September 1999



By Scott Blakesley

Family foundations, also referred to as private foundations, are useful vehicles for establishing and maintaining a long-term program of charitable giving, while at the same time yielding certain income tax benefits.

What Is a Private Foundation and Who Would Want One?

A private foundation is a tax-exempt organization controlled by the founder or members of the founder's family. The founder and family members can make charitable contributions to the foundation during their lifetimes or at death. The foundation will then make distributions for religious, charitable, scientific, literary or educational purposes. Within these general parameters, the instrument creating the foundation can further limit the purposes for which distributions may be made.

Many individuals establish private foundations because they wish to benefit society by supporting religious or charitable endeavors. Rather than make gifts directly to these organizations, individuals can choose to establish private foundations, which permit the donor to take a charitable deduction for income tax purposes in the year the contribution is made, while deferring the determination regarding where the donation will go.

The foundation also serves as a way for family members to participate together in a worthwhile endeavor, fosters an interest in charitable activity in future generations, and educates family members on investment alternatives.

Utilizing a foundation as the recipient of a portion of an estate at death also will reduce the estate taxes otherwise payable to the government. This may be particularly useful if the children will otherwise have sufficient assets for their support, and there is a desire that some of the assets be managed for charitable

How Is a Private Foundation Established?

A private foundation may be established as a trust or a corporation. Most people find that a trust is easier to administer than a corporation because trusts do not need to observe corporate formalities. However, a trust foundation can later be converted to a corporation foundation, if desired. A trust agreement is prepared and executed to govern how the foundation is created under a will or revocable trust at death. No separate trust agreement is necessary, and the family foundation provisions are included as part of the provisions of the will or revocable trust.

When the foundation is initially funded, an application for tax-exempt status must be prepared on Form 1023 and submitted to the IRS, together with a processing fee (currently $465).

After reviewing the request (and perhaps requesting additional information), the IRS will issue a determination letter indicating that the foundation is a
tax-exempt organization and that donors may take an income and estate tax deduction for contributions to the foundation, as discussed below.

Deducting Contributions

The relevant income tax rules for claiming deductions for contributions to a private foundation are complex. Those considering establishing a private foundation should only do so after obtaining qualified professional advice, based upon specific facts and circumstances.

Contributions of non-cash assets are subject to special rules, and there are annual limits on the amount that is deductible. The donor must consider the amount of gifts to public charities and private foundations, as well as gifts from prior years that have been carried over into the current year.

Ceiling on Corporate Deductions. A corporation's charitable deductions in any tax year are limited to 10% of the corporation's taxable income--exclusive of the charitable deduction and subject to some adjustments for certain other

Ceilings on Individual Deductions. For contributions of cash or ordinary income property, an individual's charitable deduction to a private foundation in any tax year is generally limited to 30% of the individual's adjusted gross income (AGI). By contrast, gifts to public charities that are not private foundations are subject to an annual limitation of 50% of AGI. For contributions of appreciated capital gain property to a private foundation in any tax year, the individual's deduction is generally limited to 20% of the individual's adjusted gross income. Gifts of capital gain property to a public charity are limited to 30% of AGI in any one tax year.

Limitations Based On Cost vs. Fair Market Value. The charitable deduction for gifts to private foundations was generally limited to the lesser of the fair market value or the cost of the property. For the past few years, Congress has enacted temporary legislation to permit donors to deduct the full fair market value of such donations. The Tax and Trade Relief Extension Act of 1998 made permanent the deductibility of the fair market value of appreciated publicly traded stock given to private nonoperating foundations.

Carryover of Excess Contributions. If corporations or individuals make charitable contributions that are greater than the above limits for any year, the excess amount can usually be carried over to the next five taxable years. Thus, the maximum limitation on a contribution is the total AGI expected in the current and next five years times the applicable percentage limitation.

Information Reporting Requirements for the Foundation

A private foundation is subject to the following reporting and disclosures:

* Federal Tax Form 990PF. The foundation must file Form 990PF annually by the 15th day of the fifth month following the end of the foundation's taxable year. For a calendar year foundation, therefore, the report would be due on May 15.

* Filing With the State. A copy of 990PF must be filed with the state attorney general.

* Annual Publication of Notice. A notice that the 990PF will be filed must be published in a local newspaper where the foundation is located. The notice must list the name, address and telephone number of the foundation Trustees and must state that the 990PF will be available for inspection for 180 days after publication. Notice must be published annually prior to the due date for filing the 990PF.

Limitations and Special Taxes

To ensure that foundations fulfill their charitable purposes, the IRC limits how foundations may operate and imposes special taxes.

