The benefits of starting a private family foundation

It’s a sobering statistic: 70% of wealth transfers fail from one generation to the next, when failure is defined as the involuntary loss of control over the assets.¹

The 30% of families who succeed have one key thing in common: total family involvement. They work together to coordinate decisions around the family’s wealth. Most importantly, family members trust and communicate well with one another.

Every family is different, and finding a way to facilitate trust, communication and proper preparation and development of the necessary skill sets of the next generation can be difficult. Today, many families are finding answers to these challenges through private family foundations.

What is a private family foundation?

A private family foundation is an independent legal entity established solely for charitable and philanthropic purposes. It can be funded with assets such as cash, investment securities, real estate, jewelry, artwork and antiques.

The main goal of a private family foundation is to preserve family wealth over generations and direct a family’s philanthropic efforts. Instead of performing charitable operations, private family foundations donate assets to qualified charitable organizations. Private family foundations are recognized as 501(c)(3) tax-exempt organizations.

Private family foundations are often established at a watershed moment, such as:

• When a wealthy family realizes they want to be more strategic about building a philanthropic family legacy.
• A liquidity event, such as the sale of a closely held business.
• Receiving a financial windfall, such as a large inheritance.

Benefits of establishing a private family foundation

Charitable organizations and other causes aren’t the only entities that benefit from a private foundation’s giving activities. Here are five benefits wealthy families with charitable intent may realize by establishing a private foundation.

1. A private family foundation solidifies the family’s core values.

Having all members of your family actively involved in a foundation can help to strengthen values across generations.

Children learn values by watching what their parents do and doing it with them. Even kids as young as five or six years old can develop a philanthropic attitude. Find out what they care about and what they may have a passion for. It doesn’t matter what the interest is; it’s enough that they explore their interest and realize that they can make a difference.

Working together will present opportunities for your family to support the passions of individual members and share in the satisfaction of the positive impacts achieved. This shared satisfaction can help increase your love and respect for each other and for the communities in which you serve.

2. A private family foundation builds a legacy of service.

You may have heard the saying, “A family that works together stays together.” It also follows that “a family that plays together stays together” and “a family that serves together stays together.”

Working together in a family foundation can be a bit of all three: work, play and service. Family unity is often enhanced when parents, children, siblings, spouses and in-laws work together in charitable endeavors. Working and serving together may help build and strengthen relationship bonds. Additionally, as grandparents, parents, children and grandchildren work together in their foundation’s endeavors, they build a legacy of generosity for future generations.

3. A private family foundation develops essential skills.

Business skills such as communication, presentation and leadership can be developed or enhanced as your family discusses grant opportunities and listens as individual members present their case for their grant opportunity. Skills such as active listening and collaboration may also be enhanced by the lively discussions that tend to be a part of this process.

Investment acumen can increase as your family discusses appropriate investment opportunities for the foundation’s assets. Working with a professional investment advisor may create additional educational opportunities for your family, as advisors share their knowledge and expertise with the next generation of family philanthropists.

Foundations may also provide a sense of purpose and leadership responsibility for individuals who might otherwise feel that there’s no way to “outdo” their parents’ success and make their own mark on the world. Learning to run the foundation or take on a key leadership role gives them something that’s all their own. Responsibility and accountability can help individuals develop a greater sense of self-worth, pride and stewardship.

4. A private family foundation builds trust and communication.

You may want to ask your private foundation’s board to employ a broad degree of leniency when approving grants recommended by family members. Doing so can increase the commitment of and strengthen trust among family members.

While the board should make sure that grants go to causes that embody your family’s core values and goals, allowing the senior generation to take complete control and only allow grants to their favorite causes may diminish individual family member commitment and ownership in the process.

Remember that actions speak louder than words. Supporting selected causes can have a greater impact than saying “pick a cause.” Open, honest, sincere and transparent communications and actions among your family will serve to build and strengthen trust.

5. A private family foundation reaps tax benefits.

Since private foundations are recognized by the IRS as charitable organizations, they have tax-exempt status under Internal Revenue Code 501(c)(3). To qualify for this status, the foundation’s purpose must be “charitable, religious, educational, scientific, literary, testing for public safety, foster national or international amateur sports, or prevent cruelty to children or animals,” according to the IRS.

A private family foundation can realize its tax benefits by adhering to strict IRS guidelines to maintain its tax-exempt status, including:

• It must distribute at least 5% of its non-charitable-use assets annually.
• It must file IRS Form 990-PF, Return of Private Foundation, annually.
• It must pay an annual excise tax on net investment income (NIIT) and report this on Form 990-PF.
• It can only make grants to qualified charities, not directly to grant recipients (except scholarship recipients, in some situations).

