How to Create a Private Family Foundation: Benefits, Drawbacks, and Alternatives
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Contents
- What Is a Private Family Foundation?
- How to Create a Private Family Foundation
- The Good Things About Private Family Foundations
- 1. You're in Charge
- 2. Create a Lasting Legacy
- 3. More Giving Options
- 4. Bring Your Family Together
- 5. Some Tax Benefits
- The Downsides of Private Family Foundations
- Is a Private Family Foundation Right for You?
- Better Alternatives for Most People
- The Real Deal on Private Foundations
- Mix and Match: The Smart Approach
- In a nutshell...
- Common Questions About Private Family Foundations
“How do I set up a family foundation?” It’s a question we hear from clients who want to make a lasting impact with their wealth.
Private foundations sound impressive—and they can be. They give you control over your charitable giving, create a family legacy, and offer some tax benefits. But before you jump in, you should know they come with serious costs, complex rules, and ongoing commitments.
In this guide, we’ll walk you through what a private family foundation actually is, the steps to create one, and whether it’s really the right choice for your charitable goals. We’ll also show you some simpler alternatives that might work better for your situation.
What Is a Private Family Foundation?
A private family foundation is a special type of charity. It’s usually funded by one person, family, or company – not by public donations. Family members typically run it and decide which causes to support.
Unlike regular charities that raise money from many people, private foundations usually start with a big chunk of money and use investment income to fund their giving. About half of all private foundations in the US are family foundations.
Think of a private foundation like your own personal charity. When you set one up, you’re essentially creating an organization that exists solely to support the causes you care about.
While big foundations like Gates or Ford get all the attention, most family foundations are much smaller, supporting local causes or specific interests of the founding family.
They provide a structured way to make a difference while keeping the family’s values at the center of giving decisions.
Here’s what makes them unique:
- Family control: Family members usually make all the important decisions.
- Tax benefits: Foundations don’t pay federal income tax, but do pay some other taxes.
- Required giving: They must give away at least 5% of their assets each year.
- Public information: Anyone can see what grants they make and their financial details.
- Long-term existence: They can continue for generations.
How to Create a Private Family Foundation
If you’re thinking about starting a foundation, here are the basic steps:
1. Decide What You Want to Accomplish
Before doing paperwork, get clear on your goals:
- What causes do you care about?
- What change do you want to make in the world?
- Will your foundation last forever or for a limited time?
- Who in your family will be involved?
Write down a clear mission statement to guide your foundation’s work.
2. Choose Your Legal Structure
Private foundations can be set up in two ways:
- A nonprofit corporation: More common, better protection from legal issues.
- A charitable trust: Simpler but less flexible.
Talk to an advisor about which structure is better for your goals.
3. Make It Legal
To create your foundation as a legal entity:
- File the right paperwork with your state.
- Create rules for how the foundation will operate.
- Get an Employer Identification Number (EIN) from the IRS.
4. Apply for Tax-Exempt Status
Fill out IRS Form 1023 to get 501(c)(3) tax-exempt status. You’ll need to include:
- Details about your foundation’s purpose and structure
- Financial information
- Description of your planned activities
The IRS typically takes a few months to review and approve your application.
This step is crucial and it’s often where many foundations hit their first roadblock. The application is lengthy (around 28 pages) and requires specific language to ensure approval.
Many foundations hire specialized advisors just for this step. Be especially careful with how you describe your mission and planned activities.
Vague statements or activities that could benefit the founding family personally can raise red flags with the IRS. We’ve seen applications delayed by 6-12 months due to simple mistakes that could have been avoided with proper guidance.
5. Set Up Your Board
Your foundation needs a board to make decisions. For family foundations, this usually includes:
- Family members.
- Outside experts in fields related to your mission.
Set clear rules for:
- How board members are chosen.
- How decisions are made.
- How to handle conflicts of interest.
- Whether board members get paid.
