Advising Private Foundations: Despite Their Administrative and Regulatory Complexity, These Philanthropic Vehicles Are Taking Off
[ILLUSTRATION OMITTED] EXECUTIVE SUMMARY * Small family private foundations are growing at a rate of six per day. This indicates a growing probability that CPA firms will be advising benefactors of family foundations. It is vital that CPA firms understand the complex tax rules related to private foundations. * Private foundations are not allowed to engage in transactions with "disqualified persons," which include foundation managers and substantial contributors, even if the transaction is conducted at fair market value. * Excise tax on the net investment income of private foundations is assessed at 2%. However, the rate is lowered to 1% for years in which the private foundation makes qualified expenditures in excess of the prior five-year rolling average qualified expenditure ratio plus 1% of current-year net investment income. * The minimum annual distribution of private foundations is roughly 5% of the average monthly fair market value of assets. Distributions in excess of this amount may be carried forward for five years to offset future required annual distributions. * Private foundations must pay an excise tax on "taxable expenditures." In general, these expenditures are made for any purpose other than religious, charitable, scientific, literary, educational or other public purposes. To ensure grants made to organizations other than public charities or exempt operating foundations are not classified as taxable expenditures, a private foundation must exercise expenditure responsibility. * Private foundations are not allowed to invest in risky investments, unless the investments are related to the exempt purpose of the foundation. Private foundations are also not allowed to invest in a business enterprise if the combined ownership interest of the private foundation and all disqualified persons exceeds 20% of the business enterprise. ********** In the arsenal of estate planning, private foundations have traditionally ranked among the big guns. With their relative formality and extensive tax rules, they have been considered the province of the truly wealthy--people with $1 million or more to dispose of charitably The belief that lesser largesse could be better served by donor-advised funds and certain types of supporting organizations (see "The Rich Truly Are Different," JofA, April 04, page 32) is changing. The Pension Protection Act (PPA) of 2006 has curtailed many of the tax and other advantages enjoyed by those two alternative philanthropic vehicles. Today, small family foundations with assets under $1 million make up nearly 60% of all foundations. One factor driving this growth is the unprecedented transfer of wealth to the post-boomer generation that has begun and is likely to accelerate in coming years. Often, these small foundations are administered by family members, who rarely have expertise regarding the complex tax regulations involved. For all these reasons, developing a niche practice in private foundations poses growth possibilities for CPA firms, according to Holly M. Pantzer, CPA, a partner with BKD LLP, one of the 10 largest CPA and advisory firms in the U.S., where her areas of expertise include advising private foundations. CPA firms are increasingly likely to be advising founding benefactors of family foundations. CPAs can be a valuable resource for monitoring compliance with the many tax laws unique to private foundations. Awareness of the nuances of private foundation laws is especially important now, given the increased scrutiny of all tax-exempt organizations by Congress and the IRS. Advisers can help prevent inadvertent but costly violations of the tax laws peculiar to private foundations. Key issues for benefactors considering a private foundation include: * Comparisons to other options (donor-advised fund or supporting organization) * Prohibitions on self-dealing * Excise taxes on net investment income * Taxes on undistributed income * Taxable expenditures and expenditure responsibility * Jeopardizing investments and excess business holdings Private foundations operate exclusively for religious, charitable, scientific or similar activities as described in IRC [section] 501(c)(3) and are exempt from income tax but commonly pay excise taxes on net investment income and, sometimes, as penalties. …