Private Foundation Essentials

Private foundations offer unique opportunities for individuals and families to pursue charitable goals and make a transformational impact on communities. Private foundations also may offer donors attractive tax benefits and a level of control, although there are legal and regulatory requirements and specific responsibilities. This article addresses some common areas for prospective donors about private foundations.

What is a private foundation?

A private foundation is tax-exempt charitable organization that can be set up as a charitable trust or nonprofit corporation under applicable state law. A private foundation is funded by one or a few donors, and donors may receive a tax deduction for their contributions.

There are two types of private foundations:

• Operating foundations carry out their own charitable activities, such as a land reserve, research center or museum. However, most private foundations are nonoperating. While they may conduct their own charitable work, their primary focus is making grants that support other qualified charitable organizations.
• Nonoperating private foundations must comply with IRS rules to demonstrate they are actively engaged in fulfilling a charitable purpose. Among other things, a private foundation must make a minimum annual distribution of roughly 5% of the average value of its noncharitable assets. Distributions that count toward this requirement include grants to charities, related charitable activities and expenses, and necessary and reasonable administrative costs that advance the foundation’s charitable mission.

Federal tax exemptions and savings

While each person’s tax situation is unique, foundation donors typically can realize significant federal tax savings, including:

• Income tax deduction for contributions to their private foundation up to 30% of adjusted gross income for cash contributions and 20% for contributions of most long-term appreciated assets.
• Capital gains tax savings by contributing highly appreciated public securities to their foundation. In addition to the donor receiving an income tax deduction for the fair market value of the stock, the foundation will pay only a nominal excise tax on the net capital gains if it sells the stock in the future.
• Assets contributed to a private foundation generally are excluded from the donor’s estate and not subject to federal or state estate taxes.

Benefits of a private foundation

The IRS provides tax incentives for individuals and families who want to engage in charitable giving through a private foundation. Whether used alone or in combination with other charitable vehicles as part of a comprehensive philanthropic plan, a private foundation can offer significant qualitative benefits to its donors.

Creating a legacy

Establishing a private foundation can help donors begin a tradition of giving that extends far beyond their lifetime, linking their name — or that of someone they want to honor — to a set of personal values and good works.

Maximizing control

Private foundations provide control over many aspects of giving. Donors decide the name of the foundation and whether they want to make it an individual or family affair; who sits on the board; which charities to support; the form and frequency of grantmaking; and whether the foundation will continue in perpetuity, terminate upon death or “sunset” on a specific date. It is important to work with a trusted investment partner or advisor that offers a wide range of advisory and administrative services, such as customized financial reporting and auditing, charitable trust administration and donor reporting, among others, to support the organization’s staff and advisors.

Donors also retain control over how foundation assets are prudently invested. That can be especially significant for individuals and families who want to leverage their foundation’s investment portfolio to generate both positive impact and competitive financial returns. The Glenmede relationship team can help customize mission-aligned portfolios to tilt toward socially responsible companies and investments intended to drive systemic change.

Optimizing philanthropic objectives

Private foundations can be combined with other tax-advantaged philanthropic vehicles such as donor-advised funds (DAFs) and charitable remainder or lead trusts to optimize philanthropic objectives. It is increasingly common for private foundations and foundation trustees to establish DAF accounts as a complementary strategy that can serve multiple purposes. For more information, see Top 5 Advantages of Donor-Advised Funds for Charitable Giving.

Involving family for next-generation engagement

While it might not be an option for every donor, involving partners, children and other family members in the private foundation offers several potential benefits. It can establish a tradition of shared service and common purpose grounded in core family values — a legacy that can be passed from one generation to the next. As a practical matter, engaging next-generation family members in the foundation’s work can prepare them to assume the responsibilities that come with inherited wealth and develop the leadership skills they will need as future trustees. The foundation can benefit as well, as the energy and fresh perspectives of the next generation can push the enterprise to identify and adapt to emerging trends and opportunities.

