the donor is limited to deducting his or her basis in the property.
Conduit foundations are similar to standard private foundations because they do not directly
operate charitable activities. However, the key difference is that none of the donations to a passthrough foundation can be used to build an endowment. Instead, all of the gifts (plus all of the
foundation’s income) must be distributed to public charities within 2-1/2 months after the end of
the tax year in which the donor made the gift to the foundation.
C. PASS-THROUGH OR CONDUIT FOUNDATIONS
A conduit foundation offers a donor the same tax deductions as an operating foundation and a
public charity:
a) Cash Gifts. The donor’s tax deduction is limited to 50% of his or her adjusted gross income for
cash gifts to the conduit foundation, with a 5-year carryover of amounts in excess of the 50% limit.
b) Gifts of Appreciated Property. The donor may deduct up to 30% of his or her adjusted gross
income for property gifts of appreciated property to the conduit foundation, with a 5-year carryover
of amounts in excess of the 30% limit.
Typically a donor would choose a conduit foundation if the donor wants to establish the foundation
structure and take advantage of more liberal tax deductions, but does not want to fully fund the
foundation until his or her death.
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III. Structure the Foundation as Either a
Charitable Trust or a Nonprofit Corporation
Once you have decided upon the type of foundation, you should determine whether to structure
the foundation as a trust or a nonprofit corporation. Below is a brief explanation of the advantages
and disadvantages of each entity, which will vary somewhat depending on state law. However, legal
counsel should further assist you in your decision and should assist you in the necessary filings.
A. CHARITABLE TRUSTS
A private foundation organized as a charitable trust is governed by a trust agreement that appoints
the initial trustees, designates the trustees’ initial powers, and provides for the future selection of
trustees to manage and operate the foundation.
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1. Advantages of Charitable Trusts Over Nonprofit Corporations
Trusts are typically simpler to create and operate than corporations. Trusts have fewer requirements
concerning trustees, state filings, regularity of meetings, minutes, etc. Trusts also have lower taxes
for any unrelated business income.
2. Disadvantages of Charitable Trusts Compared With Nonprofit Corporations
Trusts generally offer less flexibility than nonprofit corporations. For example, court approval is
generally required for any changes to the trust agreement. For some people, however, this inflexibility
may be desirable to ensure their funds stay directed towards a specific cause or charity. In addition,
because trustees are subject to restrictions relating to the delegation of their duties, trustees may be
required to be more directly involved in the management of the foundation than directors of nonprofit
corporations. Trustees also may have less legal protection from personal liability than corporation
directors in the case of ill-advised decisions. Lastly, trusts can receive deductible donations from
corporations only if they are to be used within the United States.
B. CORPORATIONS
A private foundation organized as a nonprofit corporation must normally file Articles of Incorporation
with the state Secretary of State. A nonprofit corporation is governed by a board of directors that
elects officers and carries out and properly records the foundation’s activities.
1. Advantages of Nonprofit Corporations Over Trusts
Nonprofit corporations offer a tremendous amount of flexibility that is not present in the trust structure.
For example, revising the governing documents such as the Articles of Incorporation and bylaws is
relatively easy and allows the foundation to operate in a manner that is responsive to community needs.
A nonprofit corporation also generally provides directors with greater protection from personal liability.
2. Disadvantages of Nonprofit Corporations Compared With Trusts
Nonprofit corporations have more formal operating requirements than trusts and are therefore
slightly more difficult to create. As mentioned above, a nonprofit corporation is required to file
Articles of Incorporation with the state Secretary of State. Many states also require regular meetings,
minutes, and annual reports.
Because of the great flexibility and liability protection, the corporate structure is used more often
than the trust structure.
IV. Establish Your Foundation With The State
Because trusts and nonprofit corporations are regulated by state law rather than federal law, you
must follow the specific state filing requirements when creating a foundation. Below are some
of the general state filing requirements, but it is very important to adhere to the specific filing
requirements in the foundation’s state of organization. Further, because a nonprofit corporation is
more common than a trust as a foundation structure, we will more specifically describe the steps
necessary to develop a nonprofit corporation.
A. ESTABLISHING A TRUST
To create a trust, you should consult with a qualified estate planning attorney or an attorney
concentrating in tax-exempt organizations. The trust document should include the following
information:
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• The name(s) of your trustee(s);
• A statement of the charitable purpose;
• Distribution guidelines for ongoing grantmaking and the potential dissolution of the trust;
• Name(s) of successor trustee(s) or an outline of a process for trustee selection;
• A statement of the term of the trust, if any;
• A clause prohibiting private inurement and lobbying; and
• Statements that the foundation will abide by sections 4941 through 4945 of the Code.
