© 2016 Joan E. Emery
There are various “rules of thumb” regarding the amount of assets to be transferred for charitable purposes which justify creating a private foundation. Some advisors recommend that at least $1 million be transferred to the private foundation, some recommend $5 million, and others recommend $10 million. These rules of thumb have evolved because establishing and maintaining a private foundation involves fairly significant expenditures of time and money. The time involved centers around creating the foundation, doing the work necessary to make annual gifts from the foundation, and keeping the foundation current regarding all state and federal administrative requirements. Aside from the actual asset transfers to the foundation, the cost involved revolves around the legal, accounting, and other administrative costs required to keep the foundation current with all state and federal requirements. In addition, if the foundation is terminated, there are additional financial and time costs associated with that termination. In contrast, establishing and maintaining a donor advised fund involves some time and usually minimal additional financial expense (other than the assets donated to the donor advised fund). Additionally, once the assets are transferred to the donor advised fund, the assets become the property of the sponsoring organization and there are generally no termination costs associated with the termination of the donor’s involvement in the donor advised fund.
Additionally, donor advised funds have certain federal income tax advantages which private foundations do not have. Some of the federal income tax advantages of donor advised funds are 1) no excise tax on investment income, 2) a higher percentage deduction for gifts of cash, 3) a higher percentage deduction for gifts of stock or real estate, 4) the fair market value (rather than the cost basis) of certain privately held assets is used to determine the amount of the gift, and 5) no minimum annual distribution requirement. These donor advised fund federal income tax advantages are not enormous, but they are certainly relevant in weighing the merits of each option.
In spite of the reduced administrative costs, the lesser time commitment, and the federal tax advantages of donor advised funds, there are reasons to choose a private foundation instead of a donor advised fund. One of the key reasons to choose a private foundation is the greater involvement the donor can have in the continuing administration of the gift. If the donor is interested in being significantly involved in the administration of the gift, then the greater financial and time costs and some moderate federal tax disadvantages associated with a private foundation may be outweighed by greater degree of involvement the donor has regarding a gift made to a private foundation. Those who administer a private foundation (usually the donor and his or her family) have the maximum amount of involvement and discretion permitted by the Internal Revenue Code in the decisions regarding how, when, whom, and in what amounts distributions for charitable purposes will be made by the foundation. In contrast, when a donor advised fund is created, the donor’s involvement in the specifics of the distributions for charitable purposes is limited to an advisory role. The donor can make recommendations, but the ultimate decisions regarding charitable distributions are in the hands of the sponsoring organization.
Some years ago, a gentleman came to me asking for help to establish a private foundation. When I asked him why he wanted to do so, he stated that he had set up a donor advised fund at a Chicago-based sponsoring organization and when he told the organization that he wanted them to make a contribution which supported stem cell research, the supporting organization told him that they would not make such a donation because the organization did not permit donations which supported stem cell research. Upset and frustrated that the funds he donated would not be used as he requested, the gentlemen made no further donations to the donor advised fund. Instead, he chose to set up a private foundation which could make donations to support stem cell research. His problem probably could have been avoided if he had chosen to have a meeting with a representative of the sponsoring organization before he created the donor advised fund. At that meeting, he could have asked if there were any categories of charitable donations which were outside the mission of the sponsoring organization, but he did not do that. Ultimately, a private foundation gave him the maximum flexibility permitted by law in determining how, when, whom, and in what amounts distributions were made for charitable purposes.
I am an attorney practicing in the Chicago area.