How Private Foundations Work

By Dale K. Geeslin, CPA, CFE

Many have heard of private foundations in the context of rich people coming up with an elaborate scheme used to shelter millions from taxes. Private foundations are covered in the Internal Revenue Code and are essentially a privately funded charitable organization set up to hold donated assets until those assets are redistributed to public supported charities or used to make grants to other organizations. It has less beneficial tax treatment and more rules with which to comply than a public charity because it is not directly supported by and operated for the good of the public. A private foundation can file an application with the IRS to be treated as a qualified charitable organization so that donors can deduct contributions. This application is voluminous and requires both quantitative and qualitative disclosures and also has a user fee of up to $850 just for the IRS to review it. A common type of foundation is the family foundation which funds other charitable organizations but typically does not carry out charitable activities itself. Family foundations do not normally raise funds through solicitations or grants but are funded by a single multi-generational family.

Private foundations are more restricted and transparent than public charities. There are restrictions on self-dealing with substantial contributors as well as limits on holdings in private businesses. There are requirements for annual distributions of income for charitable purposes, limitations on investments that may jeopardize the carrying out of exempt purposes and provisions to assure expenditures further exempt purposes. A private foundation must make its annual tax return and exemption application available for public inspection and, unlike other tax-exempt organizations, must disclose the names and addresses of its contributors. If any of these restrictions or requirements is violated, the private foundation can be subject to excise taxes as well as loss of its tax-exempt status.