B. ESTABLISHING A NONPROFIT CORPORATION
1. Articles of Incorporation
2. Bylaws
3. Hold an Organizational Meeting
4. Minute Book
Each of these is described below.
1. Articles of Incorporation
The first step in organizing a nonprofit corporation is to draft the Articles of Incorporation (also
sometimes referred to as Articles of Organization) and file the Articles with the state Secretary of
State. The Articles of Incorporation serve as the formal document that establishes the foundation.
You must file the Articles of Incorporation with the state Secretary of State or other appropriate
state office and enclose the required filing fee. The amount of the filing fee depends on the state
of incorporation. If you request expedited filing (which increases the filing fee), the state will
likely approve the filing within 1 or 2 days; if you do not request expedited filing, the state may
take about 3 to 4 weeks to approve the filing. Once the filing is approved, the corporation is
considered in existence.
Articles of Incorporation generally should include the following provisions:
a. Corporation Name
b.Purpose of Organization
c. Registered Agent and Address
d.Incorporators’ and/or Initial Directors’ Names and Addresses
e. Provision for Asset Distribution Upon Dissolution
f. Method for Amendment of the Articles of Incorporation
g.Clauses Prohibiting Lobbying, Political Campaigns, and Private Inurement
h. Adherence to Code Sections 4941 through 4945
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a) Corporation Name Some foundations choose a name recognizing the family or company that
provided the original source of funding (e.g., The Judith L. Weymouth Foundation, The Pearle
Vision Foundation). Other foundations choose a name that will highlight the cause or mission of
the organization (The Foundation on Aging or Youth Development Foundation). Once you have
selected a name, you should confirm that the name is available with the state of incorporation.
b) Purpose of Organization Federal law requires every foundation to be organized and operated
for religious, charitable, scientific, testing for public safety, literary, or educational purposes. The
purpose of the foundation must be described in the Articles of Incorporation. Some states allow a
very general purpose statement; other states, such as Massachusetts, require at least one specific
purpose. A broad purpose statement in the Articles allows for maximum flexibility, which may
minimize revisions (and legal fees) over time. On the other hand, a more specific purpose may help
direct future directors in maintaining the initial mission of the foundation.
c) Registered Agent and Address States require that a registered agent be designated in the
Articles of Incorporation. The purpose of the registered agent is to receive the service of process
if the foundation were to be sued for any reason. Your lawyer or accountant may serve as the
foundation’s registered agent. In addition, various companies offer services of acting as your
registered agent for a fixed annual fee.
d) Incorporators’ and/or Initial Directors’ Names and Addresses This information is public, so
consider whether to use a home or office address.
e) Provision for Asset Distribution Upon Dissolution The Articles of Incorporation must contain a
clause providing that at the foundation’s dissolution, all the assets shall be disposed of for charitable
purposes (the clause may either identify specific charities, or indicate that the board of directors will
have discretion to determine the charitable beneficiaries). Some states have provisions providing
that the corporation will be automatically dissolved if the corporation fails to file the necessary state
documents (such as annual reports) in a timely manner. (Note that such administrative dissolution
does not automatically terminate the foundation’s tax-exempt status with the IRS.)
f) Method for Amendment of the Articles of Incorporation Include a statement detailing the way
in which to amend the Articles.
g) Clauses Prohibiting Lobbying, Political Campaigns, and Private Inurement Include a statement
that states the foundation will not make the prohibited expenditures above.
h) Adherence to Code Sections 4941 through 4945 The Articles must include a statement that
the foundation will comply with the requirements of sections 4941 (self-dealing), 4942 (required
distributions), 4943 (excess business holdings), 4944 (jeopardy investments), and 4945 (taxable
expenditures) of the Code.
2. Bylaws
After the Articles of Incorporation are filed, you must prepare the bylaws. The bylaws specify
the operations and rules of conduct for the foundation. Once again, each state will have its own
specifications with respect to the content of the bylaws. For example, many states have specific
requirements such as the minimum number of board members, frequency of board meetings,
etc. Your attorney can draft these provisions for you, but you should be involved in the process,
especially when state law allows for flexibility in the bylaw provisions. You should follow the laws of
the state where the foundation is incorporated.