Planning a foundation

Given the potential benefits of a private foundation, and after consulting with the individual’s or family’s advisors, the next step is planning to bring the foundation’s vision to life. Following are some of the most common questions about the planning process.

What is the best legal structure for a foundation?

A private foundation can be established as either a trust or not-for-profit corporation under state law. While a trust generally has fewer requirements for record keeping, annual filings and setup, it is also a more formal organizational structure that may require a court order if donors want to make any changes once it is established. A corporation may be more flexible and provide more legal protection for its officers but typically requires more paperwork. Consult with an estate or tax attorney who handles foundations and other tax-exempt organizations to determine which structure is appropriate, and be sure to understand all state and local filing requirements, including state income and sales tax exemptions as well as local business registration.

How is the foundation funded?

Once the legal entity is set up, donors can contribute a variety of assets to the foundation, including cash, publicly traded securities, real estate and private assets. There are certain restrictions on business assets that a foundation may hold, so a tax attorney can help determine which assets are appropriate for funding the foundation.

Should the foundation last forever or have an end date?

Foundations can be set up to exist in perpetuity, end at a finite date (commonly referred to as “sunsetting”) or have a time frame determined by the trustees. The desired time horizon may depend on donors’ objectives.

• Do you want your charitable giving to continue after you are gone? Do you want your foundation to be an ongoing legacy that passes from one generation to the next?
• Do your philanthropic objectives lend themselves to short- and/or long-term investing?
• Will board members be prepared to balance current and future charitable needs while ensuring the foundation maintains sufficient assets in perpetuity?
• Do you want future generations to have discretion over setting their own objectives and philanthropic priorities?
• Is your family and/or board committed to supporting the foundation in perpetuity by ensuring continuity of leadership, governance, decision-making and procedures? Will you have a succession plan in place?

What does the foundation board look like?

Since the board is responsible for governance and oversight of all the foundation’s activities, board members should be passionate about the foundation’s philanthropic mission and be willing to commit the time and energy required to be responsible stewards of its assets. It is best practice to establish a job description that clearly outlines the duties and time commitments of foundation board members and trustees. A family foundation board typically includes the donor(s) and other family members, with non-family members added for independence, expertise or community representation. For example, if the foundation has a specific geographic or philanthropic focus, having board members with knowledge in that area may be appropriate.

Should family be involved in the foundation?

Bringing family into the foundation can be an enriching experience. However, it is not mandatory, nor is it the right choice for everyone. It is helpful to consider why family members might be involved. Do they share your passion for the foundation’s charitable mission or have useful expertise? Is there a benefit to younger members becoming responsible stewards of family wealth or to passing on philanthropic values to the next generation?

Consider whether family members genuinely want to participate and have the time to do so. Also, do not discount family members who show little to no interest today in the foundation. Those same family members could be an integral part of the foundation in the future as their interests evolve and careers or family status allow for more time to devote to philanthropy.

Does the foundation need to have a specific focus?

The foundation can function without a focus, but the most effective foundations approach philanthropy with intention. As a donor, choosing a focus is important in achieving more impact with giving. Taking the time now to find that focus can help clarify what donors want the foundation to achieve. Use resources wisely, measure progress, learn together with trustees and advisors and move closer to the donors’ philanthropic goals.

Consider asking board members to help define the focus. Working together to refine the foundation’s focus and identify shared values is a great way to create common purpose, build team cohesion and start the foundation off on the right foot. Consider a get-together to identify shared values and passions. Even individuals with outwardly polarized views can hold similar values, and once found, these shared values can lead to identifying a charitable focus for the foundation’s work.

Does the foundation need a mission statement?

Think of the foundation’s mission statement as its North Star. A brief mission statement codifies intentions, sets forth what the foundation means to accomplish and provides direction for all its activities, especially grantmaking. The mission statement not only guides the board but also serves as an external statement of purpose to potential grantees, partners and the community at large. The mission statement can be just a sentence or two. It should answer why the foundation exists, whom it serves and what a successful outcome looks like.

