Family Adventure Philanthropy - December Style

Family Adventure Philanthropy - December Style

Article posted in Practice on 24 November 1999| comments
audience: National Publication | last updated: 18 May 2011
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Summary

It's December 1st and you receive a phone call from a client who has just decided she wants to create a family foundation -- by year-end! What do you do? In this edition of Gift Planner's Digest, San Francisco-based consultant Jeff Shields discusses "Family Adventure Philanthropy -- December Style."

by Jeff Shields

In a conversation about the surge in family foundation start-ups and how many of these foundation's were adopting a venture capital funding model to their giving practices, Sterling Speirn, President of the Peninsula Community Foundation, commented that many family foundations were practicing "ad-venture" philanthropy more than venture philanthropy. This person's comment speaks to how family philanthropic efforts take different approaches and paths to giving.

The current environment for family giving and philanthropy is positive. Interest level among clients seems to be growing. While this interest level is exciting for advisors involved in charitable planning, many clients who are starting family foundations have limited philanthropic experience. Inexperience is not a bad thing. The concern is that inexperience in a family foundation may cause, at the least, some confusion and, at the very worst, family rifts. Most problems can be avoided if the client is provided with some general information about family foundations.

Clients starting a family foundation should consider some basic points. At the very least, a client should have the opportunity to talk with other families about their giving efforts and have time to explore the different options available. Yet, many family foundations are established at year-end and are tax-driven events. Advisors who help clients establish family foundations should consider their role in helping clients both start their foundation and then successfully navigate their philanthropic adventure.

The December Philanthropic Adventure Telephone Call

On December 1st, you receive a telephone call from a client who explains, "I was at a holiday function last night and a friend mentioned that her family created a family foundation to give away money to charities around the country. My friend told me that her children are involved and that she read about starting a foundation in a magazine article last year. She also said that her advisors helped her start the thing. How can I start one of these family foundations?"

You take a deep breath as you look at the calendar and wonder why now-and then start to answer the client's question. She interrupts you and asks, "How much money should I put into this new giving vehicle?" You respond that based on what you remember from your review of her financial statement and tax situation last year that the client could fund a family foundation with around $1 million in publicly traded stock. And then the client says, "Sounds good, I am late for a meeting, so when can I have this thing up and running?" You try to explain that it is not that simple, but the client says goodbye and hangs up the telephone

What Vehicle Does the Client Need For A Family Philanthropic Adventure?

A client, like the one in the above example, who is starting on a family philanthropic adventure without considering what vehicles or information she needs to enjoy the trip may find the journey a little bumpy. A successful family foundation is generally realized through a combination of advice and experience. In the above example, the client is just starting a family foundation and, like many clients, does not have any previous experience from which to draw. Therefore, the client will rely on the advice she receives from her advisor.

An advisor who is involved in a family foundation creation should consider his or her responsibility in making sure the client's new family foundation is in a position to succeed. Of course, it is unrealistic to expect a client to resolve every issue before creating a family foundation, but by providing a client with what amounts to an introduction to the family foundation world they will at least be aware of the issues. Advisors who help prepare their clients for any surprises will find their clients not only survive the journey, but also enjoy it.

The remainder of this article is a suggested memorandum in response to this client's year-end inquiry. Its purpose is to provide the client with an adequate amount of knowledge to make an informed decision regarding the creation of her family foundation. It is not intended to act as a legal compendium.

Preparing A Client For The Philanthropic Adventure

MEMORANDUM

To: Client
From: Advisor
Re: Starting a Family Foundation

Simply put, your family foundation will act as family "business" unit. Its primary purpose is to provide funding for charitable activities that interest you and other family members (board members). Your foundation's secondary purpose will be to involve your family members in an organized giving effort. A family foundation, like your business, is a formal structure that is governed by federal and state laws and regulations. The laws and regulations depend on the type of entity or vehicle you and your family selects to use. Most family foundations make gifts (or grants) to charitable organizations that carry out a charitable activity. For example, a family foundation interested in helping the homeless would probably provide money for a charity working with the homeless rather than directly providing services to homeless persons.

This memorandum is designed to help you better understand family foundations. It provides an introduction to family philanthropy and foundations; points out the different forms family foundations take; and reviews some of the issues that you and your family will want to consider when creating your foundation.