In addition, private family foundations must avoid inurement, or giving away assets to private shareholders. In other words, the foundation cannot use its income or assets to directly or indirectly benefit an individual who has a close relationship with the foundation. If the IRS determines that this has occurred, it could revoke the foundation’s tax-exempt status.

How to start a private family foundation

Here are five steps to follow to establish a private family foundation.

1. Develop a mission statement for your private foundation.

Before you start down the decision-making road, consider developing a mission and vision statement for the foundation based on your family’s values, goals and vision for your wealth. These statements will provide continuing guidance for future decisions across generations.

Even young children can participate in the process. Their involvement will often enhance their commitment to the goals of the foundation. And if they later pursue a passion that’s based on a value expressed in the statements to which they contributed, their level of motivation is likely increased and the value more deeply imbedded.

You may find it helpful to use a professional facilitator in your mission and vision statement development. Using a trained facilitator to help you “discover” and articulate your core values can be fun and enlightening.

2. Take care of legal considerations.

What type of entity would be best suited for your specific goals and objectives? What forms need to be filed? What governing documents need to be prepared?

Due to the technical nature of private foundation establishment and operation, you’ll most likely be working with various tax, legal and investment professionals. While legal and tax counsel are necessary, you may find that your current wealth management advisor has trained staff members with the necessary skill sets to help you expedite the process.

Remember to keep sight of your overall mission and vision as you make decisions.

3. Select board members for your private family foundation.

It’s important that future board members understand their roles and duties. Some of their responsibilities may include:

• Hiring and overseeing the foundation’s CEO.
• Review and planning for potential liabilities.
• Ensuring the foundation meets all legal obligations.
• Protecting the foundation’s human, intellectual and financial capital.
• Setting the mission and strategic direction of the foundation.

Under most state laws, a minimum of three board members is required for a private family foundation, while some experts recommend a minimum of five. As you consider who to include, you may want to start with finding a strong and competent board chairperson. The chairperson should be dedicated to the mission of the foundation and be able to guide, support, encourage and lead the foundation internally and publicly.

When selecting board members, strive to build a strong and engaged board. A foundation board needs members with impeccable reputations who are respected for their integrity and wisdom.

You may want to select board members from within your family to strengthen your sense of cohesion around a shared set of values and traditions. Also consider adding nonfamily members to bring additional expertise and diversity, as well as help mitigate any family tensions that may arise.

4. Assign day-to-day administration of your private foundation.

Some of the daily administrative tasks of running a foundation include:

• Keep complete, current and accurate financial records.
• Prepare financial statements.
• File tax returns and conduct audit reviews required by law.
• Receive applications for grants.
• Write checks and pay bills.
• Ensure appropriate liquidity between checking and investment accounts.
• Prepare reports.

It’s possible that many of these duties may be performed by members of your family if they have the necessary skill sets. In the right circumstances, these duties can provide an excellent environment conducive to an individual’s education and development. Still, many of these functions can be outsourced. It may be that a combination of outsourcing some of the functions and having family members provide others works best.

5. Manage and oversee investment selection.

There are special legal and tax limitations and restrictions that apply to the investment of a private foundation’s assets. One of the most important issues is whether a private foundation has invested in such a way that “jeopardizes” its ability to carry out its charitable purposes.

Because of the special privileges and purposes foundations enjoy, rules exist to protect the benefited charities. A private foundation must meet the fiduciary standard of care to protect its assets. A fiduciary must always put the best interests of those for whom they serve first and foremost in all they do.

Certain investment vehicles and strategies may receive heightened scrutiny, including:

• Securities traded on margin
• Any trading in commodity futures
• Investments in working interests in oil and gas wells
• The purchase of puts, call, and straddles
• The purchase of warrants
• Short sales

You may want to consider using some of the assets for values-based investing, with the goal of producing both financial and societal benefits. You’ll also need to determine how much, if any, of the assets should be allocated to alternative investments.

An investment professional can assist you in determining the best selection of investments for your private foundation’s resources. Be sure to work with a professional who is well versed in the intricacies of investing for a private foundation. They can help you develop an investment policy statement and provide you with regular economic and performance updates.

Is a private foundation right for your family?

Private family foundations may not be the best choice for every family. However, even with the risks and complexities, they do offer some significant benefits for charitably inclined families.

Along with the potential tax advantages, a foundation can help unify your family behind service-oriented causes, while developing responsibility and leadership skill sets that will serve the family across generations.

Learn how Philanthropic Services from U.S. Bank can help guide your family’s philanthropic legacy.