Why set up a private foundation? What are the benefits and tradeoffs?
A private foundation is a common vehicle for wealthy individuals and families who want hands‑on control over their charitable giving, investment policy, and long‑term legacy. In practice, foundations make it possible to build a sustained philanthropic program that outlives the founder, but they also introduce ongoing legal requirements, public reporting, and tax limitations that can erode the net value of gifts if they’re not managed efficiently.
Below I walk through how a private foundation works, the tangible pros and cons, key IRS rules to watch, realistic cost expectations, alternatives to consider, and an action checklist you can use with your attorney and tax advisor. In my practice advising family foundations for over a decade, the right structure usually depends on three things: how much you plan to give, how much control you need, and whether you want a multi‑generation legacy.
How a private foundation typically works
- Founders contribute cash, appreciated securities, or other assets into a newly created nonprofit corporation or trust that applies for 501(c)(3) status.
- The foundation establishes a board (often family members) to approve grants and set policies.
- The foundation invests its assets; typically, it must distribute at least 5% of its net investment assets each year to qualified charitable purposes to meet minimum distribution rules (see IRS guidance on private foundations) (https://www.irs.gov/charities-non-profits/private-foundations).
- The foundation files an annual public disclosure — Form 990‑PF — reporting grants, investments, compensation, and other activity (https://www.irs.gov/forms-pubs/about-form-990-pf).
These steps create a lot of flexibility for grantmaking, but also generate recurring compliance tasks and limited tax advantages that differ from donations to public charities.
Key benefits (why families choose foundations)
- Control and governance
- You decide which charities and programs receive grants, set grant criteria, and retain the ability to name successors to the board. This control is the most frequently cited reason wealthy donors choose a foundation.
- Legacy and multi‑generation involvement
- Foundations can be vehicles for family education about philanthropy and for passing values to the next generation.
- Investment strategy and asset growth
- Assets can be invested for long‑term growth inside the foundation. Gains on investments aren’t taxable to the foundation in the same way they would be to an individual, though special excise taxes apply to net investment income (see IRS on excise taxes) (https://www.irs.gov/charities-non-profits/private-foundations/excise-tax-on-private-foundations).
- Ability to make programmatic grants or run programs
- Unlike donor‑advised funds (DAFs), foundations can operate programs directly (e.g., running a scholarship program or community center).
- Naming and public recognition
- Founders often use foundations to support named projects and ensure public recognition that reflects family philanthropic goals.
Main tradeoffs and disadvantages
- Lower tax deduction limits for donors
- Cash gifts to private foundations are generally deductible up to 30% of adjusted gross income (AGI), compared with 60% for cash gifts to most public charities. Gifts of appreciated long‑term securities are generally deductible up to 20% of AGI for contributions to private foundations, compared with 30% for public charities. These limits affect the immediate tax benefit for large gifts.
- Excise taxes and operational taxes
- Private foundations typically pay a 1–2% excise tax on net investment income. Other taxes apply for prohibited transactions and unrelated business income, making tax planning important (https://www.irs.gov/charities-non-profits/private-foundations/excise-tax-on-private-foundations).
- Complex regulatory restrictions
- Foundations face strict self‑dealing rules, limits on excess business holdings, and prohibitions on certain grants and political activity. Violating rules can trigger excise taxes and penalties (https://www.irs.gov/charities-non-profits/private-foundations/self-dealing).
- Administrative and compliance costs
- Legal setup, accounting, investment management, payroll (if you hire staff), grant administration, and Form 990‑PF preparation create annual costs. Typical annual operating costs can range widely — from low five figures for small family foundations up into six figures for larger private operating foundations — depending on staff and program complexity.
- Public disclosure and scrutiny
- Form 990‑PF is a public document; compensation, grants, and investments are disclosed. If privacy is a priority, a private foundation is less private than some alternatives.
How private foundations differ from common alternatives
- Donor‑Advised Funds (DAFs): If your priorities are a large tax deduction now and low ongoing administration, a DAF is often cheaper and simpler. See our guides: “When to Use a Donor‑Advised Fund vs a Private Foundation (Choosing the Right Vehicle)” (https://finhelp.io/glossary/when-to-use-a-donor-advised-fund-vs-a-private-foundation-choosing-the-right-vehicle/) and “Donor‑Advised Funds: A Practical Guide” (https://finhelp.io/glossary/donor-advised-funds-a-practical-guide/).
