By Don Wilkinson
DFW & Associates

More affluent Americans are finding that setting up a family foundation for themselves and their families is an ideal way to give funds to charitable causes while making those funds exempt from federal income tax. Moreover, family members can work toward common goals, and instill the value of charitable giving in future generations.

The giving vehicle of a family foundation, which provides full family control, allows for extensive benefits to families who give over $25,000 a year to charity.

The family foundation, with the same characteristics as a private foundation, is a foundation whose board consists of family members of the person who originally funded the foundation. The board of a foundation has ultimate control over its actions. It can choose an investment manager, grant recipients, hire and fire staff, etc. Many families set up a foundation specifically to involve their family in their grant making. Being involved in the foundation can be an excellent way to educate younger family members about asset management, taxes, responsibility, and family values. However, a family foundation can also be set up with only a single board member.

Unlike public charities, which generally derive their funding or support primarily from the general public, and receive grants from individuals, government, and private foundations, the family foundation does not solicit funds from the public. Funding of charitable cause is derived from family resources usually under law of dispensing a minimum of 5% of the foundation's assets annually.

Tax Benefits

Since a family foundation is a charitable organization, it is exempt from federal income tax on its income, although it must pay a 1-to-2 percent excise tax on its net investment income. The gifts made to establish a new foundation or grow an existing foundation can offer the family certain tax advantages: income, gift and estate tax deductions are available under the law.

When making a gift of cash to a family foundation, a foundation principal can take an income tax deduction in the year of the gift. The amount of the deduction claimed can be as much as 30% of the foundation's principal adjusted gross income (donations in excess of this limit can be carried forward for five years).

If the principal donates appreciated stock that is owned for at least one year, the income tax deduction will be equal to the fair market value of the stock. The amount of the deduction claimed for a gift of stock can be as much as 20% of the principal's adjusted gross income (with the same provision to carry forward excess deductions for five years).

In addition to the income tax deduction for a gift of stock, the principal also avoids paying capital gains tax on any appreciation. Donations of assets other than publicly traded stock (such as real estate) are only tax deductible at cost basis, not the fair market value. However, the foundation's principal does avoid paying capital gains tax on any type of asset contributed to a foundation.

Setting Up The Foundation

Until recently, private foundations were expensive and time consuming. Today, a number of private foundation "administrators" are utilizing Internet technology to drastically reduce the time and expense of setting up a foundation. A foundation can now be set up for less than $50,000 in a matter of days. These administrators handle all of the operations of the foundation including check writing, compliance, record keeping, tax filing and administration.

The fees for these services depend on the size of the foundation, but generally come to less than 1% of foundation assets when the foundation is larger than $1 million. Foundations with lower asset levels generally find that their expenses run from 1-2% of assets. All foundation related fees are paid by the foundation, not by the donor.

An alternative to engaging a specialized administrator is for a member of the family foundation to handle the record keeping and pay an accountant to file the foundation's tax return. Because tax returns to the IRS differ from traditional charitable donations, it's best to have a tax attorney or CPA on the foundation team if hiring a specialized administrator is not desirable. The foundation can pay family members salaries to manage the foundation. This is one of the few ways available for family members to take money out of the foundation.

Private Foundations At A Glance