Building a strong foundation

As an investment and advisory services provider to foundations of all types, we frequently guide donors and boards in developing and maintaining sound policies and practices. Every foundation is unique, and establishing best practices for each begins with the manner and jurisdiction in which the foundation was formed as well as the expectations and capacities of donors, board members and staff.

That said, there are some responsibilities common to all private foundations:

• Board governance
• Grantmaking
• Financial and investment oversight
• Tax, legal and regulatory compliance
• Administration

Following is an overview of each area, including actions donors and board members might consider taking, and suggestions for some best practices.

Board governance

Having an effective board is one of the best predictors of a successful foundation, and good governance creates the foundation for an effective board. Board members generally owe fiduciary duties of care, loyalty and obedience to the foundation they serve.

• Duty of care. Board members must exercise “reasonable care” when making decisions for the organization. As a practical matter, the duty of care requires board members to be familiar with all laws, facts and information necessary to make an informed decision.
• Duty of loyalty. Each member must act in the best interests of the organization with undivided allegiance and never use information or exert influence gained through their position for personal gain.
• Duty of obedience. Board member must be faithful to the organization’s mission and conduct themselves in a manner consistent with that mission. Decisions should be grounded in the organization’s founding documents, bylaws and governance policies and procedures.

The concept of stewardship is central to everything the nonprofit board does. As stewards of the foundation’s mission and assets, board members are responsible for overseeing — and in some cases, carrying out — all foundation activities. The board’s chief task is to establish the policies and procedures governing these activities. To be effective, the board must govern itself and make provisions to ensure continuity of leadership and decision-making for the duration of the foundation’s lifecycle, be it finite or in perpetuity.

In our experience, good governance practices not only help members be responsible stewards of the assets they oversee but also establish a strategic decision-making and administrative framework that keeps the organization moving forward in service of its mission. For more information, please see Nonprofit Board Governance Essentials, a more comprehensive treatment of board governance responsibilities and best practices, and Foundation Governance Annual Review, a checklist designed to assist foundation boards in managing key policies, procedures and filing requirements.

Grantmaking

Grantmaking is the primary work of most private foundations. Successful grantmaking is directly related to how focused the foundation is on its mission. A concise mission statement can help board members connect the dots between the foundation’s values, its grantmaking approach and how it defines success. Having grantmaking policies and procedures in place streamlines the grantmaking process, freeing up the board to focus on potential grantees and decision-making.

Foundations may use a theory of change to help evaluate grantmaking programs. Theory of change is basically a “road map” outlining “how a program will work to change outcomes and deliver impact and identifies the key assumptions of the program and risks to successful implementation.” Applying this thought process could help a foundation focus on its data collection activities, grantmaking implementation and impact.¹

In our experience, the best foundations adapt their grantmaking strategies over time to address new needs and incorporate new ways to advance their missions. Glenmede works closely with foundation donors and boards to identify and customize the right approach for their organization’s style and mission. Below are basic options foundations should consider:

• SOLICITATION: By invitation, open or both. Some foundations issue open grant solicitations, putting the onus on grantees to find them. Others seek out likely grantees and invite them to submit a proposal or provide funding based on their knowledge and relationship with the grantee. Many prefer a blended approach.
• SCOPE: Geography, target population or single issue. Will the foundation consider making grants only in a certain geographic region or area of philanthropic interest, or for a specific issue? For example, the foundation might decide to make grants solely for projects in its hometown, county or state. Alternatively, it could decide only to fund nonprofits in the performing arts or charities that work directly with the homeless.
• TYPES OF GRANTS: Restricted, unrestricted or both. Restricted, or project, grants provide support for a specific undertaking or activity. Unrestricted grants allow the grantee to determine how to best use the funds in carrying out its charitable activities. Let the foundation’s mission be a guide when deciding whether one or both approaches are right for the foundation.
• FREQUENCY: One-time, ongoing or both. Some foundations limit their grantmaking to one per grantee, preferring to cast a wide net and fund as many new ideas and organizations as possible. Others prefer to foster ongoing relationships with grantee organizations that can benefit from a steady source of support. As with all grantmaking strategies, the mission can help decide if and how grant availability is limited.
• DISCRETIONARY GRANTS: Some foundations set aside a portion of their funds for family and/or board members to make grants to organizations they select, so-called “discretionary grantmaking.” As long as the grant supports the foundation’s charitable purpose and advances its mission, it can be a good way to keep key individuals engaged, incubate new ideas or charitable organizations and introduce younger family members to individual philanthropy.

