Using Private Foundations to Defer Taxes

Question:  I am selling my business this year and will have significant income to report.  I intend to make a meaningful gift to charity and would like the charitable deduction this year but do not yet know how I would like the money earmarked.  Are there any vehicles that will enable me to accomplish this?

Answer:  There are various options available although one which may be particularly suitable for your purposes is a charitable organization known as a private foundation.  A private foundation will permit you to make a charitable gift and receive a tax deduction in the year the contribution to the foundation is made yet permit you to retain control as to when and  to whom the funds will be paid.  A private foundation is an ideal vehicle for someone in your position who wants the current tax deduction but has yet to formulate a charitable giving plan.

The most common type of tax-exempt charitable organization is a 501(c)(3) organization which is organized and operated exclusively for religious, charitable, scientific, educational or other specified purposes.  501(c)(3) organizations generally are either public charities where the public at large is financially supporting the organization or private foundations where the founders and other insiders provide most of the organization’s financial support.  Both a public charity and a private foundation are tax-exempt, meaning contributions to the organization are deductible by donors while earnings from the organization are not taxable.  Cash contributions to a private foundation can be deducted by an individual donor to the extent of 30% of the donor’s adjusted gross income.  In your case, you can create a private foundation and make a current contribution which will be deductible in the year the contribution is made.  Ultimately when you decide which charities you wish to support, foundation funds can be contributed to these other organizations.

Private foundations can be formed as corporations, limited liability companies, trusts, partnerships or other entities.  Most private foundations, however, are formed as not-for-profit corporations under State not-for-profit corporation laws.  In a typical not-for-profit corporation, the organization will have directors and officers but no members.  Some State not-for-profit statutes such as the Illinois General Not For Profit Corporation Act require a minimum of three directors.  With no restriction on who the directors may be, you and other family members can constitute the corporation’s board of directors, thereby keeping you in control of the foundation and entitling you to direct the distribution of funds and manage the foundation.  Once the organization has been formed, it must apply to the Internal Revenue Service for tax exemption and, if the IRS determines the organization is tax-exempt, the tax-exemption will generally apply retroactively to the date of the organization’s formation provided the application to the IRS is made within 27 months of the organization’s formation.

Private foundations are subject to various excise taxes under the Internal Revenue Code which are imposed based on the foundation’s net income, sales and other transactions between the foundation and related parties, failure to distribute income, excess holdings of closely-held business interests and in other circumstances.  One notable exception from excise taxes is reasonable salaries paid to insiders so you can pay a salary to yourself and other family members for services rendered to the foundation if you choose.  Careful planning will generally enable you to circumvent most, if not all, of the excise taxes which the Internal Revenue Code imposes upon private foundations.

For a business seller with benevolent intentions such as yourself, a private foundation can be an ideal vehicle for obtaining a current income tax deduction and directing how you want foundation funds to be paid to other charitable organizations in the future.

 

The Tax Corner addresses various tax, estate, asset protection and other business matters.  Should you have any questions regarding the subject matter, you may contact Bruce at (312) 648-2300 or send an e-mail to bruce.bell@sfnr.com.

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