When you give $100 to your favorite charity, you are probably not overly concerned about how your donation is spent, as long as it advances the mission of the charity. On the other hand, if you are making a large donation, it is more likely that you have specific goals in mind, whether to fund a particular program or support another endeavor. This desire to specify exactly where your donation dollars will go may jeopardize your ability to claim an income tax deduction. Therefore, proper planning is essential.
If you want more control over how your donation is used, consider either donor advised funds or private foundations. Let’s take a closer look at these two options.
Donor Advised Funds
Many larger public charities, particularly those that support a variety of different charitable activities and organizations, offer donor advised funds. This type of charitable giving vehicle is based upon an agreement between the donor and the charity stating that the charity will consider the donor’s wishes with respect to the ultimate use of the donated funds. However, the agreement is non-binding, and the charity will exercise final control over the disposition of the funds, consistent with the organization’s mission.
A private foundation is a nonprofit organization that typically has been created via a single donation from an individual or a business, and whose funds and programs are managed by its own trustees or directors. Through the choice of directors or trustees, the donor has greater control over the specific use of funds, rather than relying on a public charity.
Private foundations generally fit into two categories: private operating foundations and private non-operating foundations. Private operating foundations actually run the charitable activities or organizations they fund, while private non-operating foundations simply disburse funds to other charitable organizations. A private foundation can also serve as a “family enterprise,” whereby members of the family can work together in supporting charitable causes over the long term.
However, the benefit of increased donor control through the use of a private foundation may come at a price. The following rules are designed to ensure that private foundations serve charitable interests and not private interests:
- Private foundations are generally required to pay out for charitable causes at least 5% of their asset value annually or be subject to a penalty.
- Substantial penalties are imposed on transactions between the foundation and its donors or managers, although payment of reasonable salaries is permitted.
- Private foundations are generally prohibited from benefiting a private individual.
- A private foundation is responsible for ensuring that the funds it distributes to a private charity are expended properly. (Schools, hospitals, and churches are examples of public charities, to which this does not apply.)
- An excise tax of up to 2% of investment income is imposed annually on investments.
- There are restrictions on the types of investments made by private foundations.
The deductibility of contributions to private foundations is more limited than for contributions to public charities. Depending upon whether cash or property is being donated, deductions to private foundations are limited to 20% to 30% of adjusted gross income, whereas deductions to public charities have higher limits of 30% to 50%. Finally, the administrative and legal costs of creating and managing a private foundation need to be considered.
Depending on the circumstances, a private foundation may allow for greater control over how your charitable donation is spent. It can be highly rewarding to be involved in charitable endeavors, however, be sure to consult your tax and legal professionals for specific guidance.