6. Fund Your Foundation
Most foundations start with at least $1 million to make the setup costs worthwhile. You can donate:
- Cash
- Stocks and bonds
- Business interests
- Real estate
- Other valuable property
Most of the time, these assets can be given without triggering any capital gains tax.
But remember, once you donate assets to your foundation, they no longer belong to you personally.
7. Plan Your Giving Strategy
Create guidelines for:
- How foundation money will be invested.
- How to apply for and approve grants.
- How to check if your grants are making a difference.
Don’t forget that private foundations must give away at least 5% of their assets each year.
8. Handle the Day-to-Day Operations
Foundations require ongoing work, including:
- Managing finances.
- Processing grants.
- Making sure you follow all the rules.
- Keeping records.
- Filing tax forms.
You can do this work yourself or hire someone to help.
The Good Things About Private Family Foundations
1. You're in Charge
With a private foundation, you control:
- How the money is invested.
- Which organizations get grants.
- When and how much to give (as long as you meet the 5% minimum).
- The overall focus and direction.
This lets you be strategic about your giving.
This level of control means you can be nimble and responsive in ways other charitable vehicles simply can’t match.
You can quickly provide emergency relief after natural disasters, create specialized scholarship programs with unique criteria, or fund innovative approaches to problems that larger organizations might consider too experimental.
These personalized approaches to giving would be difficult or impossible with most other charitable options.
2. Create a Lasting Legacy
A private foundation can:
- Keep your family’s charitable work going for generations.
- Get multiple generations involved in giving.
- Pass down your values and interests.
- Create a structure for family giving over time.
3. More Giving Options
Private foundations can give in ways individuals can’t directly:
- Fund scholarships for specific people.
- Support nonprofits in other countries.
- Make investments related to your mission.
- Help in emergencies.
- Give to groups that aren’t traditional charities.
These expanded options open doors that aren’t available to individual donors.
For instance, if you’re passionate about a specific issue like water quality or education, you could fund direct scholarships to students, partner with foreign nonprofits working on the ground, make loans to social enterprises, and provide emergency grants during crises.
This comprehensive approach allows you to tackle problems from multiple angles instead of being limited to just writing checks to established US charities.
4. Bring Your Family Together
A foundation can:
- Unite family members around shared values.
- Teach younger generations about giving back.
- Create meaningful work for family members.
- Build leadership and financial skills.
5. Some Tax Benefits
While not as good as other charitable options, foundations do offer:
- Income tax deductions for donations (with limits).
- No capital gains tax on donated stocks or assets.
- Estate tax benefits.
- Federal tax-exempt status for foundation income (although other taxes and rules may apply).
The Downsides of Private Family Foundations
1. They’re Expensive
Private foundations come with higher costs:
- Legal and accounting fees to set up ($5,000-$25,000+).
- Ongoing administration costs (usually 2-5% of assets each year).
- Investment management fees.
- Possible salaries for board or staff.
- Tax on investment income (currently 1.39%).
These costs mean less money for actual charitable giving.
2. Lots of Paperwork
Foundations require significant administrative work:
- Annual tax forms (Form 990-PF).
- Detailed record keeping.
- Overseeing investments.
- Processing and tracking grants.
- Following complex rules.
3. Strict Rules
Private foundations face many regulations:
- Must give away at least 5% each year.
- Can’t make deals that benefit the donors or their families.
- Limits on business ownership.
- Restrictions on certain investments.
- Special requirements for some types of grants.
Breaking these rules can result in heavy penalties.
4. Fewer Tax Benefits Than Other Options
Compared to other ways of giving:
- Lower deduction limits (30% of your income vs. 60% for public charities).
- Lower limits for donated stocks or property.
- Limited deductions for gifts of private business interests.
- Tax on investment income.
5. No Privacy
Private foundations must publicly share:
- All grants they make.
- What they pay board members and staff.
- Detailed financial information.
- Names of major donors.
Anyone can look up this information online.
6. Potential Family Disagreements
Foundations can sometimes create family tension:
- Disagreements about which causes to support.
- Conflicts over how to invest the money.
- Issues about who’s in control.