- Supporting Organizations: Legally distinct but linked to a public charity; they can offer some governance control with different tax rules.
- Charitable Trusts (CRT, CLT): Useful for income planning and tax‑efficient transfers of appreciated assets; they also have different tax treatment and payout rules.
Choosing between these vehicles usually depends on your giving timeline, desire for direct control, and tolerance for administrative burden.
Practical examples and a simple illustration
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Example 1: Appreciated stock gift. Donating highly appreciated stock directly to your private foundation allows the foundation to sell the stock without the donor recognizing capital gains — but the donor’s deduction will be limited (generally 20% of AGI for appreciated assets). A DAF often provides similar capital gains avoidance with higher AGI deduction limits for the donor in many cases.
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Example 2: Ongoing grantmaking. A family foundation with $5 million in assets that meets the 5% distribution requirement will need to pay out roughly $250,000 a year in qualifying grants or program expenditures. That payout requirement drives grant planning and affects the foundation’s investment policy.
Setup and ongoing compliance checklist
- Define mission and board governance structure (term limits, conflict‑of‑interest policy).
- Choose entity form (nonprofit corporation vs charitable trust) and draft bylaws or trust agreement.
- Apply for 501(c)(3) recognition with the IRS and obtain an EIN.
- Adopt an investment policy statement and grantmaking policy; document due diligence for grants.
- Establish a budget for legal, accounting, and administrative costs; plan for Form 990‑PF filings.
- Implement conflict of interest, document retention, and succession planning for board seats.
Common mistakes I see in practice
- Underfunding at startup: creating a foundation with too little capital to support minimum payouts and administrative costs.
- Ignoring self‑dealing and excess business holdings rules: these areas generate the most common and costly IRS penalties.
- Failing to document grant decisions: weak documentation raises excise tax and private benefit risks during reviews.
When a private foundation makes sense
- You plan to give substantial sums over many years (typical practical threshold is often several hundred thousand to millions in assets).
- You want tight control over how grants are made and the ability to run programs directly.
- You value naming, family governance, and a multi‑generation philanthropic plan.
When you only need a simple, low‑cost vehicle for charitable giving, a DAF or a supporting organization is often the better starting point (see our DAF guides above).
Next steps and professional advice
If you think a private foundation might fit your goals, take these actions with your advisor team:
- Run a five‑year cash‑flow and grant projection to see whether you meet distribution needs and cover costs.
- Compare the tax consequences of gifting cash versus appreciated securities into a foundation vs a DAF.
- Engage counsel familiar with nonprofit law to draft governing documents and a conflict‑of‑interest policy.
- Set governance rules and document succession planning for board membership.
For authoritative IRS rules and practical filing details, read the IRS private foundations overview, excise tax guidance, and self‑dealing rules at the IRS website: https://www.irs.gov/charities-non-profits/private-foundations (https://www.irs.gov/charities-non-profits/private-foundations/excise-tax-on-private-foundations) (https://www.irs.gov/charities-non-profits/private-foundations/self-dealing).
Professional disclaimer
This article is educational and does not replace personalized legal or tax advice. In my practice as a CPA and financial planner, I recommend consulting your attorney and tax advisor before creating a private foundation, because small drafting and governance decisions can have large tax and compliance consequences.
Selected further reading
- IRS — Private foundations information and Form 990‑PF instructions (https://www.irs.gov/charities-non-profits/private-foundations)
- Internal Revenue Service — About Form 990‑PF (https://www.irs.gov/forms-pubs/about-form-990-pf)
- FinHelp guides: “When to Use a Donor‑Advised Fund vs a Private Foundation (Choosing the Right Vehicle)” (https://finhelp.io/glossary/when-to-use-a-donor-advised-fund-vs-a-private-foundation-choosing-the-right-vehicle/) and “Donor‑Advised Funds: A Practical Guide” (https://finhelp.io/glossary/donor-advised-funds-a-practical-guide/).
If you’d like, I can convert this checklist into a one‑page planning worksheet you can share with your attorney and investment committee.