Common elements of bylaws include:
a. Officers and Directors
b.Meetings of Directors
c. Meetings of Members
d.Other Duties
a) Officers and Directors
• The general powers of the board of directors;
• The responsibilities, number, and length of the term of the directors, as well as the method
for selecting, replacing, and removing directors;
• Authorizing the compensation of the directors, if any;
• The number, title and duties of the officers (such as president, vice-president, secretary, and
treasurer) and terms of office, as well as the manner of electing and removing officers and
filling vacancies; and
• A provision indemnifying officers and directors (and any other individuals serving on behalf
of the foundation, such as members of an advisory committee) and establishing the rights of
indemnified individuals.
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b) Meetings of Directors
• Notice requirements needed to call meetings, the meeting schedule, and definition of a
quorum;
• Voting requirements and the manner of taking actions;
• Whether standing committees will be established and if so, what type of standing
committees will be established; and
• A provision allowing for the creation of ad hoc committees.
c) Meetings of Members
• A statement as to whether the foundation will have a member structure. A membership
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structure gives special status to certain individuals, who may or may not be directors
themselves. A member usually selects the directors and therefore has ultimate control over
the foundation;
• If the foundation does have members, the powers of the members, the responsibilities of the
members, the number of members, and length of the term (if any) of the members, as well as
the method for selecting, replacing, and removing members; and
• If the corporation does have members, the date for the annual meeting and the requirements
for calling special meetings.
d) Other Duties
• A list of the officers that have the power to handle assets and bind the foundation with
respect to contracts, loans, checks, deposits, investments, and expenses;
• A statement regarding the tax year of the foundation (whether a calendar or fiscal year); and
• The procedures for amending the bylaws.
Bylaws are not static, and the board should review them regularly. Bylaws should accurately reflect
how the foundation operates and should remain relevant. Accordingly, it may be necessary to
amend the bylaws periodically. Keeping bylaws simple in language and content can help ease this
process. Some foundations appoint a task force to review the bylaws and make suggestions for
revision to the whole board. After the bylaws are revised, they should be approved by the full
board. The date of the board approval should be indicated on the revised bylaws.
V. Obtain an Employer Identification Number
3. Hold an Organizational Meeting
After the Articles of Incorporation are filed and the bylaws are drafted, your foundation must have
an organizational meeting to accomplish the following tasks:
• Adopt the bylaws;
• Elect directors and officers (if not specified in the Articles of Incorporation);
• Adopt the corporate seal, if you have one or if required by the state;
• Adopt a resolution permitting the opening of appropriate bank accounts and specifying
signing authority, and sign bank signature cards;
• Establish the foundation’s fiscal year, if not specified in the bylaws;
• Authorize payment of initial expenses; and
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• Authorize officers to file for tax exemption.
The secretary should take minutes of the organizational meeting as well as all future board of
directors’ meetings.
4. Minute Book
The secretary should create and retain a minute book that will include the foundation’s Articles of
Incorporation, bylaws, and minutes of all of the meetings.
Although establishing and operating a nonprofit corporation appears to be a lot of work, the reward,
as stated above, is that a nonprofit corporation is more flexible than a foundation structured as a
trust.
Even if the foundation does not have any current or anticipated employees, the foundation must
obtain an employer identification number. To obtain an employer identification number, you should
complete and submit IRS Form SS-4, “Application for an Employer Identification Number.”
Vl. Apply to the IRS for Tax-Exempt Status
After you have completed the steps above, you must apply to the IRS for tax-exempt status.
To obtain the necessary forms to apply for tax exemption, you may contact the IRS by calling
877-829-5500, or download the forms from the IRS’s Web site at www.irs.gov. Follow the links from
the homepage to Forms and Publications. You can download the form by its number.
A. FORM 1023 - APPLICATION FOR RECOGNITION OF EXEMPTION
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You must apply to the IRS for tax-exempt status by completing Form 1023: “Application for
Recognition of Exemption under Section 501(c)(3) of the Internal Revenue Code.” Because of the
comprehensiveness of Form 1023, an estate planning attorney, an attorney concentrating in taxexempt organizations, or a qualified accountant should help you complete the document. Form
1023 requests information about the foundation such as the following:
• Purpose and activities;
• Main sources of financial support;
• Plans for fund-raising, if any;
• Contact and compensation (if any) information for directors or trustees;
• Potential lobbying or political activities;
• Type of grantmaking along with any special grantmaking plans (such as providing
scholarships or making grants internationally, which will require detailed procedures);
• Current year revenue and expenditures;
• Proposed estimated budget for the next 2 years (you aren’t bound by this budget); and
• Articles of Incorporation and bylaws or trust document.
