Private foundation trustees and staff oversee countless activities, from setting direction and selecting grantees to reviewing policies and investing assets. Several foundation tasks—some mandatory, some voluntary—call for additional care.
All are worth your careful consideration to help you be financially savvy and legally compliant, and to help you take full advantage of your foundation’s flexibility.
Reducing your excise tax
Foundations must pay a small excise tax on net investment income each year. The tax is currently 2% of net investment income minus certain expenses, although it is possible to qualify for a 1% rate if, generally speaking, your current year’s expenditures exceed by 1% of net investment income your average expenditures over the past 5 years.
It is difficult for private foundations to qualify for the reduced rate every year without forever increasing their payout rates and depleting their assets, but many foundations miss the opportunity every few years. To see if a small increase in distributions would qualify you for the 1% rate, be sure to calculate your qualifying distributions a month or two before the year’s end. Some foundations accelerate their distributions to qualify.
Engaging in transactions with foundation insiders
Self-dealing rules prevent private foundations from entering into a broad range of transactions with foundation insiders, known as disqualified persons, unless specific exceptions apply. No topic within the private foundation rules raises as many questions and concerns as self-dealing, because the rules can be counterintuitive and the penalties steep.
To avoid self-dealing in all cases, be sure to understand the rules and take care when hiring or leasing space from foundation insiders, inviting guests to galas or fundraisers, paying personal pledges, compensating trustees and staff, and paying for family travel with foundation funds—activities that lend themselves easily to self-dealing. Consult knowledgeable legal counsel before engaging in any transactions with insiders.
See Exponent Philanthropy’s publication How to Avoid Self-Dealing >>
Choosing alternative investments
A relatively new class of investments, known as alternative assets or alternatives, has become an increasingly popular way to address limitations in traditional equities and fixed income securities.
Alternatives offer a range of risk, return, and diversity and encompass a wide array of products, including hedge, private equity, real estate, venture capital, and commodity funds, and funds of funds. They may be limited partnerships, limited liability corporations, regular corporations, or trusts.
Before investing in alternatives, be sure to:
- Determine whether the investment is consistent with your investment policy.
- Determine whether any limitations on withdrawals create the potential for liquidity problems.
- Determine whether the investment will generate unrelated business income, which may trigger a tax at corporate rates, a requirement to file Form 990-T, or filing obligations in multiple states.
- Determine whether the investment will generate U.S. filings for transactions with a foreign investment vehicle or require other annual disclosures (e.g., Report of Foreign Bank and Financial Accounts [FBAR]).
- Have legal counsel review offering information.
- Meet face-to-face with the investment firm’s management team and look for reputable third-party information on the fund and its managers.
Filing your Form 990-PF
The Form 990-PF is a complex, public document filed annually with the IRS that can stump even savvy accountants. Regulators conservatively estimate that at least 25%of 990-PFs have errors, yet foundation managers and their accountants can easily avoid mistakes if they know what to look for.
For dozens of tips and a complete sample Form 990-PF, see Exponent Philanthropy’s publication Filing the Form 990-PF >>
Making international grants
Private foundations may give directly to non-U.S. organizations for charitable purposes by making an equivalency determination or exercising expenditure responsibility. Foundations that give internationally (as well as domestically) must also comply with antiterrorism rules.
An alternative to giving directly overseas, grants to U.S.-based intermediaries that have networks in foreign locations may reduce a foundation’s due diligence. Although simpler, this option may limit a foundation’s opportunity for direct contact with the beneficiaries of its grants.
Making grants to supporting organizations
Supporting organizations are not publicly supported, but rather are closely associated with publicly supported charities. Examples include some university or hospital foundations, foundations created to support libraries or elementary schools, or personal trusts created to benefit particular public charities.
Private foundations may make grants to supporting organizations (also known as 509(a)(3) public charities), but grants to certain types of supporting organizations may require expenditure responsibility and/or may not count as qualifying distributions.
Making program related investments (PRIs)
PRIs are loans, loan guarantees, or other investments to charitable or for-profit entities that count toward a foundation’s distribution requirement if they serve a charitable purpose and meet a few basic requirements.
Although foundations can make PRIs through reputable intermediaries without much more diligence than a typical grant, making PRIs directly requires additional care, including:
- Structuring the PRI so that profit is not its primary purpose
- Confirming, with help of an attorney, that the PRI serves a charitable purpose
- Complying with expenditure responsibility if the PRI is made to a non-501(c)(3) public charity
- Monitoring the PRI’s progress, perhaps more intensely than for a typical grant; intervening in the event of problems; and, if necessary, exiting without serious consequences for the recipient
- Reporting the PRI appropriately on your Form 990-PF
Making grants to non-501(c)(3) public charities
Private foundations may make grants for charitable purposes to domestic organizations without 501(c)(3) public charity status, including the Rotary, trade associations, labor unions, chambers of commerce, and even for-profit entities, but the foundation must exercise expenditure responsibility (see below) for the grants to count toward the foundation’s 5% payout. Grants to other private foundations are permitted as well, although grants to private non-operating foundations require more than just expenditure responsibility to count toward the foundation’s 5% payout.
Making large grants to small organizations
By causing a grantee to fail its public support test, particularly large grants can tip a grantee out of its favored public charity status into private foundation status—a change most public charities want to avoid. It is critical to understand how to avoid tipping while still allowing your grantees to realize the benefits of a large grant.
Making grants to a fiscal sponsor
Rather than exercise expenditure responsibility when funding organizations or projects that do not have public charity status, private foundations may choose to fund fiscal sponsors with public charity status. In theory, fiscal sponsorships are relatively simple: A fiscal sponsor retains legal control and discretion over the funds it receives on behalf of the sponsored organization or project. In practice, however, grants to fiscal sponsors require special care. Foundations cannot earmark grants to fiscal sponsors for organizations or projects. Be sure to seek knowledgeable legal counsel before entering such arrangements.