Ultimately, your family foundation will evolve into something that reflects your family and your family's values. Family foundations, by nature, develop their own style. For example, some foundations employ staff and use a very structured approach to giving, while others use the kitchen table to discuss where it will give money each year. Both styles work, it just depends on what your family wants to accomplish, and how it wants to accomplish it. There some issues that family foundations have in common, and while different family foundations may have different solutions to the same issue, it is important that you have some idea about what you are starting.

One attractive element of a family foundation is the tax benefits it affords. The government acknowledges the importance of your contribution to charity with an income tax deduction (the amount of the deduction varies depending on a number of different factors). While the media and tax advisors spend a lot of time focused on the tax benefits of charitable giving, a successful family foundation is about much more than taxes. This memorandum will only touch on the tax benefits.

What Is Family Philanthropy?

Although it has no formal definition, family philanthropy is commonly thought of as the deliberate blending of individual family members' interests and concerns into a common vision or "story," followed by implementation of a strategy intended to accomplish the family's common objectives.

Family involvement is a critical element for successful family philanthropy. The process of crafting a collective philanthropic purpose is not always an easy process, but if individual family members are allowed to communicate their personal interests, generally a family can find at least a couple of areas on which to focus. Often times, a family foundation will be dominated by its founder or the founder and his or her spouse. When this happens, the next generation family members are less likely to involve themselves in the foundation because it does not include their interests. Creating an environment that gives each family member an equal voice leads to a better experience for all family members.

Family philanthropy is not always successful. A family with communication problems will find that philanthropy may accentuate the problem rather than make it better. Family relationships are complicated and should be considered as a family enters into a philanthropic venture.

What Is A Family Foundation?

A family foundation is an organized giving effort. There is no legal term called family foundation and no mandated form. Historically, a family foundation is associated with what is called a private foundation (technically, most family foundations are organized as private nonoperating foundations). This means they do not conduct charitable activities themselves; rather, the make annual financial grants to charitable organizations. In the last 10 years, family foundations in the form of donor advised funds and supporting organizations have become very popular. These two forms were once thought of as private foundation "alternatives," but you will find that donor advised funds and supporting organizations provide tax and non-tax benefits that are not available to a family foundation organized as a private foundation, and therefore, it is recommended that you consider all three as viable options. A longer discussion of these three vehicles appears below. Regardless of which type of family foundation you choose, many of the same issues discussed in this memo apply.

The Council on Foundations, an association that counts family foundations of all sizes and types among its membership, reports that family foundations organized as private foundations "hold an estimated $86 billion in assets and make around $5 billion in grants (gifts) per year." It also reports that most family foundations have less than $5 million in assets. These statistics do not include family foundations organized as donor advised funds or supporting organizations. Many industry observers would probably agree that family foundations organized as advised funds in community foundations and other public charities and supporting organizations are growing at the same rate.

Foundation Purpose

Many clients start a family foundation without considering its purpose. Imagine starting a new business without a purpose. It is recommended that you consider purpose and discuss it with the family members you envision participating in the family foundation. A short purpose, or mission statement, regardless of how basic and broad it is, will help guide the rest of the foundation start-up process. For example, if you are considering an organization that focuses on economic development in a foreign country, it may effect the start-up strategy and entity type. Defining purpose may prove difficult. Some clients browse the newspaper for issues that they might be interested in supporting while other clients have issues that have touched their families (for example, cancer). Your foundation's philanthropic interests will change over time-that's a given-but by thinking about your foundation's original purpose you will have a very good starting point.

One strategy to determine a philanthropic purpose is to "test-drive" philanthropy before creating a formal vehicle. You could set aside a specific dollar amount for giving and then meet as a family to decide how and where to spend these charitable dollars. In the first family meeting you may want to encourage each family member to describe one issue they feel strongly about, such as the environment, and why the family foundation should support an organization in that area of interest. In the second meeting family members can bring ideas about which organizations they feel should be supported. This experience may help your family think more about the foundation's purpose. Since you have decided to create your family foundation at year-end, there is not enough time to use this strategy, but it may prove useful for starting up your foundation's giving program.

Governance

As founder, you will need to consider how to select family members to participate in the family foundation. Most often, a family foundation will include all immediate family members. This becomes more difficult as the family grows from children to grandchildren to great grandchildren. Creating a plan for ongoing family involvement in the foundation's giving activities is important so that other family members understand how the foundation operates, and so they all have an opportunity to participate. Of course, this process does not need to be in place to start your family foundation.

