What are the differences between private foundations and donor-advised funds?

Private foundations and donor-advised funds (DAFs) are two commonly used philanthropic vehicles that play crucial roles in the world of charitable giving. Each of these vehicles bears distinctive advantages and drawbacks, but what is the pivotal distinction between them when we step back for a broader view? Private foundations excel in fostering collaborative philanthropy by assembling teams, while DAFs shine in facilitating individual giving and individual charitable decision-making. Understanding the unique strengths and key differences between these entities allows prospective philanthropists to select the charitable vehicle that best aligns with their aspirations and requirements.

What is the case for private foundations?

Private foundations provide a robust platform for establishing a structured and enduring approach to philanthropy, emphasizing collaboration and teamwork. A private foundation offers the opportunity to create a distinct charitable entity with its own board of directors or trustees, an invested endowment, and the potential for paid employees. However, this flexible structure also means that private foundations come with increased administrative responsibilities and compliance obligations.

Within the structure of a private foundation, the composition of the team is flexible, spanning from immediate family members to a more expansive organizational structure. This structure can include well-developed operational systems, complete with a considerable workforce of hired employees, each playing specialized roles to ensure the foundation's effective functioning. The scale and sophistication of some of the largest foundations are nothing short of remarkable. Take, for instance, the Gates Foundation, which boasts over a thousand employees and harnesses cutting-edge operational methods and technology. Their rigorous approach entails not only substantial investment in evaluating potential grants but also meticulous monitoring of grant outcomes through careful record-keeping and thorough analysis. Naturally, many foundations operate on a more modest scale, with the majority being small entities driven by the original contributor and closely associated family members.

What is the case for donor-advised funds?

Donor-advised funds offer distinct advantages to potential philanthropists seeking a more individualistic and streamlined approach to giving. Typically, donor-advised funds revolve around a solitary individual or a married couple who possess the authority to initiate grants. While extending authorization to additional individuals is feasible (often including the donor's adult children), each person generally wields equal influence and can independently initiate actions. However, it's crucial to note that donor-advised funds are restricted from hiring employees and incurring operating expenses, including conducting due diligence on potential grantees. In the context of DAFs, the deliberation involved in grantmaking tends to be less rigorous compared to private foundations. Giving through donor-advised funds often resembles a straightforward check-writing exercise. Donor-advised funds particularly stand out due to their streamlined setup procedures, cost-effective ongoing administration, and more flexible regulations when it comes to deducting contributions for tax purposes.

Features of Private Foundations

Private foundations provide a formal legal structure for creating an enduring organization that can endure into the future. Private foundations allow deep family involvement that can extend to future generations.

• Private foundations are frequently used to establish robust organizations, complete with hired personnel and intricate operational structures.
• Private foundations remain open to receiving additional charitable contributions at any time allowing the donor to claim a tax deduction. The charitable income tax deduction associated with private foundations is subject to more stringent limitations compared to donations made to DAFs. Cash contributions are deductible up to 30% of the individual's Adjusted Gross Income (AGI), whereas the deductibility of contributions involving appreciated securities is limited to 20% of AGI. Any remaining unused deduction can be carried forward for a span of up to five years.
• Private foundations often boast larger endowments. They also generally find it easier attract more substantial gifts from third parties.
• Private foundations offer remarkable grantmaking flexibility, encompassing a range of options that extend beyond grants to officially recognized public charities. These options include prize programs, individual assistance, grants to international charities.
• Private foundations grant a high degree of control over the allocation of endowment investments, offering a diverse array of possibilities. This includes the ability to invest in public securities, private equity, hedge funds, and even privately held businesses.
• Private foundations are subject to an annual distribution requirement that is approximately 5% of their asset base.
• Annually, private foundations are required to submit a mandatory tax return (Form 990-PF) that calculates and assesses a 1.39% excise tax on their investment income.
• Private foundations are responsible for covering their own administrative and operational expenses, the extent of which can vary significantly based on the foundation's size and scope.
• Information about grants provided by private foundations is accessible to the public and can be located within the foundation's tax return on Form 990-PF. Although private foundations have the option to request confidentiality for donor names in grantee reports, they are obligated to include the grantee's name in their own publicly accessible Form 990-PF.

