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Private Operating Foundation

Private foundations are often overlooked. You may have heard of a few — like the Gates Foundation — but you likely don’t think about them much. But flying under the radar doesn’t mean that these organizations don’t significantly impact the world. The Ford Foundation, to take just one example, has spent 54 BILLION dollars (adjusting for inflation) on charitable contributions since its inception, and it is currently spending ~1 billion dollars each year.

There are many different types of private foundations, but one that is growing in popularity is the private operating foundation (POF). Let’s take a look.

What is a Private Operating Foundation?

A private operating foundation is a type of non-profit organization. Expressly is a kind of private foundation typically set up by individuals, families, or companies who want to use their assets for charitable purposes. These purposes range from giving grants to other non-profits to running their charitable programs.

Private operating foundations have been a part of American life for over a century. The first U.S. POF was the Carnegie Foundation, established in 1901 by the Scottish-American steel magnate Andrew Carnegie. Carnegie created this foundation to promote education and scientific research, and the Foundation was at one point responsible for the creation of 80% of the public libraries in this country. Over the years, private operating foundations have become more common — they’re not just for steel magnates and railroad barons anymore — and are now used by individuals, families, and companies to support various charitable activities.

Benefits of Private Operating Foundations

One of the key benefits of a private operating foundation is that donations are especially tax-advantaged: In most cases, contributions are valued at the market value to determine your charitable tax deduction and allow you to write off up to 60% of your income (if donating cash) or 30% (for non-cash donations). These numbers are as large as the benefits of contributing to any charitable entity.

Additionally, private operating foundations have more flexibility than other non-profits regarding how they can spend their funds. This allows them to be more creative in their approach to charity work.

These benefits must be balanced against several downsides to private operating foundations. High administrative costs can be associated with running a foundation, and private foundations can be subject to greater scrutiny from the IRS than other types of non-profits.

What Is The Purpose of a Private Operating Foundation?

A private operating foundation can be used for various activities, including grant-making, advocacy, and program services.

  • Grant-making involves giving money to other charitable organizations to support their work.
  • Advocacy involves working on behalf of specific issues or causes to effect change. However, POFs are not allowed to engage in overt political activities.
  • Program Services involve delivering programs and services directly to those in need.

Because a private operating foundation is so flexible, you ultimately maintain significant control over how it spends the funds. You can gift donations to other charitable organizations or use their contributions to conduct charitable activities.

Why Might You Set Up a Private Operating Foundation?

There are several reasons why you might choose to set up a private operating foundation:

  1. Tax Benefits: A POF can receive tax-deductible donations from you or others.
  2. Flexibility In Spending: POFs offer an immense amount of flexibility when it comes to deploying funds. POFs can gift donations to other charitable organizations or use the donations themselves to conduct charitable activities.
  3. Fewer Administrative Costs: Because POFs can operate their charitable programs, they can use more of their donations for charity by avoiding donating to another non-profit which has its administrative costs

Having a private operating foundation will help you save significant money on your taxes and allow you to use those proceeds to benefit the charitable causes you care about most. Most people who choose to set up an operating foundation typically expect to run charitable programs themselves and stay in control of how their foundation resources are deployed.

What’s the Difference Between Private Operating Foundations and Private Non-Operating Foundations?

The core difference between an operating and non-operating private foundation is that an operating foundation is allowed to run its charitable programs. There are a few other differences as well:

Non-Operating Foundations:

  • Required to distribute annually at least 5% of the total fair market value of assets through grants to charitable causes
  • Limit the percentage of business enterprises it owns (essentially limited to cash and investment assets)

Operating Foundations

  • Must spend at least 85 percent of its adjusted net income or its minimum investment return (versus 5% of assets)
  • Can own business and non-cash or investment assets (generally, they have more leeway with the assets they own)

How Do Charitable Deductions Differ for Operating and Non-Operating Foundations?

Donations to private non-operating foundations are usually limited to 30% of your adjusted gross income (AGI) for cash and 20% of your AGI for other assets. Perhaps more critically, in practice, non-cash donations to non-operating foundations are valued at their cost basis (not their current or appreciated value), except for publicly traded stock which is deductible at its market value. This often means that your charitable deduction and tax write-off will be lower if you donate appreciated assets to a non-operating foundation.

Donations to private operating foundations, meanwhile, receive better tax treatment. In most cases, your deduction will equal the market value of donated assets, so you can take advantage of appreciation. The AGI limit is higher—you can deduct 60% of your income with cash contributions and 30% with non-cash donations. Accordingly, in most cases, your deduction will be more significant if you donate to a private operating foundation.

What Taxes Might a Foundation Pay?

There are a few different taxes that a foundation might have to pay. The most common is the net investment income tax. This tax is charged on the foundation’s net investment income, the income from investments less any expenses related to those investments. The net investment income tax rate is currently 1.39% or $1.39 on each $100 granted.

In addition, the IRS will charge an excise tax when a foundation transfers money out of its funds. This tax is typically paid by the grant recipient, not the foundation itself, and is used to help fund government programs. The excise tax is charged at a rate of 0.39%, meaning that for every $100 a foundation transfers out of its funds, the recipient will have to pay $0.39 to the government.

Next Steps

You have options when it comes to charitable intent and a desire to run a foundation. In most cases, individuals focused on their careers and maximizing their earnings will likely default to a private foundation, specifically a POF, because of the favorable tax treatment. A POF allows you to reduce your taxes, preserve your capital, manage your assets to your liking, and make grants or run charitable programs you deem worthy.

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