Why families form a foundation
A family foundation is an intentional, long-term way to centralize charitable giving, involve multiple family generations, and build a philanthropic legacy. Beyond emotion and values, foundations create legal structures that control how assets are invested and distributed, and that allow donors to shape grantmaking over decades. In my practice advising family offices and high-net-worth clients, foundations are chosen when families want governance, control over grant criteria, and a vehicle to teach heirs about stewardship.
Initial decision points (before you begin)
- Mission and scope: Define the charitable focus (education, health, environment, local community, etc.). Narrow scope improves impact and compliance.
- Scale and funding: Decide the initial endowment and whether the foundation will be perpetual or spend-down.
- Legal form: Most family foundations are private foundations organized as nonprofit corporations or charitable trusts under state law and recognized as tax-exempt under IRC 501(c)(3).
- Alternatives: Consider donor-advised funds (DAFs) or fiscal sponsorship if you want lower cost and administrative simplicity. See our donor-advised fund guidance for comparison: Donor-Advised Funds (DAFs) and How to set up a private foundation.
Sources: Internal Revenue Service guidance on private foundations (irs.gov/charities-non-profits/private-foundations) and Form 990-PF filing requirements (irs.gov/forms-pubs/about-form-990-pf).
Step-by-step setup process
1) Clarify mission, governance and initial budget
- Draft a short mission statement and grantmaking priorities. Decide whether the foundation will be field-of-interest, programmatic, or unrestricted grantmaker.
- Set a preliminary budget: seed gift, expected annual payout, operational budget, and investment policy.
- Determine if the foundation will be perpetual or a limited-life (spend-down) foundation. Spend-down eliminates perpetual governance issues but requires a different investment and grant strategy.
2) Choose legal structure and jurisdiction
- Most families form a nonprofit corporation or trust under the laws of the state where they have legal ties. State rules vary on registration, charitable solicitation, and trustee duties — consult a nonprofit attorney.
3) Draft governing documents
- Prepare articles of incorporation (for a nonprofit corporation) or a trust agreement, plus bylaws or a governance manual. Include: board size and terms, conflict-of-interest policy, grant approval process, executive compensation rules, and succession plans.
- Build a conflict-of-interest policy and code of conduct early; the IRS and state regulators expect documented safeguards.
4) Fund the foundation
- Contribute seed assets: cash, publicly traded securities, and sometimes real estate or closely held business interests. Appraisals and qualified appraisal reports may be required for non-liquid contributions.
- Think about the tax character of gifts: appreciated stock can be tax-efficient for the donor and the foundation (see IRS Publication 526 on charitable contribution limits).
5) Apply for federal tax-exempt status
- File Form 1023 (Application for Recognition of Exemption) or, if eligible, Form 1023-EZ with the IRS to obtain recognition under Section 501(c)(3). The application documents the mission, activities, governance, and proposed operations. See: https://www.irs.gov/forms-pubs/about-form-1023.
- After recognition, private foundations must file Form 990-PF annually (https://www.irs.gov/forms-pubs/about-form-990-pf).
6) State registrations
- Register with your state’s charity regulator and attorney general if you will solicit funds or operate programs in that state. Some states require an initial registration and annual filings.
7) Establish governance and operations
- Appoint a board (commonly family members plus one or two independent advisors). Adopt an investment policy statement (IPS), grantmaking guidelines, and an annual budget.
- Select service providers: investment manager or family office, accountant, and an experienced nonprofit attorney.
8) Start grantmaking and compliance
- Institute grant application and monitoring processes, recordkeeping, and impact measurement. Track grants, receipts, outcomes and ensure grants are payable to qualified charities (see IRS rules on distributions).
Compliance essentials and recurring obligations
- Minimum distribution requirement: Private foundations are generally required to make annual qualifying distributions (commonly calculated at about 5% of the foundation’s assets on average). Check IRS guidance and your tax advisor for the specific calculation method. (IRS — Private Foundations)
- Annual IRS filing: Form 990-PF is required and is publicly available. It discloses grants, investments, trustee compensation, and taxes paid.
