A family foundation can be an excellent way to achieve long-term charitable objectives and pass down intergenerational values and a lasting family legacy. Sixty percent of the over 42,000 family foundations in the U.S. have endowments of less than $1 Million and the cost of creating one can be as low as $5000. The greatest difficulty in managing a family foundation may be complying with the myriad of complex rules the IRS imposes on them.
During its existence, a private foundation has numerous interactions with the IRS. Assets must be invested prudently, tax and legal forms must be filed correctly and family members need to remain united around the foundation’s mission. IRS rules are so stringent that virtually any proposed transaction between a foundation and a disqualified person should be considered a potential act of self-dealing.
IRS self-dealing rules can be a broad catch-all for any disqualified person and potential conflict of interest. It can include officers and managers of the foundations and its affiliated corporations. It can include family members and donors who contribute over $5000. And it can result in a 10% penalty tax on the amount involved and an ugly tax audit.
Family members must understand that once they donate money to a family foundation, it is not their money any longer. The foundation is a separate legal entity and they cannot use foundation funds for personal benefit. Actions of family members may seem fair and above reproach but the IRS may look at them as conflicts of interest.
Here are some examples where family foundations can get into hot water with the IRS.
Private foundations with paid family leaders usually perform better than volunteer family members. But a foundation is not a job bank for family members, even at fair wages. Family members can manage investments and review grant proposals but can’t conduct operational jobs like real estate and secretarial. Use a compensation expert when figuring out wages because excessive compensation can result in a 25% tax on the recipient.
Leasing office space in a building owned by the family can also raise red flags. Don’t use foundation offices for non-foundation business.
Travel expense is an area that very often leads to trouble. Family members who are not trustees cannot deduct travel expense. That includes spouses, children or grandchildren.
Tickets to Galas must be related to the foundation mission to be expensed. Extended family must pay their own way. Be aware that gala tickets received from a charity in exchange for a grant from the foundation should not be used by the family. The tickets should be donated to another charity.
Making loans or extending credit between the foundation and disqualified person is not allowed. Also, a family member cannot use foundation money to fulfill a personal pledge to a university or charity.
And don’t even think about donating to lobbying or political groups!
How to make it work.
Avoid self-dealing. The belief that family members can still make use of what they have given away is the root cause of many costly acts of self-dealing and painful IRS audit results. And the responsibility falls on the directors and officers to ensure that all the rules and regulations are met. Three times as many foundations (82%) have conflict of interest policies in place compared to 10 years ago.
Get an expert at the start. Look into donor-advised funds or outfits like Exponent Philanthropy or RFS Social Finance. Hire an attorney, a CPA and a CERTIFIED FINANCIAL PLANNER™ who specializes in private foundation work. They’ll help to navigate the IRS challenges and administrative burdens that come with family foundations.
Olson Wealth Group is a full-service wealth management firm that leverages capital in all forms to support investors who wish to align their values with their investments to solve complex social and environmental problems. Specializing in hands-on experience and high-level oversight for smaller ($2-20M) family foundations, we provide training and guidance in fiduciary responsibility including cost management, asset class selection, and performance/allocation measurement.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Excerpts taken from IRS Family Foundation Requirements, The New York Times, Forbes, and Investopedia: 8 IRS Red Flags for Private family Foundations.