Grants are just one way to advance a foundation’s mission. Foundation board members can donate their time and experience to charitable organizations or become involved in mission-aligned community activities. There are also investment strategies that can extend the foundation’s mission and impact.

Grantmaking best practices

A private foundation should have clear grantmaking policies and procedures for evaluating potential grantees. Private foundations should conduct due diligence on proposed grantees, including potential discretionary grantees, to ensure the grant will be used for a charitable purpose and the grantee is an existing public charity. If the foundation wants to make a grant to an organization that is not a public charity, the foundation must follow an IRS-mandated enhanced due diligence process called expenditure responsibility, which the foundation should discuss with its advisors.

Making an impact

In our experience working with individual and family foundations, the boards that experience the most fulfillment from grantmaking are the ones that
focus on the foundation’s values, are clear about the foundation’s mission and share an understanding of what success looks like. Consider ways to connect grantmaking with the desired impact. Maybe that takes the form of engaging with the community, seeing next-generation family members assume leadership positions or realizing a mission-aligned program goal. Whatever it may be, when a foundation board is able to connect the dots between the grantmaking process and its values, they can point to the impact they made and say, “We did that, and that’s exactly what we’re here for.”

Financial and investment oversight

Board members have a fiduciary duty to be responsible stewards of the foundation’s assets. They must ensure the foundation maintains adequate financial resources to advance its mission; oversee and monitor investment assets; maintain a current investment policy statement (IPS); provide budgeting, accounting and financial oversight; and make grantmaking and spending decisions, including creating written policies and procedures for both. Because private foundation assets have unique investment requirements, board members generally delegate the day-to-day investment responsibility to professional managers.

Investment Policy Statement

The IPS outlines the investment policies that will determine how foundation assets are invested, and its importance cannot be overstated. As the detailed roadmap for how foundation assets will be invested, it helps boards stay focused on oversight, governance and strategy-related activities by:

• Memorializing the investment philosophy and goals.
• Aligning the investment strategy with the organization’s mission, time horizon and short-term distribution and spending needs.
• Defining roles and responsibilities of board members, including executive management and investment managers.

Investment assets must support the foundation’s mission throughout its lifespan, be it in perpetuity or finite, and meet annual distribution and spending needs. Investment market turns and unanticipated changes in cash flow or the foundation’s time horizon can throw the current investment policy out of alignment with long- and short-term investment objectives. The board should review the IPS at least annually to confirm if the current investment policy supports the foundation’s objectives and make tactical or strategic allocation adjustments as necessary to sustain the organization going forward. (For more information, see Nonprofit and Foundation Investment Policy Statement Essentials.)

In response to increased regulatory scrutiny and because the IRS can impose severe sanctions on foundations that engage in self-dealing, private foundations should have a formal conflict of interest policy that includes specific steps for identifying, disclosing and avoiding potential conflicts among board members, trustees, directors and staff. Since conflicts often touch on areas of investment and financial oversight, it makes sense to include the policy statement in the IPS.

Using foundation assets to extend charitable impact through mission-aligned investing

Investment assets could be a way for a private foundation to advance its mission and make an impact beyond grantmaking. There are several ways to help align investments with mission and values. In addition to putting more of the foundation’s assets to work in direct service of its mission, many of these strategies have the potential to generate positive returns over time, increasing the asset pool available to make grants. Glenmede’s team of endowment and foundation experts often provides tutorials and educational programs for foundation boards interested in exploring these and other investment topics.

Mission-aligned investment value statements should be included in a foundation’s IPS, if applicable. Identify the specific approaches to be used, including relevant criteria, advocacy, public policy or other guidelines for choosing preferred assets and determining permitted or prohibited investments.