- Excise taxes and self-dealing: Private foundations face excise taxes on net investment income, and strict prohibitions on self-dealing between disqualified persons and the foundation. Document decisions and consult counsel on related-party transactions.
- Recordkeeping: Keep minutes, grant agreements, independent valuations, and financial statements for audit trails.
Sources: IRS private foundation resources and Form 990-PF instructions (irs.gov).
Typical timeline
- Planning and document drafting: 4–12 weeks (varies with complexity and state requirements)
- Filing for tax-exempt status and IRS review: 3–9 months (Form 1023 processing times vary; 1023-EZ is faster but limited in eligibility)
- Operational launch (bank accounts, investments, first grants): usually within 3–12 months from initial decision
Costs — startup and ongoing (real-world ranges)
Below are typical ranges based on client work and industry norms. Costs vary widely by complexity, asset types, and the use of professional services.
- Legal formation and incorporation/trust drafting: $2,000–$12,000 (complex trusts and multi-state filings can cost more).
- IRS application fees: $400–$600+ (Form 1023 user fee varies; check latest IRS fee schedule).
- Initial accounting and tax planning: $1,000–$5,000.
- Annual audit or financial review (if required or recommended): $3,000–$25,000 depending on size and complexity.
- Ongoing legal and compliance: $1,500–$10,000 per year.
- Investment management fees: 0.5%–2% of assets under management (institutional fees may be lower; private equity or real asset fees higher).
- Administration or back-office support (if outsourced): $5,000–$50,000+ per year.
Example simple budget for a $2 million seed foundation (first-year):
- Legal & filing: $6,000
- IRS fee: $600
- Initial accounting/setup: $2,500
- Investment fees (assumed 1%): $20,000
- Administrative support: $8,000
- Total first-year run rate (approx): $37,100
Note: Many families find a foundation requires a larger endowment ($1M–$5M or more) to cover ongoing costs while funding meaningful grants. For families seeking lower cost and faster setup, a donor-advised fund can be an attractive alternative; compare options here: How to set up a donor-advised fund.
Pros and cons — practical trade-offs
Pros:
- Control over grantmaking and selection of grantees
- Ability to involve family across generations
- Potential tax advantages when structured correctly
- Perpetuity and legacy planning
Cons:
- Administrative and compliance burden (Form 990-PF, state filings)
- Ongoing costs may be significant for small endowments
- Limits on donor tax deductions relative to public charities
- Restrictions on self-dealing and rules on investments
Common mistakes I see in practice
- Underestimating ongoing costs and the annual distribution requirement, which can strain small endowments.
- Weak governance: failing to document conflict-of-interest policies or to include nonfamily oversight.
- Relying on non-liquid assets as the sole seed funding without a liquidity plan for payouts and operating expenses.
- Neglecting state filing and solicitation rules when the foundation supports or solicits donors outside its home state.
Practical checklist before launch
- Finalize mission and payout policy
- Choose entity type and state of formation
- Engage a nonprofit attorney and CPA with foundation experience
- Draft bylaws, conflict-of-interest policy, IPS, and grant guidelines
- Prepare and file Form 1023 (or 1023-EZ if eligible)
- Obtain EIN, open bank and brokerage accounts, and set up accounting
- Plan first-year budget and hire any necessary staff or vendors
Resources
- IRS — Private Foundations overview: https://www.irs.gov/charities-non-profits/private-foundations
- IRS — About Form 1023: https://www.irs.gov/forms-pubs/about-form-1023
- IRS — About Form 990-PF: https://www.irs.gov/forms-pubs/about-form-990-pf
- Council of Nonprofits — resources and state-level requirements: https://www.councilofnonprofits.org
Professional disclaimer: This article is educational and not legal or tax advice. Laws and IRS rules change; consult a qualified attorney and tax professional before creating a foundation.
If you’d like, I can provide a one-page checklist or a sample bylaws outline tailored to your state and family goals.