Foundations, but with Juicier Tax Breaks
For many philanthropists, creating a family foundation is the ultimate goal. With a foundation, you are assured that your name and philanthropic vision will live on. In addition, foundations often wield more influence than even benefactors who write big checks. But before telling your lawyer to draft a foundation, consider this: You get better tax benefits from just handing a check to a charity.
As philanthropists have wised up to this downside of foundations, a similar charitable vehicle that boasts better tax benefits, the Supporting Organization, has become more popular. An SO doesn't have as much flexibility as a foundation does to change beneficiaries. That's because it must channel its money to one or more charities that the donor names up front in the SO's charter. Also, a donor is not permitted to control an SO's board. But in return for giving outsiders a bigger role, the Internal Revenue Service gives you better tax breaks.
An SO has much of the appeal of a foundation. You can name it after yourself or your family; you can even call it a foundation. You can also wield influence over funding decisions by naming relatives to the board and requiring that the seats stay in the family.
As is the case with foundations, establishing and maintaining an SO can be expensive, so unless you have $500,000 or more to donate, it won't pay.
The tax benefits are compelling. For cash gifts, you can deduct an amount equal to 50% of your adjusted gross income, vs. 30% for foundations. If you donate stock or real estate, you can deduct the equivalent of 30% of income, vs. 20% for a foundation. (If your gift exceeds these thresholds, you can carry over deductions in up to five subsequent years.) Moreover, in calculating your deduction, you can use the fair market value of any appreciated stock or real estate. With a foundation, publicly traded securities can be deducted at market value. But the deduction for all other assets--private stock, real estate--is based on what you paid.
The SO itself also enjoys better tax treatment. Whereas a foundation pays an excise tax--generally 2%--on its investment income, SOs have no such requirement. SOs can be more flexible, too. Foundations must distribute 5% of their assets each year. But an SO has more leeway to trim payouts if investment returns head south.
The biggest downside to an SO is that you have less control over how your money is invested and distributed. Those who fund SOs have to fill a majority of board seats with independent directors. Depending on which type of SO you create--there are three--that can mean ceding control to a charity (table). But donors can maintain influence by appointing friends and charitable administrators with whom they have relationships.
SOs also have less freedom to change beneficiaries than foundations, which can do so at will. SOs are limited to the charities or causes in their charters. Still, you can name several charities and decide whether to fund all, some, or just one each year. Or, if you select a community foundation that funds an array of charities, you can choose which to support. "Legally, they aren't giving me total freedom. But in practice, there is almost total freedom," says Randy Fertel, whose SO, The Fertel Family Foundation, benefits The Greater New Orleans Foundation.
Like foundations, SOs can be expensive to run. Accountants' fees for annual tax forms can run to $5,000--and expenses rise if you hire staff. But if you team with a community foundation, it might take care of the paperwork. Be prepared to pay $10,000 to $20,000 to file startup forms. If the IRS contests your application--and it has hiked its scrutiny of Type III SOs--the figure could hit $50,000, says Laura Peebles, a director at Deloitte & Touche in Washington, D.C. It sounds daunting, but creating a sustained legacy with serious tax breaks makes SOs worth exploring.
By Anne Tergesen