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Private Foundations: Avoiding the Pitfalls


3/6/14

The following article was included in CohnReznick's The Not-for-Profit Advisor - Winter 2014 issue.

Establishing a private foundation can be a great way to enjoy the tax benefits of giving while retaining control over how your charitable dollars are spent. At the same time, private foundations are susceptible to abuse, so they are closely regulated.

The rules governing private foundations create several traps for the unwary. Even inadvertent violations by well-meaning founders or managers can lead to significant taxes and penalties. Here are some common pitfalls:

  • Self-dealing. Foundations generally are prohibited from engaging in transactions with or otherwise benefiting “disqualified persons,” such as founders, managers, substantial contributors, and their families. Prohibited transactions include selling or leasing property; lending; and furnishing goods, services, or facilities. Even seemingly innocent transactions – such as paying the founder’s personal pledge obligations or purchasing a table at a fundraising event for managers and their families – can violate this prohibition.
  • Excessive compensation. It is permissible to hire disqualified persons, so long as their compensation is reasonable. Document these workers’ hours and activities and consult compensation studies to be sure their salaries are in line with those received by unrelated parties.
  • Travel expenses. Avoid paying travel expenses for family members unless they are bona fide employees traveling on foundation business.
  • Grants to individuals. Exercise caution when making grants to individuals, such as scholarships or disaster relief. These grants are taxable unless certain requirements are met, including pre-approval by the IRS in some cases.
  • Grants to ineligible organizations. To avoid having to exercise “expenditure responsibility,” be sure that each grant recipient has a determination letter from the IRS stating that it is a 501(c)(3) public charity. The IRS maintains a searchable database of exempt organizations at: http://apps.irs.gov/app/eos.
  • Failure to meet distribution requirements. Each year, private non-operating foundations are required to distribute at least 5% of the fair market value of their net investment assets for exempt purposes.
     

What Does CohnReznick Think?
Private foundations can be a very useful tool to achieve philanthropic goals. The traps and pitfalls are avoidable if the foundation uses caution.  If the foundation manager is unsure whether a transaction will create a problem, the foundation manager should discuss the transaction with their tax advisor before the transaction occurs.

Contact

For more information, please contact Thomas Lanning, Partner, at 646-834-4108, or Lori Rothe Yokobosky, Manager, at 973-403-6940. To learn more about CohnReznick’s Not-for-Profit Industry Practice, please visit our webpage.


This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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