Tax on net investment income. The foundation must pay a tax equal to two percent (2%) of the foundation's net investment income (including dividends, interest, rent, and capital gains) for each taxable year. In general terms, the tax on net investment income may be reduced from 2% to 1% if 1) the foundation makes the required minimum charitable distributions (discussed below) in each of the prior five years and 2) the foundation's charitable distributions in the current tax year equals or exceeds the foundation's average charitable distributions over the last five years, plus 1% of the foundation's net investment income for the current tax year. If the foundation's net investment income tax liability will be $500 or more, the foundation must make quarterly estimated tax payments, otherwise an underpayment penalty may be imposed.

Prohibition on self-dealing. Because private foundations are charitable organizations, they must be used for charitable purposes and not for the benefit of the founders or substantial contributors. To enforce this policy, a foundation is prohibited from engaging in "self-dealing" transactions.

Generally, the prohibition on self-dealing means that contributors and their family members (and any businesses or trusts in which the family, taken as a whole, is a substantial owner or beneficiary) may not lend to or borrow from the foundation, sell assets to or purchase assets from the foundation, receive excessive compensation (although reasonable compensation for services is allowed) from the foundation, receive impermissible distributions, or conduct any other business with the foundation.

Minimum distributions to charity. The foundation is required to make an annual distribution for charitable purposes in an amount equal to 5% of the adjusted fair market value of the foundation's assets, as determined at the beginning of the year. This distribution must be made by the end of the following taxable year, plus one extra day.

Prohibition on excess business holdings. The Federal government does not want private foundations operating businesses because this would give the tax-exempt foundation an unfair advantage over competitors. The competitors are subject to income tax, and the foundation is only subject to the nominal tax on investment income discussed above. Therefore, a private foundation cannot continue to hold "excess business holdings".

Generally, a foundation is deemed to have excess business holdings if it holds more than a 20% share of a corporation's voting stock or other interests in a business enterprise. Ownership attribution rules apply in calculating this 20% amount.

Tax on unrelated business income. If the foundation earns income from carrying on a trade or business which is not substantially related to its exempt function, a tax is imposed on the unrelated business income, at the same rate as if the income was earned by a taxpayer subject to income tax. If the foundation's tax liability for unrelated business income will be $500 or more, the foundation must make quarterly estimated tax payments or an underpayment penalty may be imposed.

Prohibition on investments that jeopardize the foundation's charitable purpose. The trustees of the foundation may not imprudently invest the foundation's assets in a manner that would jeopardize the foundation's ability to carry out its charitable purposes.

Prohibition on Impermissible Expenditures: The foundation trustees may not make improper expenditures, such as disbursements for political activities, lobbying, and grants to individuals or noncharitable institutions without complying with specified guidelines. *

Scott Blakesley is a partner in the Kansas City office of Blackwell, Sanders, Matheny, Weary & Lombardi, LC, Kansas City, Mo. He can be reached at (816) 274-6909,, or


John Wiley & Sons, paperback,
$6.99. ISBN: 047131644x

Reviewed by William Bregman, CPA/PFS, CFP

F inancial Planning Essentials is written in such plain English that many accounting professionals will miss the fact that this guide, in less than 300 easy-to-read pages, covers all the necessary aspects of the financial planning process.

This book starts by walking the reader through the basic stages of planning: calculating net worth, cash flows, budgeting, and debt management. The book moves on to discuss how to build wealth to meet financial goals. The two main topics covered are retirement and investment planning. Obviously, a CPA knows how to talk about IRAs, 401(k)s, and other qualified plans.

The section on investments is very solid in that it spends a lot of time reviewing an analytical framework. It discusses the concepts of total return, expected rate of return in light of historic returns, and investment risk. The discussion leads to the structuring of portfolios through the use of asset allocation and appropriate mixes for different life stages. The merits and mechanics of term and permanent cash value life insurance are discussed. Medical, liability, automotive, and home insurance are also covered.

The final chapters deal with estate planning. They stress distribution objectives, the need for flexible planning, liquidity needs, and tax minimization. The reader learns how to calculate the value of an estate and the taxes due. The book then explores gifting programs, the use of credit shelter, marital, and life insurance trusts. Finally, the generation-skipping transfer tax and estate-freezing techniques end the book.

This is a good book for the lay person. It may be a better book for the professional, however, because it demonstrates how difficult concepts can be explained in a manner that the person who needs planning can understand. *

Milton Miller, CPA

William Bregman, CPA/PFS

Contributing Editors:
Alan J. Straus, LLM, CPA

David Kahn, CPA
American Express Tax & Business Services, Inc.

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