The Pros and Cons of Starting a Foundation

Charity is an industry like any other. It has competitive aspects, and a beginner in the non-profit business must be wary of all the same pitfalls and dead ends as for-profit startups. The key requisite for a non-profit is the question of tax-exempt status, which involves dealing with the IRS, and that is never easy. The essence of non-profit tax exempt status, or 501(c)(3) status as it is more commonly known, is to shelter charitable donation to the greatest extent possible from taxation. At its most basic, a private family foundation absorbs the funds or legacy of a single individual or family for the purpose of charitable distribution, and at a more complex level, a charitable trust or foundation accepts donations from other 501(c)(3) organizations, raises funds from the general public, and runs and operates programs.

There are multiple subdivisions in between, but at its most basic, these are the questions that you need to consider as you begin to plan the formation of your organization.

1. What are you hoping to achieve?

If you simply wish to disperse your wealth to a variety of good causes at your own discretion, but under the management of a much lager foundation structure, then perhaps a Donor Advised Fund is the answer for you. The National Philanthropic Trust defines a Donor Advised Fund as:

A donor-advised fund, or DAF, is a philanthropic vehicle established at a public charity. It allows donors to make a charitable contribution, receive an immediate tax benefit and then recommend grants from the fund over time. 

This offers a safe, reliable and trouble method of dispersing funds to worthwhile causes, but it lacks the flexibility of a more formal trust or foundation. Perhaps the key limitation is that funds can only be distributed to other 501(c)(3) organizations, and does not allow the donor to start and operate specific programs of his/her own choosing.

If, on the other hand, you are looking for a means to distribute grants and donation more creatively, for example to fund scholarships of entertain grant proposals, or even to support individual suffering hardship, or with specific aims and objectives, but at the same time you are not considering fundraising as an activity, and nor perhaps running your own programs, then a Private Family Foundation would suit you better. A Private Foundation is defined by investopedia as:

A private foundation is a nonprofit organization which is usually created via a single primary donation from an individual or a business and whose funds and programs are managed by its own trustees or directors. As such, rather than funding its ongoing operations through periodic donations, a private foundation generates income by investing its initial donation, often disbursing the bulk of its investment income each year to desired charitable activities.

And then finally there is a Public Charity, which conforms more to the general perception of what a charitable non-profit organization is. It’s functions on many levels do not materially different from a private foundation other than its reliance on on contributions from the general public. Donations to public charities are tax deductible. As a general rule, organizations that are classified as public charities tend to be those that

  • Are churches, hospitals, qualified medical research organizations affiliated with hospitals, schools, colleges and universities,
  • Have an active program of fundraising and receive contributions from many sources, including the general public, governmental agencies, corporations, private foundations or other public charities,
  • Receive income from the conduct of activities in furtherance of the organization’s exempt purposes, or
  • Actively function in a supporting relationship to one or more existing public charities.

There are in fact 28 different types of non-profit organization recognized by US tax laws, but from the point of view of a private donor or a small organization, a Private Foundation or Public Charity are the most commonly acquired. It is perhaps worth noting that the IRS classifies any 501(c)(3) organization as a private foundation until such time as it displays and proves the characteristics of a Public Charity.

2. The First Steps

Having identified the route that you wish to pursue, the next step is to know what you are dealing with. If you plan to place the entire matter in the hands of an attorney or a CPA, then the technicalities of incorporation and tax-exempt applications will be taken care of, but it still helps to know what you are dealing with, so research the matter thoroughly. There is a wealth of information online, some of it contradictory, some overly technical, but a few hours of searching and reading will help you get a grip of what is required, and what can practically be achieved by yourself.

Most professionals will overstate the difficulties for obvious reasons, but the fact is the process is essential quite simple. Incorporation and application. Establish your trust or corporation, and submit an application for 501(c)(3) recognition. The IRS is never in a hurry to exempt organizations from tax, so will make you work for your approval, but so long as you keep your objectives standard and the manifesto very general, you should ultimately be able to navigate the process with a minimum of difficulty.

So therefore, even if you choose to hire a professional, research the question and understand all of the facts.

There is, however, a third option to either hiring a professional or navigating the route yourself, and that is the boilerplate option of using one of the many foundation websites that offer incorporation and IRS tax-exempt recognition at varying prices and with varying levels of guarantee. These, however, do tend to be formulaic, and will not offer much out of the ordinary. The advantage is that the process is simple, and affordable, and the technicalities are taken care of by folk who do it frequently and know what is required. Most of the options out there are standard, although prices vary considerably. Consider:

There are, of course, a number of others, but the service that each provides is essentially the same.

Then What?

Typically, once your corporation or trust has been established, and your application for tax exempt status has been submitted, it is simply a matter of waiting. There will almost certainly be some follow up to deal with.


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