Private foundations may help you manage donations

March 1, 2006

In order to ensure that private foundations are truly legitimate charitable entities, they are subject to numerous complex tax rules.

Q I would like to take more control of and be more active with my charitable contributions, and it has been suggested that I create a private foundation. Is this a reasonable strategy?

A private foundation is defined as a charitable organization created and funded by a donor, either during his life or at death, which is designed to achieve one or more specific charitable purposes. The responsibility for overall management of the foundation is delegated to a board of directors, or trustees, usually named or appointed by the donor. For their efforts, fees may be paid to the directors or trustees from the foundation's assets, as long as the compensation is considered to be reasonable, based on their services.

To ensure that private foundations are truly legitimate charitable entities, they are subject to numerous complex tax rules, one of the most scrutinized of which is "failure to distribute income." If a private foundation fails to distribute its annual income by the end of the subsequent year, it will be subject to a 15% tax. In addition, if the income is not distributed by the date the tax is assessed or by the ending date stated in the IRS' 90-day warning letter, the tax may be increased up to 100%.

Excise taxes may be assessed if the IRS determines that "self dealing" has occurred by a "disqualified person." A disqualified person, under current law, is defined as an individual who is a substantial contributor to the foundation, a foundation manager, certain family members, and others who may hold a fiduciary capacity within the foundation. Penalties include a tax of 5% of the amount of money involved, and can increase up to 200% of additional tax if the self dealing isn't corrected.

The most common examples of self dealing involve transferring foundation income or assets to disqualified persons and furnishing foundation money to government. Self dealing also can involve issues related to the amount of compensation paid and expenses reimbursed to disqualified persons.

Q Is it true that the death benefit of a life insurance policy may be subject to estate taxation?

A That is correct, but with proper planning, your beneficiaries should be able to receive life insurance proceeds without triggering and incurring any estate taxation.