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Published on: 01/22/2024 • 7 min read

What to Know About Creating a Foundation for Charity

While charitable giving is an essential part of financial planning for many high-net-worth individuals and families, many often struggle to find the most effective means of giving. Establishing a charitable foundation is an increasingly popular avenue, offering not only the opportunity to make a significant impact but also providing potential tax benefits. However, creating a foundation for charity is no small task; it requires keen planning, a clear vision, and an understanding of the regulatory landscape.

In this article, the financial professionals at Avidian will guide you through the steps to creating a charitable foundation, and discuss some important considerations you should take into account when determining the best approach for reaching your philanthropic goals, particularly from a fiscal perspective.

The 3 types of charitable foundations and their benefits

Charitable foundations come in three main types recognized by the IRS:

  • Private foundations
  • Public charities
  • Donor-advised funds

Each has its own set of benefits and limitations that should be carefully evaluated before making a decision on which is right for you.

When deciding on the best type of foundation for your charitable efforts, it is important to consider a few key factors:

  • Control and involvement: Do you want to have more control over how funds are used and distributed, or are you open to a more hands-off approach?
  • Flexibility: Will the 5% minimum distribution requirement be feasible for your foundation, or do you need more flexibility in fulfilling your charitable mission?
  • Tax implications: How will the different tax rates and regulations affect your overall philanthropic goals?
  • Funding sources: Are you planning on relying on a single source of funding, or do you want to diversify your funding base?

Depending on your needs, one of the following foundation types may be suited for your charitable endeavors.

1. Private foundations

Private foundations, including charitable trusts, are established by an individual or group of individuals with a specific mission in mind. This type of foundation is typically funded by a single source, such as a family or an individual donor.

One of the main benefits of a private foundation is the control it gives the founder over how funds are distributed and used. This allows for greater personal involvement in philanthropic efforts and can ensure that the funds align with the founder’s values and goals.

However, there are also limitations to consider. Private foundations are subject to stricter regulations and higher tax rates compared to donor advised funds (DAFs)* or public charities. They also require a minimum distribution of 5% of their assets each year, which can be challenging for smaller foundations.

*Learn more about the difference between a donor advised fund vs private foundation

2. Public charities

Public charities are funded by a broad base of donors and have a more diverse funding structure than private foundations. They are often established as non-profit organizations and must meet certain requirements to maintain their tax-exempt status.

One of the main benefits of a public charity is the ability to receive donations from multiple sources. This can provide a steady and diverse stream of funding for charitable activities. Additionally, public charities are subject to less stringent regulations and lower tax rates compared to private foundations.

Public charities, however, give you less control over how funds are used and distributed. They must follow certain procedures and restrictions to maintain their tax-exempt status, which can limit the founder’s involvement.

3. Private operating foundations

Private operating foundations are a hybrid of private foundations and public charities. They operate more like a traditional charity, with a specific mission and programmatic activities, but they receive funding from a single source or small group of donors.

The main benefit of this type of foundation is the ability to have more control over how funds are used while still maintaining tax-exempt status. Private operating foundations also have more flexibility in terms of fulfilling their charitable mission, as they are not subject to the 5% minimum distribution requirement.

However, like private foundations, private operating foundations face stricter regulations and higher tax rates. They must also maintain a certain level of public support to avoid reclassification as a private foundation.

What do I need to start a charity foundation?

Creating a foundation for charity requires careful planning and consideration above all. Here are some key steps to get you started:

  1. Determine your mission: The first step is to identify the cause or issue that you want to address with your foundation. This will help guide all of your decisions moving forward.
  2. Establish a board of directors: A charitable foundation typically has at least three members on its board of directors who will oversee the foundation’s operations and decision-making.
  3. Choose a legal structure: As discussed previously, each structure comes with its own benefits and limitations and will change how you do business considerably. Consider consulting with a lawyer or financial advisor to determine the best option for your specific goals.
  4. File necessary paperwork: Depending on the type of foundation you choose, there may be paperwork or applications that need to be filed with the IRS or state government.
  5. Develop bylaws: Bylaws outline the rules and procedures for how your foundation will operate, including governance and decision-making processes. These bylaws should be constructed with the Uniform Prudent Management of Institutional Funds Act (UPMIFA) in mind, which provides guidance for managing and investing funds held by charitable institutions.
  6. Obtain tax-exempt status: To qualify as a tax-exempt organization, you will need to file for 501(c)(3) status with the IRS. This process can take several months, so plan accordingly.
  7. Establish accounting and record-keeping procedures: As a non-profit organization, it is important to maintain accurate and detailed records of all financial transactions and activities.

When running your charity, it’s important to have a trusted financial partner. This partnership not only helps to ensure the efficient management of your funds but also aids in navigating the complex financial landscape, helping you meet your philanthropic goals with financial efficacy and integrity.

Tax implications to consider when starting a foundation

In addition to the legal and operational aspects, it is important to understand the tax implications of starting a charitable foundation. Here are a few key considerations:

  • Donation deductions: Donors may be eligible for tax deductions on donations made to your foundation, depending on its classification as a public charity or private foundation.
  • Tax-exempt status: As mentioned before, obtaining 501(c)(3) status with the IRS can provide your foundation with tax-exempt status, which can have significant financial benefits.
  • Financial reporting: Charitable foundations are required to file annual reports with the IRS, providing details on their activities and finances. This includes a Form 990 or 990-PF for private foundations and a Form 990-EZ or 990-N for public charities.
  • Tax rates: As discussed, different foundation structures will be subject to different tax rates. Private foundations generally face higher taxes compared to public charities and DAFs.
  • Unrelated business income tax (UBIT): If a foundation earns income from activities unrelated to its charitable purpose, it may be subject to UBIT, which can affect its tax-exempt status and require additional reporting.

To ensure compliance with tax laws and regulations, it is important to consult with a financial advisor or accountant when starting and operating a charitable foundation. They can guide you through the necessary steps and help maximize your impact while minimizing any potential tax implications.

Continue reading: How do charitable donations affect taxes?

Looking for a co-fiduciary and financial partner for your foundation? Let’s Talk!

Creating a foundation for charity is an incredibly complex process that requires careful planning and consideration. Whether you choose to establish a private foundation, a public charity, or a private operating foundation, you should know that each comes with its benefits and challenges, and making strategic decisions now will influence the success of your foundation for years to come. From determining your mission to selecting a legal structure, establishing a board of directors, filing paperwork, developing bylaws, and obtaining tax-exempt status, each step plays a critical role in shaping your foundation’s trajectory.

With a trusted financial partner like Avidian Wealth Solutions by your side, you can work to navigate this complex landscape and put plans in place that work towards helping your foundation operate with financial efficacy and integrity, ultimately maximizing its impact on the cause you’re passionate about.

Avidian acts as a co-fiduciary for endowments and private foundations, assisting in creating and implementing investment strategies that align with your organization’s specific goals and mission. Our team of financial advisors will work closely with you to understand your unique needs, providing personalized guidance and support every step of the way.

Schedule a conversation with one of our wealth managers in Houston, Austin, Sugar Land, or The Woodlands today!

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Please read important disclosures here

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