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Starting a Private (Family) Foundation: Operating Versus Non-Operating Family Foundations and What You Need to Know

When most people think of charity and fundraising, they think of public efforts such as a GoFundMe to account for a tragic loss of a loved one or a car wash for the high school volleyball team. They may also think of public entities like the Make-A-Wish Foundation and The Susan G. Komen Foundation. However, charitable giving can also be accomplished through a private foundation consisting of one individual, a family, or even a corporation.

Establishing a private foundation is an effective way to underscore the humanitarian issues you and your family care about. Foundations provide donors and families with a vehicle that spans generations and time to invest their philanthropic assets.

Over time, families might begin to narrow their foundation‘s vision with more direct goals. They can use their charitable dollars towards programs and services for a specific neighborhood, area of interest, or original research. Some examples of Colorado‘s 2,265 private charitable foundations include:

Charter School Growth Fund (CSGF)
Anschutz Foundation
The Colorado Health Foundation
Daniels Fund
The Cielo Foundation

What is a Private or Family Foundation?

Private foundations have a charitable mission just like their public counterparts. However, they don‘t receive public monetary support—a family, an entity, or an individual funds and controls a private foundation. Private foundations must abide by a strict set of rules that often have significant tax penalties for noncompliance. Usually referred to as the “Private Foundation Rules,“ they govern business transactions between specific parties such as founders, significant donors, managers, or family members. The foundation can generate sizable “taxes“ on the parties involved.

All private foundations:

Are for charitable purposes while providing donors with tax deductions based on their contributions

Have their own board of directors
Garner most of their financial support from and are generally controlled by their founding members
Are required to make charitable donations during their tax year
Are tax-exempt, with the exception that they are subject to a nominal excise tax of 1.39 percent on their net investment income

Generally, making grants to public charities are a private foundation‘s most significant endeavor, though they can also:

Manage programs, provide services, and lead direct charitable activities
Provide aid to individuals and families for hardship assistance and disaster relief

Operating vs. Non-Operating Private Foundations

Private foundations must be either operating or non-operating. An operating foundation primarily takes part in its own charitable activities. These foundations must be substantially and continuously involved in their projects to sustain them.

An operating foundation has direct charitable expenses through its projects instead of making grants to other organizations. For instance, an operating foundation might operate a library, museum, zoo, or research facility.

To guarantee that operating foundations are effectively and directly engaged in performing their charitable activities, the IRS requires them to spend at least 85 percent of their investment income on actively conducting their charitable operations, known as direct charitable expenditures. For example, instead of providing a grant to a food bank, an operating foundation could purchase food and supplies independently and hire its own delivery driver.

On the other hand, a non-operating foundation usually makes grants to charities and sometimes other private foundations. Most foundations fall under this category. They aren‘t focused on conducting independent charitable programs but on financially supporting those who do. Typically, the IRS requires non-operating private foundations to make annual distributions equal to approximately five percent of the previous year‘s average net investments. Distributions counting toward this requirement include:

Grants to charities and specifically related expenses (not including investment expenses)
Necessary and reasonable administrative costs

Seek Legal Help Creating Your Private Foundation Today

Forming a private foundation of any type is a noble pursuit. Unfortunately, such a quest is often a minefield of government regulation. To avoid stepping into one of these minefields and sabotaging your efforts, you need help from legal and financial experts.

Before forming your private foundation, it‘s imperative to speak with an attorney who has an in-depth knowledge of the Private Foundation Rules and experience working with private foundations. Using a lawyer for this process is the smartest approach. At Hackstaff, Snow, Atkinson & Griess, LLC, our seasoned legal team can:

Determine the best corporate and tax structure for your foundation
Provide legal guidance on board and management structure, operations, scholarship, international giving, and much more
Draft and file your Articles of Incorporation

Draft IRS-required bylaws and conflict of interest policies
Draft your IRS Exemption Application (IRS Form 1023) to include budgets, a statement of purpose, your mission statement, and a description of your program activities
Represent you in dealings with the IRS and manage all follow-up inquiries concerning your application