Another consideration is if you are going to include non-family members in the family foundation. It is a strategy that some family foundations have used very successfully to enhance the overall experience. Non-family board members may include trusted friends, experts in specific giving areas (for example, a biologist familiar with environmental issues may fit into a family's giving purpose), or business associates. Non-family board members can prove valuable in focusing the foundation on giving and keeping family quarrels outside the foundation's business.

The different types of family foundations require different approaches to governance. A family foundation organized as a private foundation will require a board of directors in a formal sense. A family foundation created in the form of a supporting organization will also require a formal board, but it will probably have non-family board members involved. And finally, if you create your family foundation in the form of a donor advised fund, you will probably create an advisory committee since a formal board is not a requirement. All three can feel the same. It is important that while all three might feel alike, all three have different legal standing and requirements.

If you are thinking that your family foundation will continue for several generations, you will need to consider how to grow the family's philanthropic leadership talent. You will find more information about this subject later in this memo under the succession planning section.

Management

After determining which family members will participate in the foundation, you will want to consider how to manage it.

Management questions include:

  • Will professional staff manage the foundation?
  • Does the foundation want to hire a family member to manage the foundation?
  • If there is no intention by the foundation to hire staff, who will manage the foundation?
  • How will the foundation identify organizations and causes?
  • Will the foundation have formal policies regarding board involvement or grantmaking?

Like any organization, there are many management questions for a family foundation to consider. A foundation that intends to give to the same charities that its family (board) members have had long-time relationships with will not face the same management challenges as a foundation that intends to make charitable grants for economic development when a family has no real background in the issue area.

Management takes various shapes. In some cases, a client will think about the management issues and decide to select the vehicle with the least amount of management. In other cases, a client wants family members to learn how to operate a formal structure.

Vehicle Selection

Vehicle selection is a key element for successful family philanthropy. As discussed earlier, clients generally select to organize their family foundation in one of three ways: as a private foundation, as a donor advised fund, or as a supporting organization. All three have advantages and disadvantages. It is important that you consider your family foundation's goals and then review the vehicle types.

One issue that deserves special attention is control. The three primary vehicles, as mentioned above, will provide you with varying degrees of legal control. There are two levels of control to consider: the gift level and the vehicle level. At the gift level, once you have made a contribution to any of the philanthropic family vehicles, those assets are now for charitable purposes only. It is an irrevocable gift that must be used for the public good.

At the vehicle level you will find varying degrees of legal control. The private foundation allows for the most control, but the trade-off for control is added government regulation and less advantageous income tax deductibility. The advised fund and supporting organization do not allow a donor the same level of control as a private foundation, but both vehicles offer higher tax deductibility and less government regulation. You should focus on the start-up issues and then consider how important the control factor is for your family foundation. Clients will often focus entirely on the control issue and then later realize there is more to a family foundation than just control.

The following is a summary of all three family foundation vehicles:

Family Foundation As Private Foundation

The private foundation, as mentioned earlier, is the historic favorite of charitably minded families and still holds a special place in philanthropic circles. A family foundation organized as a private foundation will generally retain the family's name (Smith Family Foundation) and is a separate entity for tax purposes; therefore, it requires an annual tax return. It also requires a formal board of directors (or trustees). The board may consist of all family members (of course, non-family members may be involved) and the board is responsible for all decisions regarding the foundation.

One long-held view in the foundation world is that there is a specific threshold dollar amount associated with starting each family foundation type. This is a distraction that you should put away for now. When you were starting your first business did you focus on how much the form would cost you or did you find the form that would help you meet your objective? You want to identify the form that you and your family are happiest with and then consider the costs associated with its operation. A more cost-efficient structure may provide cost savings, but if the form does not work then the cost savings will all be for not.

The private foundation form provides a formal structure that allows your children to participate as equals and may be used to teach them about issues such as finance and policy setting. They will also have the opportunity to learn about how you allocate assets when your resources are limited. All of these activities can be accomplished in the other forms, but since the private foundation is "wholly-owned" by the family, many clients find it the most attractive.

