Private Foundations – The Best Laid Plans? – Part 2

May 10, 2012

In my last post, I addressed why private foundations are appealing to many donors who want to formalize or advance their personal philanthropy.  What many donors don’t consider before creating one, however, are the costs that come with this seemingly flexible solution.  These unanticipated costs lead many private foundations to fail over time.

Here are three common reasons why:

1.    Inability to address a private foundation’s administrative burdens.  People who form private foundations are often surprised by the administrative tasks required to establish and operate a private foundation.  They must file certain documents with the state and IRS when forming the foundation.  They must segregate the foundation’s assets from their own and invest them.  They must file tax returns annually and comply with other IRS requirements when making grants to other charitable organizations.  They must comply with the restrictions against private inurement, private benefit, and self dealing.

Failure to comply with the rules can result in action by the state’s attorney general or the IRS, including losing a private foundation’s tax exempt status.  Several companies provide these administrative services to private foundations for a fee.  In June 2011, however, 275,000 nonprofit organizations lost their federal tax exempt status for failure to file legally required documents with the IRS for three consecutive years.

2.    The next generation has different abilities or priorities.  Although families form private foundations as a way to promote family giving, the needs of the family and purpose in their giving often change or diverge over time.  For example:

•    Areas of interest change – where Mom and Dad were interested in health care, the children are interested in the arts and the environment.
•    Family members move – where Mom and Dad were interested in supporting local charities, the children do not feel the same connection to the place or are more interested in supporting causes elsewhere.
•    Children don’t have the time or energy to spend on private foundation matters due to jobs, a new family or other obligations.
•    Children lack the ability or are simply not interested in managing the administrative burdens required to ensure the tax exempt status of the family’s private foundation.

Private foundations are often dissolved and their assets distributed to a donor advised fund, supporting organization or public charity after the first or second generation.

3.    Cost of administration reduces the impact made on the cause.  While there are over 100,000 private foundations, based upon IRS filings, more than 65% have less than $1 million in assets and more than 90% have less than $10 million.  Costs of administration reduce the ability of a private foundation to meet its main objective, namely providing funds to a particular need.  Accordingly, private foundation boards often decide to dissolve and distribute the assets to achieve greater impact.

Thanks for reading,
Don
Don Gottesman is a senior development officer at the California Community Foundation

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