Latest / The High Net Worth Podcast with Fexingo: Wealth Management, Tax Strategy, and Affluent Finance / How Wealthy Families Use Private Foundations for Tax-Efficient Giving
Transcript
- Lucas: You hear about wealthy families giving away hundreds of millions, and a lot of that flows through something called a private foundation. It's not the only option, but for families that want control and a true family legacy, it's a powerful vehicle. Luna: We've talked about donor-advised funds on this show. What's the real difference? Lucas: Great question. With a donor-advised fund, you give the assets to a sponsoring organization like Fidelity Charitable or Schwab Charitable. You get the tax deduction upfront, but legally the assets no longer belong to you. You can recommend grants, but ultimately the sponsor has the final say. A private foundation is a separate legal entity — usually a corporation or trust — that the family controls. You and your family are on the board. You decide how the assets are invested, which charities receive grants, even how much the foundation pays in salaries. Luna: That sounds like a lot more than just writing a check. How does the math work out? Lucas: Let me walk through a concrete scenario. Say a family has a concentrated position in publicly traded stock worth $100 million, with a cost basis of maybe $10 million. They decide they want to give $10 million of that stock to their private foundation. First, they donate the stock directly — they never sell it, so they owe zero capital gains tax. The foundation then sells the stock tax-free because it's a charitable entity. The family gets a charitable deduction equal to the fair market value of the stock, which for a private foundation is capped at 30 percent of their adjusted gross income. If their AGI that year is, say, $20 million, they can deduct up to $6 million. The unused deduction carries forward for five years. Luna: So they avoid a huge capital gains event, and they get to write off a chunk of income. But do they have to give away all that money immediately? Lucas: No, and that's one of the trade-offs. Private foundations are required to distribute at least 5 percent of their net investment assets each year for charitable purposes. That's the minimum. So if the foundation holds $10 million, they need to grant out at least $500,000 annually. But they can hold onto the rest and invest it. The foundation's investment income is also subject to a 1.39 percent excise tax on net investment income — that was reduced from 2 percent a few years ago. Luna: Honestly, if today's conversation about how families use foundations to save on taxes and build a legacy was worth a coffee to you, that's the link — buy me a coffee dot com slash fexingo. It's how we keep the podcast ad-free and focused on concrete strategies like this. Lucas: Exactly. And listener support is what lets us dive into the details without having to speed through sponsorships. Appreciate it. Luna: So back to the structure — families have to file a Form 990-PF every year, which is public. That's different from a DAF. Lucas: Right. The IRS wants transparency. The 990-PF lists grants, compensation, even the foundation's investment holdings. Some families don't love that because it's open for the public to see. But for the Waltons or the Gateses, it's part of the package. Speaking of the Walton Family Foundation — that's one of the largest family foundations in the U.S., with assets over $4 billion. They use it to focus on education reform and conservation. The family controls the board, sets the strategy, and determines how much to grant each year. Luna: And then from an estate planning perspective, if the founder dies while holding stock in the company, that stock goes to the foundation, not the estate. So it avoids estate tax entirely. Lucas: That's a huge benefit. If you're a billionaire with a concentrated stake, leaving shares to your foundation instead of to your heirs means no estate tax on that portion. Of course, you have to be willing to give up control over those shares to some degree — but since family members sit on the foundation board, they still have a say. Another tactic: families can also name their foundation as the beneficiary of a retirement account, which avoids both income tax and estate tax. Luna: What about the potential pitfalls? I've heard the term 'self-dealing' — that sounds like something to watch out for. Lucas: It's the biggest gotcha. The tax code prohibits any transaction between the foundation and any disqualified person, which includes family members, board members, and their businesses. So the foundation can't buy a house from the family, can't loan money to a family company, can't even lease office space from them — unless it's at fair market value and there's a specific exception. The penalties are harsh: a 5 percent excise tax on the self-dealer, and up to 25 percent on the foundation managers if they knew the transaction was improper. Luna: So it's not a vehicle for personal benefit. But within those rules, there is flexibility — families can pay reasonable compensation for services. Lucas: Yes. A cousin who acts as a paid executive director can earn a salary if it's comparable to what the market demands for that role. Same for investment advisors. Many family foundations hire family members as staff, but they have to document the hours and benchmark the pay. And grants to non-charitable entities — like a for-profit school — are forbidden. It has to go to public charities or operating foundations. Luna: So how does a family decide between a private foundation and a donor-advised fund? Is it purely a question of money? Lucas: Money plays a role because the administrative costs are real. You need a CPA who understands foundation tax law, you may need an attorney, and you're filing the 990-PF every year. Some families with under $5 million in the foundation find it's not worth the hassle compared to a DAF. But if you're committing $20 million or more, and you want the control and the ability to hire family and invest the corpus your way, a private foundation becomes compelling. Plus, the deduction limits are different — with a public charity, you can deduct up to 60 percent of AGI for cash donations. With a foundation, it's 30 percent. So if you need a big deduction in one year, a DAF might be better. Luna: So it's about control versus flexibility. But for truly wealthy families — the ones with nine- or ten-figure estates — the control often wins. Lucas: Exactly. And there's also the estate planning angle I mentioned. If you leave stock to your foundation, no estate tax. If you leave it to your kids, it's subject to 40 percent at the federal level plus potential state taxes. For a family with a legacy of giving, the foundation is a way to ensure that their philanthropic intent continues across generations. They can even include in the bylaws that future board members must be descendants of the founder. That keeps it in the family. Luna: One last practical note — when you set up a foundation, you need an initial endowment. What's a realistic minimum? Lucas: Most advisors suggest at least $1 million to $2 million, because the fixed costs eat up too much of a smaller pool. But there are community foundations — basically shared private foundations — where several families pool resources and get their own donor advised like accounts with more control. Those are sometimes called 'supporting organizations'. But that's a whole other episode. Luna: We'll save that for another day. So for the high-net-worth family that wants to engage the next generation, create a board, and have a direct hand in grantmaking, a private foundation is a classic tool. Lucas: It is. And with the current tax environment — high estate tax exemptions slated to drop after 2025 — it's a good time to think about moving assets out of the taxable estate. Private foundations don't get the same attention in the press as QSBS or 1031 exchanges, but for the ultra-wealthy, they're a cornerstone.