A private foundation is governed by federal and state regulations. You might say the government allows your family to have its own private charity, and affords an income tax deduction for gifts to your foundation if you follow specific rules. The rules governing private foundations are generally regarded the most onerous of the three types of family foundations. While the rules may be more cumbersome than those governing the other two types of family foundations, they should not impede your foundation's success. The government enacted most of these rules in 1969, after it was discovered that a few private foundations were abusing the charitable status afforded them.

In recent years, there has been a tremendous growth in the creation of private foundations. One issue for families that have started a foundation is how to find charitable organizations doing work the family wants to support, especially small charities that do not have marketing budgets. This becomes an even harder task when a family is new to philanthropy and has little historical contact with charities. Families also discover that they will start to receive unsolicited inquiries for information about their foundation and for grant monies. This can be viewed as either a positive or negative development depending on your family foundation's objectives.

One area that many clients are interested in is anonymity. Clients think of the private foundation as family-owned and therefore "private." In reality, a private foundation must make its tax returns available to the public, and therefore, information about the foundation may become known that a family would prefer not be disclosed. Cachet is also a consideration for some families starting foundations. Some clients like the idea of having their own foundation controlled by the family. For other families, this is not an important issue. Again, it depends on your objectives.

Family Foundation As Donor Advised Fund

A donor advised fund is a family foundation that is established within another charitable organization. In general, most clients establish family foundations organized as an advised fund within a type of charity called a community foundation. A community foundation specializes in helping its donors find charitable funding opportunities and providing opportunities for its donors to learn about specific issue areas. Other types of charitable organizations such as hospitals and educational institutions also sometimes offer advised funds.

While a family foundation created as an advised fund within a charity can retain a name selected by you or your family (Smith Family Foundation or Fund), because an advised fund is a fund of the charity, you and your family do not legally control it. Instead, you and your family retain the right to make ongoing recommendations regarding the charities your family foundation supports. The charity in which you establish an advised fund within is responsible for determining whether you and your family's grant recommendation is proper and fits into the charity's greater purpose. At first, clients find this situation problematic, but they soon discover that a charity offering advised funds is not attempting to dampen the family's enthusiasm to make grants to qualified charitable causes and organizations, but is complying with government regulations (just like private foundations have rules, advised funds also have rules).

The upside to an advised fund is that the charity you start your foundation within will have a staff waiting to help you and your family. This generally means less of you and your family's time is devoted to management and administration, and more time is available to focus on giving. The charity may charge a modest management fee for these services (deducted from your foundation or fund). As you can probably imagine, the advised fund option is a good one if you believe the charity you are working with has the services and is the type of organization that will enhance you and your family's foundation experience. You need to be comfortable with the philosophy, track record, and services of the organization.

One growing trend among charitably minded clients interested in starting family foundations is to establish both a private foundation and an advised fund. This is a very effective strategy if the charity that you work with has a program that provides information about potential giving opportunities. Some clients with advised funds work with the charity to learn about a particular area of interest, such as education, and then start making grants from both their private foundation and advised fund in that interest area. Another strategy is to create separate advised funds for your children so they can explore their own interests with the staff of the charity. This allows your children to develop their own "philanthropic voices" and they can also bring what they learn to the private foundation discussions. A third reason for starting an advised fund is often the anonymity that it provides. A grant can be made from an advised fund without the recipient ever knowing it came from your foundation. Many articles on this subject discuss "selecting" a vehicle for your family foundation. In some cases multiple vehicles is the way to approach starting a family foundation.

Family Foundation As Supporting Organization

A family foundation that is established in the form of a supporting organization is more complicated to explain than either the private foundation or advised fund. It is a separate entity much like a private foundation and therefore has its own board of directors and has to file a tax return annually. The costs associated with starting and running a family foundation organized as a supporting organization are similar to those for private foundations. But because a supporting organization has an ongoing relationship with a public charity or charities, a supporting organization is afforded the same favorable income tax deductions as a gift to an advised fund. A supporting organization is also not governed by the private foundation regulations.

The key difference between a private foundation and a supporting organization is that with the latter, operating control must vest with one or more public charitable organizations. One common way of structuring a supporting organization is to simply name a majority of board members from a local charity. In other words, the organization could have three family members and four representatives from a local charity and qualify as a supporting organization.

Your family foundation as a supporting organization provides you with your own entity but in the model discussed above, you and your family will not control the entity. The trade-off for control is that you have the resources of the charity that you support waiting to help you and your family start your foundation. Many clients find this type of family foundation attractive because they have the ability to customize their philanthropic experience, but can rely on the charity(s) the foundation supports to help manage the foundation's activities.

