ELITE ADVISOR BEST PRACTICES
The Family Foundation of Choice - Part Two
Potential benefits of private foundations over donor advised funds
By Michael King
- For some families, a private foundation may be a better solution than a donor advised fund for meeting their charitable and family goals and objectives.
- Private foundations provide the greatest level of control and influence over foundation activities, including charitable grants and investment of the foundation’s assets.
- Private foundations permit family members and others to receive reasonable compensation for the services they provide to the foundation.
In Part One of this series, we reviewed 11 key reasons that donor advised funds (DAFs) can be attractive alternatives to private foundations (PFs). Here we’ll explore the potential benefits of a PF over a DAF.
There are primarily two factors or considerations—control and compensation—that might cause an individual or family to select a PF over a DAF. A PF allows givers to exercise the greatest level of control, oversight and direction, compared with any other charitable vehicle that an individual or family might use to facilitate their giving. This factor might be of particular importance to a giver who desires (or requires) maximum control over the wealth they have accumulated—whether still retained by them, or whether transferred to others in the form of gifts to charity or family (most commonly children). Because a giver can appoint 100 percent of a PF board, the giver effectively has direct control and final decision-making authority over all aspects of the PF. For example, all grant decisions and investment decisions may ultimately be determined by the giver.
A DAF, on the other hand, removes such direct control and oversight from the giver. Although the giver maintains advisory rights on grant and investment decisions, the ultimate decisions are legally vested in the organization that provides the DAF platform. A giver may advise the DAF sponsor to make a grant to a specific qualified charity, in a specific amount and at a specific point in time. However, the DAF sponsor is not legally obligated to honor such advice or requests, though as a practical matter, most DAF sponsors do in fact honor such requests in the vast majority of situations.
However, some DAF sponsors have restrictions on the charities to which they will distribute grants. For example, some DAFs that are sponsored by community foundations will not honor grant requests to charities that reside outside a designated geographical area. Other community foundations will not honor grants to faith-based organizations. Some DAF sponsors require that a certain portion of assets contributed to their DAF platforms be distributed to the DAF sponsors themselves. For example, a college or university that sponsor’s a DAF platform might require that at least 40 percent of the contributed assets are distributed to the institution, thus allowing the remaining 60 percent to be distributed to any number of other charities. DAF platforms that are sponsored by faith-based organizations will often allow grants to charitable organizations that are NOT faith-based, but would generally prohibit distributions to charities whose mission, purpose or practices are antithetical to the traditional tenets of their particular faith.
Any grant restrictions imposed by a DAF sponsor are generally communicated to the giver prior to the establishment of an individual or family DAF. Therefore, for the vast majority of givers, the issue of control is not a factor of significant concern—especially in light of so many other factors that weigh heavily in favor of DAFs.
A second factor or consideration that may cause a giver to select a PF over a DAF is the desire to employ family members (including the giver) or others. A PF may directly compensate the giver, family members or others for services provided to the PF as long as such compensation is reasonable in light of the services provided. The determination of reasonableness will generally be a factor of the amount of time dedicated to the PF, the amount of the PF assets, the nature of the services provided, and the specific skills, experience and competency of the individual providing such services. Therefore, it is not feasible to provide compensation, for example, to children, without an exchange of legitimate services to the PF.
A DAF, on the other hand, is prohibited from providing direct compensation or distributions to any individual, including the giver or members of the giver’s family. However, there may be opportunities for a DAF to support a family member or other individual who wants to work in a charitable environment. This is most often accomplished through grants distributed by a DAF directly to a charitable organization that is employing, or will employ, the family member or individual. This approach may allow parents or grandparents to provide financial support to their children or grandchildren through their DAF without violating the prohibitions on distributions to individuals. Because the tax rules in this area are lacking in crystal clear guidance and authority, it is generally recommended that any such grants be made to the charity in an unconditional manner that does not legally bind the charity to use the funds in this manner.
When viewed through the lens of control and compensation, private foundations can offer several advantages over DAFs and other charitable vehicles. However, in the next installment of this article series, we’ll look at ways in which savvy givers and advisors are using both DAFs and PFs in conjunction with one another to maximize the benefits and flexibility of their charitable endeavors.