October 28, 2011

Private foundations have been a force for positive change since their invention at the beginning of the last century. Their philanthropic power has spurred economic and social progress. They have comforted the afflicted and fed the hungry. Some local private foundations have millions in assets, and some of our most treasured community institutions bear their founders’ names.

For years, foundations both large and small have been able to unleash their philanthropic power and self-support their overhead and operations. But the Great Recession created administrative and financial problems never before seen for private foundations, especially those with assets of less than $1 million, making these foundations uneconomical to sustain. Thus, the reasons to transfer the assets of the private foundations to donor-advised funds at community foundations – a more common occurrence in the last three years – have never been more compelling.

Most private foundations are created by individuals or families. They have an endowment and provide grants and scholarships out of the investment income. Amid tumbling and turbulent markets, the loss of assets, along with the high costs of accounting, auditing, and federal and state reports, can reduce the amount of money available for good deeds.

As well, many of these entities start out with close ties to the donors who created them, but over time the children may lose interest or be unable to administer the foundation; new trustees may be hard to find. In many of these situations, transferring the assets to a community foundation makes sense.

A community foundation is classified by the IRS as a public charity rather than as a private foundation. Thus, community foundations are subject to fewer regulations and taxes. Donations to community foundations are also subject to more favorable levels of deductibility than gifts to private foundations.

The donors, and any advisers they name, can call on the expertise and knowledge of the foundation’s staff and board to help them with their grantmaking. The savings in administrative costs increases the funds available to charities, a benefit particularly critical during economic downturns, when charities confront a rise in need with a decline in giving.

Section 507(b)(1)(A) of the Internal Revenue Code describes the requirements to terminate a private foundation in either trust or corporate form and distribute assets to a community foundation. The private foundation must also comply with state law requirements for termination of a trust or corporation.

Donors often use the dissolved assets to establish a donor-advised fund at the community foundation. A donor-advised fund removes the unwanted responsibilities. Record- keeping is greatly simplified. The community foundation assumes all back-office tasks, such as compliance monitoring, state and federal filings, and grant disbursements in accordance with IRS guidelines.

The 2 percent annual excise tax that a private foundation pays on the net investment income is eliminated. The 5 percent minimum payout requirement also goes away. And much like a private foundation, families can set up their donor-advised fund to reflect their family’s name and values, and recommend grants from their fund to any local or national charity.

There are solid arguments in favor of private foundations, but the liabilities of administration, tax compliance and asset depreciation can make them more of a burden than a pleasure. The concept of a private family foundation will always be attractive, but a donor-advised fund at a community foundation can put more money into good causes with less overhead and fewer headaches.

Christine Piersall is a trusts and estates attorney with Williams Mullen. Her email is cpiersall@williamsmullen.com.