In working with family businesses over the years, we have found that many have philanthropic intentions as part of their core values. Most of these businesses choose to make contributions directly to individual charities each year. However, there are two often-overlooked alternatives for making these contributions. Determining which vehicle is best for you depends largely on your goals and the level of control you wish to have on the contributed funds.
Donor-Advised Funds
One popular option is the donor-advised fund (DAF). Assets (typically cash and appreciated stock) are contributed directly to an investment brokerage account which is managed by a sponsoring organization. The donor (which can be an individual or the company), in turn, receives an immediate income tax deduction upon the contribution of funds to the DAF. The donor then advises the sponsoring organization to direct donations from the DAF to 501(c)(3) charities. These requests are reviewed and either approved or denied by the sponsoring organization.
The donor is not required to meet annual donation minimums and can contribute additional funds as desired. After contributions are made, the donation is invested and any growth in the investments is now outside the donor’s income and further available for charity.
In addition to the tax-free growth of the investments, the other big benefits to utilizing a DAF is that they are simple to establish, have relatively low thresholds for initial funding, and have low ongoing fees. Donors utilizing a DAF often want to make regular levels of contributions to a charity but may have irregular levels of income. The DAF strategy would allow you to match higher years of deductions with higher years of income while minimizing the ups and downs of contributions to a charity. The donor-advised funds also work well as an estate planning tool because assets in the account are not included in the donor’s estate.
Private Foundations
An alternative option is to establish a private foundation. A private foundation is used in cases where there are a limited number of donors, such as the family business as the sole donor.
In this scenario, the family business would make donations directly to the private foundation and receive an immediate income tax deduction. Unlike a DAF, the private foundation is a separate entity that nominates directors to run and control the activities of the foundation, which are typically family members. This means the family retains more control over the direction of those contributions.
In addition, the private foundation can direct grants to other not-for-profit organizations and even individuals, which is not allowed through a donor-advised fund. However, because a private foundation is a separate not-for-profit entity, it requires a higher level of administration and investment to start and maintain. Private foundations are required to file annual tax returns, their grants and contributions are public record, and there are annual donation requirements.
Overall, private foundations are good in situations where it is a higher priority to have control over the assets as well as flexibility on where the grants can be directed, whether to another charity, to help an individual, or to establish a scholarship. The hands-on nature of private foundations can also be beneficial in creating a pattern of intergenerational giving within a family.
Ultimately, both donor-advised funds and private foundations can be useful tools in fulfilling philanthropic desires, while also providing significant tax benefits. The decision on which vehicle to use depends on what is important to you and your family business. If you have any questions or would like to discuss which approach is best for your family business, please reach out to our Family-Owned Businesses Specialists. If you have any questions related to potential tax benefits, please reach out to our Tax Strategies team, or contact us here.
Authors:
- Elizabeth Bishop, Manager, Audit & Accounting
- Steven Staugaitis, Director, Audit & Accounting
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