A supporting organization operates more like a private foundation (without the control) and provides a formal structure for children to learn within. Because it is a separate organization, a supporting organization has the same cachet of a private foundation. Again, you will need to consider what you and your family are trying to accomplish.

Tax Planning And Vehicle Selection

The amount you can deduct for income tax purposes for gifts to family foundations varies depending on the type of foundation you choose. These rules are very complicated; however, they can be summarized as follows:

Gifts to donor advised funds and supporting organizations are treated the same as gifts to public charities. This means you can deduct up to 50% of your adjusted gross income for gifts of cash and 30% for gifts of long-term capital gain property. Also, in general, gifts of long-term capital gain property are deductible based on their fair market value at the time of the gift.

Gifts of cash to a private foundation are limited to 30% of your adjusted gross income and gifts of long-term capital gain property further reduced to 20%. It is also important to note that with the exception of publicly-traded stock, gifts of long-term capital gain property to private foundations are limited to the lesser of fair market value or your cost basis in the property.

Gifts at your death to any of the three vehicles do not produce income tax deductions, but are fully deductible for estate tax purposes without limit regardless of the type of foundation you select. This sometimes causes a client to use one vehicle (advised fund or supporting organization) while he or she is alive and another one vehicle when he or she is planning for gifts at death (private foundation).

Preformation planning should focus on you and your family's philanthropic objectives and then blend in your tax planning needs. For example, if you are interested in the idea of starting your own organization and your wealth is held primarily in nonpublicly traded stock, it would be recommended that you consider starting your family foundation as a donor advised fund or supporting organization (a gift of nonpublicly traded stock to a private foundation is deductible at cost basis only whereas a gift of such stock to a donor advised fund or supporting organization is generally deductible at fair market value).

Education, Resources, And Networking

There are a growing number of organizations that are working with families to create both formal and informal networks for discussions about common challenges and programs. There are many strategies that can be taken to meet other family foundations. Some clients attend meetings that local charities organize for family foundations. Other clients attend national conferences for family foundations. You will find that other family foundations are interested in sharing their experiences. It is highly recommended that you spend some time with other family foundation members to discuss how they operate before you move to far along in the process.

Grantmaking

Many new family foundations start-off by making grants to charitable organizations that your family members have long supported. At some future point, your family foundation may want to identify new giving opportunities. You will also need to decide whether you will accept applications from local charitable organizations as they hear about your family foundation.

Some clients discover the process of finding new charities to support is difficult, while other clients complain about how their giving has little focus and makes little difference. These are some of the challenges that all family foundations face.

Succession Planning

Succession planning is not a topic most clients consider when they are creating a family foundation. Although it is not a primary concern as you start your family foundation, it is an issue you will need to eventually discuss with other family members. A family foundation may be created to operate in perpetuity, or it may be created to exist only while the founder generation is alive (or somewhere in between). Succession planning generally depends on the next generation family members' interest in involving themselves in the foundation.

Many founders think the idea of a perpetual charitable entity is attractive. The problem is that family philanthropy becomes more difficult as the family grows in size and spreads out across the country. As time passes, and your family grows, many of your heirs in succeeding generations will not have known you personally, and therefore, will not have the personal connection you may desire to carry out your charitable largess. You should ask yourself if you would be interested in participating in a family foundation created by your great grandfather or great grandmother. If the answer is no, or maybe, then having a plan to close the family foundation, and for distributing the money to charities, may prove helpful to future generations.

Conclusion

As you can see, there are many factors to be considered in selecting which type of family foundation is best for you. It has taken you many years to create your wealth. Although it doesn't take that long to give a portion of it away, the decisions regarding how you do so take time and must be carefully weighed against their alternatives.

Given the fact there are less than three weeks left in the current tax year, it would be difficult for you to make a truly informed decision and for your advisors to create a private foundation or independent supporting organization. As a starting point, however, you may wish to consider meeting with the charitable organizations you currently support to find out the resources they offer in connection with the creation and management of family foundations. You may then want to make outright year-end charitable gifts to the organizations you wish to support that will optimize your income tax benefits for this year with a view towards formalizing the creation of your family foundation in the early part of next year.

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