Create a whistleblower protection policy

A whistleblower protection policy outlines the confidential procedures that staff, employees and volunteers can follow to report suspected financial impropriety, misuse of the organization’s resources or other complaints about financial practices. It also sends a signal to staff, volunteers, board members, grantees and the community at large that your foundation values transparency and accountability.

Self-dealing/conflict of interest²

There are strict federal regulations surrounding self-dealing/conflict of interest for charitable organizations. According to the IRS, a conflict of interest occurs “where individuals’ obligation to further the organization’s charitable purposes is at odds with their own financial interests.” A conflict of interest could arise, for example, when hiring family members or making a grant to a charity run by a board member’s child. The IRS urges organizations to adopt a conflict of interest policy as a way to establish procedures that will offer protection against charges of impropriety involving officers, directors or trustees.

A conflict of interest policy is intended to help ensure that when actual or potential conflicts of interest arise, the foundation has a process in place under which the affected individual will advise the governing body about the relevant facts concerning the situation. A conflict of interest policy is also intended to establish procedures under which individuals who have a conflict of interest will be excused from voting on such matters.

There may be legal consequences for boards that fail to recognize a conflict of interest, and organizations could lose their tax-exempt status unless they operate in a manner consistent with their charitable purposes. For example, paying an individual in a position of substantial authority excessive compensation serves a private interest. Providing facilities, goods or services to an individual in a position of substantial authority also serves a private interest unless the benefits are part of a reasonable compensation arrangement or available to the public on equal terms and conditions.

Tax, legal and regulatory compliance

A board member’s fiduciary duty of care requires awareness of and compliance with all applicable federal and state filing, reporting, distribution and other requirements, as well as any other laws and regulations relating to the private foundation’s activities. The regulatory and legal environment can also affect policy, particularly in areas touching on the foundation’s investments and finances.

In the most extreme cases, failure to comply with federal and state requirements can carry civil and criminal penalties and trigger additional excise taxes and loss of the foundation’s tax-exempt status. But for most private foundations, compliance with all applicable laws and requirements helps the board protect its most valuable commodity — the foundation’s reputation and public standing with grantees and the communities it serves.

For specific legal and tax advice, consult with your organization’s attorney and accountant.

Administration

Whether the foundation has one part-time volunteer or a paid staff operating under the leadership of an executive director, it still must deal with the day-to-day realities of supporting a safe and productive work environment. Clear policies and procedures can help keep things running smoothly. For example, maintain a record retention and destruction policy and review it annually. Include paper or electronic files with relevant documentation, including governing documents and bylaws; IRS tax exemption documentation, Form 1023, Form SS-4, IRS Determination Letter and other official correspondence; policies; meeting minutes; resolutions; filed tax and legal forms; and grant information. Update after each meeting or as appropriate.
Foundations may want to take advantage of grant management software applications. The software can help track fundraising, save time and automate the grantwriting, submission and review processes. The software also helps foundations comply with regulations during the grant management cycle.

One area of increasing concern is technology and data security. Given how quickly technology, digital platforms and related vulnerabilities evolve, technology policies and cybersecurity protocols should be reviewed frequently. Assess technology needs, including foundation email, website, antivirus and spam filter software; digital/social media accounts; system administration and security protocols; personal information and data protection;
and cybersecurity.

Conclusion

A robust private foundation is always a work in progress. Donors and boards learn to remain flexible, evolving over time while staying focused on a charitable mission rooted in foundational values. The idea of establishing a private foundation may seem overwhelming at first, but once it is in place, engaging
in its work can be a deeply rewarding experience for donors, family members and the board. A family foundation can be a wonderful way to connect multiple generations in a common cause and create an enduring legacy that can extend in perpetuity.

If you are interested in learning more about comprehensive philanthropic planning or exploring whether a private foundation is appropriate for you and your family, please contact EFSolutions@Glenmede.com or reach out to your Glenmede Relationship Manager.