If you submit the Form 1023 within 27 months (15 month deadline subject to a 12-month automatic
extension) of the date the foundation was formally organized (i.e., the date the Articles of
Incorporation were filed or the trust was established), the foundation’s tax-exempt status will be
retroactive to the date of incorporation of the nonprofit corporation or the establishment of a trust.
If Form 1023 is filed after the 27-month period, the foundation’s tax-exempt status will begin on the
date of IRS approval. A page-by-page guide to Form 1023 is available at www.form1023help.com.
B. USER FEE FOR EXEMPT ORGANIZATION DETERMINATION LETTER
When you file Form 1023 with the IRS, you must include the proper user fee as indicated in the form.
C. IRS DETERMINATION LETTERS
Once the proper documents are filed with the IRS, you simply wait for your IRS determination letter,
which you should receive in approximately three to five months. You may be required to answer
additional questions before it is issued.
Vll. Register and Apply for Exemption with the State
Many states require charities to register with the state Attorney General’s office, in addition to
incorporation with the Secretary of State’s office. You should check the requirements of any state
where your foundation will be operating and register appropriately with the state.
After you have obtained tax-exempt status for the foundation from the IRS, you need to confirm
that the foundation is also exempt from taxes at the state level. In some states, exemption at the
federal level will automatically exempt the foundation from state income taxes. In others, the
foundation must affirmatively apply for exemption from state income taxes. Furthermore, most
states require a foundation to apply for exemption from sales and use taxes and real property taxes.
Vlll. Operate Your Private Foundation
According to the Laws
Although standard private foundations provide donors with numerous benefits, they are also
subject to several important restrictions and taxes, as described below.
Please note that this overview is just that—a review of the main rules governing
private foundations. The Exponent Philanthropy primer Legal Essentials for Small
Foundations and www.exponentphilanthropy.org offers additional information on legal
matters. Also, Exponent Philanthropy recommends that all foundations consult with legal
counsel on an ongoing basis to get answers to specific questions. Exponent Philanthropy’s
Professional Directory for Foundations lists attorneys nationwide who have been nominated
by members as being experienced in foundation work.
This section has two parts:
A. File the Appropriate Tax Forms
B. Adhere to the Main Rules Related to Private Foundations
A. FILE THE APPROPRIATE TAX FORMS
1. Form 990-PF
This is the foundation’s annual federal tax return, with detailed financial activity. If a tax deadline
passes during the time you are waiting for your tax-exempt status recognition, you must file a Form
990-PF with the Internal Revenue Service (IRS) and state authorities as if your federal tax-exempt
status had been granted.
B. ADHERE TO THE MAIN RULES RELATED TO PRIVATE FOUNDATIONS
2. Form 990-T
A foundation must file this form if it receives $1,000 or more in gross income from an unrelated
trade or business or debt-financed income.
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3. Form 8109
If annually owing more than $500 in excise tax on investment income, the foundation must file
this form with estimated quarterly tax payments. The foundation may have to make payments
electronically using the Electronic Federal Tax Payment System (EFTPS) if it meets certain threshold
requirements.
4. Possible Additional State Requirements
The federal Form 990-PF must be filed with the state of incorporation, as well as the state of your
principal office. Many states also have additional reporting requirements.
5. Employment-Related Filings
The above does not include forms filed quarterly related to employment tax withholding, retirement
fund accounts, or non-employee compensation.
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Sections 4940 through 4945 and 6104 of the Code contain rigorous rules regarding the governance
of standard private foundations and private operating foundations.
Remember: You must follow state laws as well, which are becoming more demanding in many cases.
More information on tax and legal rules is in Exponent Philanthropy’s primer, Legal Essentials for
Small Foundations, available at www.exponentphilanthropy.org.
This section has seven parts:
1. Section 4940 Excise Tax Based on Investment Income
2. Section 4941 Taxes on Self-Dealing
3. Section 4942 Taxes on Failure to Distribute Income (5% Payout)
4. Section 4943 Taxes on Excess Business Holdings
5. Section 4944 Taxes on Investments That Jeopardize Charitable Purpose
6. Section 4945 Taxes on Taxable Expenditures
7. Section 6104 Public Disclosure Rules
1. Section 4940 Excise Tax Based on Investment Income
Foundations are responsible for paying an excise tax on their investment income each year.
For tax returns filed after August 17, 2006, foundations must pay this excise tax on an expanded
list of types of investment income. See the Legislative Update page at www.exponentphilanthropy.
org for more information.
The tax is usually 2% of net investment income, though it can be reduced in certain cases to 1%.
