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January 21, 2021 - Choosing the right charitable giving vehicle for your philanthropic goals is an important part of giving strategically. Private foundations and donor-advised funds are two giving vehicles that are often compared due to their similarities. While both allow donors to designate assets for current and future grants to charities, there are quite a few differences between them as well. Whether you are deciding which one is right for you or you are considering a combined approach, we want to highlight the differences and look at the advantages and disadvantages of each.

HOW THEY WORK

A private foundation is a nonprofit organization that is usually funded by a principal gift from a single source, such as an individual or family. The funds are managed by the foundation’s directors or trustees. The majority of private foundations support other charitable organizations by disbursing funds to them through grants.

A donor-advised fund is a charitable giving account sponsored by a public charity and funded by a donor’s tax-deductible contributions. Donors retain the right, for themselves and potentially for family members, to recommend grants to the public charities of their choice.

SET-UP & ADMINISTRATION

Private Foundations – The cost of setting up a private foundation can be substantial. It can take weeks to months to set up, and the process includes filing state incorporation paperwork and submitting an IRS Application for Recognition of Exemption Under 501(c)3. Board members must be named and staff hired to manage and administer all functions, including recordkeeping, asset management, review of grant applications, tax filings, commissioning of independent audits, etc. Annual tax returns are public and must include names of board members and donors, grants, investment fees, and staff salaries. In order to justify the initial set-up and ongoing administration costs, funding of a private foundation is commonly several hundred thousand, if not several million, dollars.

Donor-Advised Funds – The set-up costs of a donor-advised fund varies between sponsoring organizations. Required minimum contributions to open a donor-advised fund can range from $0-25,000. This giving vehicle can often be opened within minutes to a few days, sometimes entirely online. The sponsoring organization handles all the administration and tax reporting and typically charges an annual administrative fee.

TAX IMPLICATIONS

Private Foundations – Donors do not pay capital gains tax on donations of appreciated assets to a private foundation, and because the assets contributed to a private foundation are excluded from a donor’s estate, they are not subject to estate taxes upon the death of the donor. Donations to private foundations are generally tax deductible up to 30% of the taxpayer’s adjusted gross income (AGI) for gifts of cash, and up to 20% of AGI for appreciated assets. Private foundations must also pay an excise tax of 1.4% of their annual net investment income.

Donor-Advised Funds – Like private foundations, donors can avoid capital gains tax by contributing appreciated assets to their donor-advised fund, and because the assets contributed to their donor-advised fund are excluded from a donor’s estate, they are not subject to estate taxes upon the death of the donor. Unlike private foundations, contributions to donor-advised funds are tax deductible at the public charity levels of up to 60% of AGI for cash and 30% of AGI for appreciated assets. Additionally, grants from donor-advised funds to qualifying public charities do not incur excise tax.

GRANT-MAKING

Private Foundations – The foundation’s board of trustees has discretion over how funds are distributed to charity, within the limits set by the IRS. Grants from private foundations can be made to public charities as well as individuals, if the grant is for a charitable purpose. Because private foundations must file public tax returns with all donor and grant information, it is not possible to give anonymously.

Donor-Advised Funds – The donor advisor recommends grants to the IRS-qualified public charities of his/her choice, within the limits set by the IRS and the grant-making policy set by the sponsoring organization. With donor-advised funds, donors can give anonymously.

FAMILY INVOLVEMENT & LEGACIES OF GIVING

Private Foundations – Family members can be employed by the foundation or serve as board members. Future generations may continue the mission of the foundation, thus creating a legacy of family giving.

Donor-Advised Funds – Family members can be named as additional advisors or as successor advisors for a donor-advised fund, which may exist for multiple generations. Additionally, a donor-advised fund can be named as a beneficiary of other charitable giving vehicles. For example, the remainder of a donor’s charitable remainder trust could be used to set up a donor-advised fund, to be advised by the donors’ heirs.

CONTROL

Private Foundations – A private foundation maintains ownership of its assets and, therefore, has greater control in this way. But, as board members must agree upon investment and grant-making decisions, no one individual has sole decision-making power.

Donor-Advised Funds – The sponsoring organization of a donor-advised fund has ownership of the contributions made to it, and the donor retains the right to make recommendations about the investment of the fund and grants to charities. While donors do not have legal control of the assets once they have been contributed, they are able to make unilateral decisions regarding the grant recommendations. Grant recommendations are commonly approved by the sponsoring organization so long as they are within the granting policy guidelines of the sponsoring organization.

BOTTOM LINE

If you’d like to employ family, retain legal control of assets, handle all administration, or be able to grant to individuals in need, a private foundation may be the right option for you.

If you’re looking for quick set-up, low minimums, ease of administration, anonymous giving, or sole authority to make grant recommendations that are then vetted by the sponsoring organization, a donor-advised fund might be right for you.

Since the vehicles operate differently, you might find using them together in a combined approach could help you achieve your charitable planning goals.

How can HighGround help? In addition to providing legal guidance to help you determine the best solution for you, we can expertly manage the assets and investments of your private foundation and sponsor your donor-advised fund. Call us today at 214.978.3300.