Private foundation, donor-advised fund or giving directly?

This guide is for donors and families who want to give in a bigger, more organized way, and for founders who hear "let's start a foundation" from a generous supporter. A private foundation is one way to do it, but it isn't the only one, and for many people it isn't the simplest. After reading, you'll know how a private foundation, a donor-advised fund and giving directly to charities compare, what each costs in money and paperwork, and which questions to take to a tax adviser.

This is general information, not tax or legal advice. Deduction rules depend on each donor's own situation and can change from year to year, so talk to a tax adviser before deciding.

The three options at a glance

Giving directly

The simplest option is to give straight to the charities you care about. There's nothing to set up and nothing to file beyond keeping records. For a gift of $250 or more, you need a written acknowledgment from the charity to claim a deduction. Our donor acknowledgments guide explains what it must say.

Giving directly suits donors who give each year from income, who already know the charities they want to support, and who don't need a family structure or a public name for their giving.

A donor-advised fund

The IRS describes a donor-advised fund as "a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization." It adds: "Once the donor makes the contribution, the organization has legal control over it. However, the donor, or the donor's representative, retains advisory privileges with respect to the distribution of funds and the investment of assets in the account."

In practice, you put money or assets into the fund, usually claim a deduction in that year, and then recommend grants to charities over time. The sponsor checks each charity and sends the grant.

Things to know:

• You give up legal control. The sponsor usually follows your recommendations, but it doesn't have to. Publication 526 says you can't deduct a gift to a donor-advised fund unless you have a written acknowledgment from the sponsor that it "has exclusive legal control over the assets contributed."
• Deduction limits follow public charity rules. Sponsors are 501(c)(3) public charities, so cash gifts generally count toward the 60% of AGI limit described in Publication 526.
• The sponsor's fees and policies vary. Compare minimum balances, fees, investment choices and any rules on how often you must recommend grants. We don't recommend any particular sponsor.
• Grants mustn't benefit you. The IRS warns about arrangements that provide "impermissible economic benefits to donors and their families" and can impose excise taxes on donors, managers and sponsors. Don't use the fund to pay for tickets, memberships or pledges that give you something back.

A private foundation

A private foundation is its own organization, with its own board, bank account and tax return. It gives families the most control and lets them hire staff, run programs and involve the next generation. It also comes with the most rules.

• A yearly public return. Form 990-PF must be filed "by the 15th day of the 5th month following the close of the foundation's tax year," and the instructions require the foundation to make its returns available for public inspection.
• A minimum payout. A private foundation that isn't an operating foundation must pay out its "distributable amount" each year in qualifying distributions. The Form 990-PF instructions say this starts from the minimum investment return, which is "5% of the total fair market value (less acquisition indebtedness) of its noncharitable-use assets." If it falls short, the IRS says there's "a 30 percent excise tax under section 4942 on the undistributed income," and "an additional 100 percent tax" if the shortfall isn't made up in time.
• A tax on investment income. The IRS says the excise tax is "1.39% of net investment income" for tax years beginning after December 20, 2019.
• No self-dealing. The IRS lists transactions between a foundation and "disqualified persons," such as its founders, big donors and their families, as self-dealing: selling or leasing property to them, lending them money, providing goods or services to them, paying them, or transferring the foundation's assets for their benefit. Get advice before any transaction between the foundation and a founder or family member.
• Lower deduction limits. Publication 526 puts most private non-operating foundations in its "second category" of organizations. Cash gifts to them are generally limited to 30% of AGI, and gifts of capital gain property to 20%. Gifts of appreciated property other than "qualified appreciated stock" may also be reduced.

Setting one up also means forming a nonprofit corporation or trust in your state, adopting bylaws and applying to the IRS for exemption, with legal and accounting help along the way. Our guide to forming a charity describes the steps; a foundation follows a similar route.

Which might fit?

• Choose giving directly if you give from income each year to charities you already know, and want no extra paperwork.
• Consider a donor-advised fund if you have a large one-off amount to give this year (from selling a business or property, for example) but want time to choose charities, and you're happy to give up legal control.
• Consider a private foundation if you'll give a large amount over many years, want your family to govern it, want to employ staff or run programs, and are ready for annual returns, payout rules and professional advice.

Many families use more than one: direct gifts for regular support, and a fund or foundation for larger, planned giving.

Questions to take to your adviser

1. How much do we plan to give, and over how many years?
2. Do we want legal control, or are advisory privileges enough?
3. Which deduction limits apply to us, given our income and the assets we'd give?
4. Are we giving cash, publicly traded stock, or other property such as real estate or a business interest?
5. Who in the family will do the work, and will anyone be paid?
6. How comfortable are we with a public annual return?
7. What happens to the money if no one wants to run it in 20 years?

Your checklist

• We've written down what we want our giving to achieve
• We've compared giving directly, a donor-advised fund and a private foundation
• We understand who would have legal control in each option
• We've checked the deduction limits for our gifts with a tax adviser
• If considering a foundation, we understand the payout rule, the excise tax and the self-dealing rules
• If considering a donor-advised fund, we've compared sponsors' fees and policies
• We keep written acknowledgments for every gift we deduct