Starting and Benefitting from Private Foundations and Trusts

In the article, “How to Supercharge Your Charitable Giving” in the latest On Course, I discussed some relatively basic strategies that clients can use to optimize their giving to nonprofits.

For those looking to make larger and longer-lasting contributions to their favorite organizations, there are some more advanced options — notably foundations and trusts — that also entail more complexity. Let’s start by looking at Private Foundations, which share some similarities to Donor Advised Funds but provide more flexibility.

Many people believe that private foundations are for the ultra-rich, but there are companies using technology and scale to make these vehicles available to a wider audience. Generally speaking, donations of $1 million and more make the most sense when creating foundations, but depending on your desired use of the funds, one could create a foundation with a minimum of $500,000.

Private foundations offer more flexibility when it comes to making grants, plus other advantages that DAFs can’t provide, such as:

• Make grants to individuals: many clients express the desire to help specific people. While DAFs can only be used to make grants to other nonprofits, foundations can be used to make direct cash payments to individuals in need.
• Donate to foreign charities: it is more difficult to donate to a foreign charity, especially when there is not an IRS-recognized nonprofit that can act as an intermediary. Foundations may be used in these instances.
• Make loans or loan guarantees: many nonprofits do not have the creditworthiness to secure a loan from a third party. A foundation, however, can help the organization build a credit history or guarantee a third-party loan.
• Create scholarship programs: if there is a specific kind of scholarship program you would like to create, a foundation could create and run this program.
• Hire and/or involve family members: foundations are like a business. They can require a board and possibly the need to hire employees. This is a great opportunity to involve family members in decisions and even help support them financially.

All this added flexibility does come with a price, of course. Foundations are more expensive to create and administer than a DAF, and there are many compliance requirements to make sure people are using the funds appropriately. To ensure proper governance, there are companies that will take on all compliance, operations, and tax reporting work. As mentioned above, depending on your goals, a private foundation can be a cost-effective way to further your philanthropic vision.

Other options include Charitable Lead or Remainder Trusts, which can also provide benefit to both your family and your charity. The “lead” and “remainder” part of the name refers to when the charity receives the benefit of the gift, either at the beginning of the term or at the end.

It is important to note that these are irrevocable trusts, so once funded, it is difficult (or impossible) to make any changes.

Charitable Remainder Trusts (CRT): With this type of trust, a contribution is made to the trust and you receive an annual payment for either a determined number of years or for the lifetime of a person. At the end of the term, charities receive the remainder of the trust.

In the year that you make a trust contribution, you receive a partial tax deduction based on a calculation that estimates how much would flow to the charity at the end of the term. The income beneficiary is taxed annually on income received, but there are no capital gains taxes assessed, making this a great tool for low basis assets.

CRTs have the advantage of providing a flow of income to you or your family for a period, which can help supplement retirement income needs. You also receive a partial tax deduction in the year of the contribution, which could be helpful in a high-income year.

It is also possible to name your family’s Donor Advised Fund as the charitable beneficiary of the trust, giving you future flexibility for grants even after the end of the term.

Charitable Lead Trusts (CLT): this trust works in reverse order as a CRT. In this case, the creator of the trust makes a contribution, and the charity receives regular payments for a specified term based on a specified number of years or the lifetime of a person. At the end of the term, the funds left in the trust are distributed to the beneficiaries, usually family members or even to yourself.

Taxation is more complex with a CLT. You may or may not be able to take a tax deduction at the time of the contribution, depending on whether the trust has grantor or non-grantor status. You also may owe tax on income generated annually.

Like the CRT, you can pair a DAF with a CLT to retain control over granting to particular charitable beneficiaries.

Both CRTs and CLTs have several advantages, including the ability to donate appreciated securities, some types of closely held stock, real estate, and other complex assets. They also can reduce estate and gift tax depending upon circumstances.

One final note: your wealth advisors must understand your charitable goals and work with your accountant and attorney to determine what vehicle will best fulfill your wishes.