Features of Donor-Advised Funds (DAFs)

• DAFs excel in their role as uncomplicated and cost-effective channels for charitable contributions. However, they are not conducive to establishing substantial organizational structures. Within a DAF, the donor retains advisory privileges, empowering them to make individualized decisions regarding the distribution of funds within the account.
• DAFs offer a straightforward creation process, often requiring an initial contribution as low as $1,000. In contrast to the process needed to set up a private foundation, the steps involved in setting up a DAF are considerably simpler.
• DAFs typically incur lower administrative costs compared to private foundations, although certain sponsoring organizations may have higher fees. From an administrative standpoint, managing a DAF is notably straightforward, largely due to the fact that the sponsoring organization is responsible for tasks such as compliance and record-keeping.
• DAFs can receive additional contributions at any time allowing for additional tax deductions. However, it’s rare for a DAF to receive charitable contributions from anyone other than its founder. Contributions made to DAFs enjoy more lenient charitable income tax deduction rules, aligning with the same regulations that apply to donations made to public charities. Cash contributions can be deducted up to 60% of Adjusted Gross Income (AGI), while deductions for contributions of appreciated stock are capped at 30% of AGI. Moreover, any remaining unused deduction can be carried forward for a span of up to five years.
• With a DAF, the donor's authority extends solely to offering recommendations to the sponsoring organization regarding grants to public charities. It's important to note that while the sponsoring organization consistently upholds these requests and exceptions are extraordinarily uncommon, the recommendations themselves do not hold legally binding authority..
• The investment options accessible to funds within DAFs are typically narrower compared to those available to private foundations, as the range of investment choices is dictated by the sponsoring organization overseeing the DAF.
• DAFs are not required to meet an annual specified minimum payout obligation. This contrasts with private foundations which must adhere to a 5% annual payout requirement. This gives DAFs the freedom to provide grants on a more flexible timetable.
• DAFs provide a measure of privacy, enabling donors to give discreetly if desired. The DAF donor usually has the choice to decide, grant by grant, whether the gift remains anonymous, confidential, or publicly acknowledged. However, it's important to note that creating a completely untraceable gift, even through a DAF, is challenging. Rigorous external research, especially for large grants, might uncover the donor's identity.

Which Vehicle Suits You Best?

Private foundations and donor-advised funds present distinct attributes and advantages, making them invaluable tools for philanthropy. Your optimal choice depends on your individual circumstances, as both avenues hold considerable merit.

Importantly, this doesn't have to be an "either-or" decision. You have the opportunity to strategically leverage the strengths of both mechanisms in tandem. Consider individuals or families seeking to maximize tax deductions for charitable contributions in a given year. They can intelligently allocate a portion of their donations to a private foundation, which operates under lower deductible contribution limits. Concurrently, they can direct any additional contributions to a donor-advised fund, benefiting from its higher deductible limits.

Moreover, private foundations can seamlessly extend their philanthropic reach by integrating donor-advised funds. Although a well-defined mission aids foundations in focusing their efforts and magnifying their impact, this mission isn't legally binding unless formalized in governance documents. It's common for private foundation donors to expand their giving scope to address various societal needs. Donor-advised funds come to the forefront when foundations wish to streamline off-mission grants, reducing the likelihood of grantseekers approaching the foundation with non-mission-related requests. Furthermore, private foundations can also utilize donor-advised funds strategically to maintain confidentiality for certain grants that they prefer not to publicize. This can be particularly useful when providing support to controversial causes that may attract public scrutiny.

Ultimately, the decision between private foundations and DAFs rests on individual preferences, aspirations, and goals. By thoughtfully assessing the unique strengths of both options and harnessing their complementary advantages, philanthropists can craft a multifaceted strategy that maximizes their ability to create a multifaceted strategy that optimizes their capacity to foster positive and enduring impact on the world.

Seeking expert guidance? We're here to help!

At CPA KPA, we're passionate about magnifying the positive impact of private foundations. Feel free to reach out to us anytime at 888-402-1780 for a complimentary and obligation-free conversation. You can also conveniently submit your questions and inquiries through our contact page. Let's connect today and explore how we can help your foundation have a lasting and meaningful impact!