On this day that commemorates the life of Martin Luther King Jr., which many people observe through community service activities, I'd like to discuss how a family foundation can help your family business, as well as the community in which your business operates.
What is a "family foundation?"
A "public charity" is a charitable organization whose funding comes from the general public and/or the organization's operations related to its charitable purpose. In contrast, a "private foundation" is a charitable organization that does not qualify as a public charity because it is funded primarily by one source, such as one individual or one business, or a small group of related parties. "Family foundation" is an informal term that simply means a private foundation that is funded by, and managed under the supervision of, members of a single family.
A family foundation typically aggregates charitable gifts from family members and then makes grants to public charities that provide charitable services to the community that the family wants to support. Most family foundations do not provide charitable services directly to the public, but, rather, they support a broad range of charitable objectives that the family, acting on its own, could not otherwise pursue. For example, a family foundation could make grants to a community college for education, a hospital for health care, and a museum or performing groups for the arts.
Often, a family funds its foundation with sums well in excess of the grants that it might make to public charities in any one year. Generally speaking, the foundation must make average annual grants totaling at least 5% of the foundation's assets. The foundation's remaining funds are invested and managed, like an endowment, by the foundation managers, usually members of the founding family.
How is a family foundation established?
I recommend that you form your family foundation as a nonstock corporation, for reasons discussed below. You can create a nonstock corporation by filing articles of incorporation (a/k/a charter) with a state secretary of state's office.
In the articles of incorporation, you will name the initial foundation directors. They will convene a meeting to adopt bylaws, a conflict of interest policy, a mission statement, and other documents they deem necessary or advisable to govern and guide the foundation's activities. The directors will appoint officers, and the officers will file a simple form with the IRS to request a formal grant of tax exempt status.
The foundation then can accept financial contributions from family members, family business entities, and family trusts. The board will oversee management and investment of these contributions, usually with the help of an investment advisor. At least once a year, the board will approve grants from the foundation to one or more public charities.
What are the tax benefits?
I do not suggest a family foundation for the tax benefits alone, because there are easier ways to secure such benefits. True, lifetime contributions to a family foundation can qualify for a charitable income tax deduction, and testamentary bequests to a family foundation can qualify for an estate tax deduction. Also, the return on investments held in a family foundation are generally tax-exempt. All of these tax benefits, however, are subject to limitations that do not apply to a public charity or even a "donor-advised fund," which is an easier way to aggregate family charitable giving.
A donor-advised fund is like a family foundation, except that it is managed and administered by a public charity. The donor-advised fund can be designated with the name of the donor-family, and the donor-family can direct which public charities will receive grants from the fund each year.
From the standpoint of tax benefits alone, the donor-advised fund often is superior to a family foundation. This is not a trivial consideration. The charitable deduction against gift taxes or federal estate taxes can be a useful tool for planning the succession of wealth to future generations.
Nevertheless, a family foundation can provide non-tax benefits for family business succession that a donor-advised fund cannot truly deliver.
How does a family foundation benefit family business succession?
A family foundation is more complicated to manage than a donor-advised fund, but that is the reason why a family foundation can assist with family business succession. Participating in the management of a family foundation can give your children an opportunity to learn some basic concepts and skills that will be helpful to them when they transition into participation in your other family enterprises. Here are some examples:
● Mechanics of Board Service. Attending board meetings as a director of a family foundation can help your children become familiar with the mechanics of board service, including preparing for board meetings, participating in board meetings, and working with board minutes, proposals, and resolutions. Your children should develop these basic skills before they begin serving as directors on the board of your family business entities.
● Duties of Board Service. Serving as a director of a family foundation can help your children become familiar with concepts of fiduciary duties and conflicts of interest. Such legal and ethical concepts are important for them to understand before they start to serve on a family business board or family council.
● Financial Reporting. As foundation directors, your children will review financial reporting of public charities that are candidates for foundation grants. This will help them learn how to read financial statements and other performance reports of business-like entities, which will help them better understand the financial reporting they will need to analyze when they serve on a family business board or family council.
● Investment Portfolios. As foundation directors, your children will work with financial advisors who will teach them about investing and managing the foundation's portfolio of marketable securities. This will help your children become better stewards of their own investments and prepare them to serve as trustees of trusts that hold investments for other family members.
A family foundation can teach your children valuable skills that will help them transition into positions of ownership and governance in your family business. You may want to use a donor-advised fund for some charitable giving when the additional tax advantages are needed, but the greater complexity of managing a family foundation can be a benefit when working toward family business succession.
Photo Credit: "Capitol Sunrise: Wisconsin," Gregory Monday, Dec. 23, 2019