If the annual estimated tax is expected to be $500 or more, the excise tax must be paid quarterly,
on dates set by the Code corresponding to your fiscal year.
2. Section 4941 Taxes on Self-Dealing
The basic rule is that any direct or indirect transaction between a private foundation and a disqualified
person is prohibited, unless it is permitted under a specific exception. A partial listing of disqualified
persons includes: officers, directors, trustees, substantial contributors to the foundation, an owner
of more than 20% of a business that is a substantial contributor to the foundation, and any member
of the family of any such manager, substantial contributor, or owner, including ancestors, spouses,
and direct descendents. You should check with legal counsel for a complete list of disqualified
persons. Some of the direct or indirect transactions include:
• Sale, exchange, or lease of property;
• Lending of money or extension of credit;
• Furnishing goods, services, or facilities;
• Satisfying a disqualified person’s enforceable pledge; and
• Transferring the foundation’s assets or income to a disqualified person, or use for the benefit
of such a person. (Exception: trustees/directors can be compensated for some services, and
family members can be hired as staff, if both the services performed and compensation are
necessary and reasonable.)
3. Section 4942 Taxes on Failure to Distribute Income (5% Payout)
Every year private foundations must distribute an amount equal to at least 5% of their assets for
qualified charitable purposes. Qualified charitable purposes include, but are not limited to, grants,
reasonable administrative expenses, and direct charitable activities. Expenditures made to produce
income (investment management fees, etc.) cannot be included. Legislation enacted in 2006 also
prohibits private foundations from counting grants to certain supporting organizations as part
of their 5% payout (supporting organizations are classified as 509(a)(3) public charities). See the
FAQs at www.exponentphilanthropy.org for more information.
4. Section 4943 Taxes on Excess Business Holdings
Generally, a foundation together with its disqualified person(s) cannot collectively own more than
20% of any business enterprise, whether incorporated or unincorporated. If you can satisfy the IRS
that effective control of a business enterprise is in an individual or entity other than the foundation
and its disqualified persons, a 35% limit may be substituted for the 20% limit.
5. Section 4944 Taxes on Investments That Jeopardize Charitable Purpose
A foundation may not invest either its income or principal in a manner that may jeopardize its ability
to carry out its charitable purpose. No specific investments or investment policies are per se prohibited under this statute; trustees and directors must make prudent decisions about the foundation’s
investments.
6. Section 4945 Taxes on Taxable Expenditures
Foundations are liable for taxes on certain expenditures that are 1) prohibited; or 2) in an IRS-specified area without following the respective IRS rules. These are called taxable expenditures.
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The following are prohibited:
• Non-charitable expenditures;
• Influencing public elections; and
• Lobbying.
• The following grants require special steps to be compliant:
• Grants to individuals;
• U.S. or foreign organizations that are not public charities;
• Grants to certain supporting organizations; supporting organizations are classified as 509(a)
(3) public charities;
• Voter registration; and
• Public policy or advocacy efforts.
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Note: The law allows foundations considerable leeway in this area, however. See Exponent
Philanthropy’s primer Funding and Engaging in Advocacy.
7. Section 6104 Public Disclosure Rules
Private foundations are required to make the following information accessible for public inspection
upon request:
• The foundation’s three most recent years’ Forms 990-PF (including names and addresses of
contributors and trustees of the foundation);
• The foundation’s initial IRS Form 1023 (application for tax-exempt status) and all related
correspondence; and
• The foundation’s three most recent years’ Form 990-T (unrelated business income tax
return), if any.
More information on public disclosure rules for foundations, including how you can use the Web
to fulfill disclosure responsibilities, is in Exponent Philanthropy’s primer, Keeping Good Records:
Small Foundations’ Guide to Staying Organized, available at www.exponentphilanthropy.org.
lX. Conclusion
Private foundations, if operated correctly, can provide significant benefits to individuals, families
and companies. They provide tax benefits to taxpayers and enable them to build a long-lasting
tradition of charitable giving. For more information about resources that can assist you in starting
your foundation, please contact the staff at Exponent Philanthropy, at either
info@exponentphilanthropy.org or 202-580-6560.
Exponent Philanthropy is a vibrant membership organization that provides
resources and valuable connections to help thousands of philanthropists with few
or no staff make the most of the minutes they have and the dollars they give.
Exponent Philanthropy
1720 N Street, NW
Washington, DC 20036
Phone: 202-580-6560 Fax: 202-580-6579
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How to Start a Private Foundation PRIMER SERIES TAX AND LEGAL

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