- Disputes over who serves on the board.
Is a Private Family Foundation Right for You?
A private foundation might be a good fit if:
- You have substantial money to commit (typically a few million dollars+).
- You want complete control over your giving.
- You’re willing to handle the paperwork and costs.
- You want to involve family members in structured giving.
- You want to create a multi-generation legacy.
- You’re okay with your giving being public.
- The extra giving options outweigh the tax limitations.
A private foundation probably isn’t your best option if:
- You have modest assets for giving.
- You want the largest possible tax benefits.
- You prefer a simpler, cheaper approach.
- Privacy matters to you.
- You don’t need the expanded giving capabilities.
- You don’t want the ongoing compliance headaches.
Better Alternatives for Most People
Before committing to a private foundation, consider these options. In our experience helping clients with charitable planning, we’ve found that these alternatives often provide most of the benefits people want from a private foundation with far fewer headaches and costs:
1. Donor-Advised Fund (DAF)
A donor-advised fund is like a charitable savings account. It offers many foundation benefits with far fewer headaches.
Good things about DAFs:
- Much cheaper to set up and run.
- Better tax deductions (60% of income for cash, 30% for stocks).
- No required annual giving.
- No special taxes.
- Almost no paperwork.
- Option to give anonymously.
- Full market value deductions for all appreciated assets.
Limitations of DAFs:
- Less control (you “advise” rather than direct).
- Can only give to registered charities.
- Can’t hire staff or pay family members.
- May have limits on succession planning.
- Usually can’t give directly to individuals or foreign groups.
For most families, a DAF provides most of the benefits they want at a fraction of the cost and hassle.
2. Supporting Organization
A supporting organization is a type of charity that supports other charities.
Good points:
- Better tax deductions.
- More flexible than a DAF.
- No special taxes.
- Can give scholarships to individuals.
Drawbacks:
- Must be connected to the supported charity.
- Less donor control than a private foundation.
- Still requires significant setup and management.
3. Community Foundation
Community foundations are charities that pool donations to support local causes.
Benefits:
- Local expertise and connections.
- Administrative support.
- Better tax deductions
- Option to create a named fund.
- Connection with other donors.
Limitations:
- Usually focused on a specific geographic area.
- Less direct control.
4. Direct Giving to Charities
Sometimes the simplest approach is best – giving directly to the charities you want to support.
Advantages:
- Maximum impact (no administrative costs).
- Better tax deductions.
- No ongoing responsibilities.
- Immediate results.
Drawbacks:
- No structured family involvement.
- No lasting legacy beyond your lifetime.
- Less coordination across your donations.
The Real Deal on Private Foundations
Let’s be straight: US private foundations aren’t great tax planning tools. We’ve seen plenty of people try to personally benefit from their tax advantages, but rarely is this a good idea over time.
Rather, it makes sense only when the charitable mission is your main goal, not tax breaks.
In our nearly 40 years working with clients, we’ve found that most people are better served by other charitable options unless they have at least millions to dedicate to philanthropy and are truly committed to the ongoing work.
What about foreign foundations? With few exceptions, these usually create even more problems for US taxpayers, including reporting headaches, potential tax traps, and compliance issues that aren’t worth the trouble.
Mix and Match: The Smart Approach
Many of our clients find that combining different giving methods works best. For example:
- Using a donor-advised fund for regular giving while maintaining a private foundation for more complex projects.
- Consider starting with a DAF while building assets for an eventual foundation.
- Creating a foundation for family engagement while also making direct gifts to maximize tax benefits.
In a nutshell...
Private family foundations can be powerful tools for giving, offering control, flexibility, and a way to create a family legacy. But they come with significant costs, paperwork, and regulatory hurdles.
Before starting a foundation, carefully think about your charitable goals, available resources, and willingness to take on ongoing responsibilities. Talk to advisors who understand charitable planning to figure out what’s best for you.
For many people, alternatives like donor-advised funds offer similar benefits with much less complexity and cost. The best strategy is the one that maximizes your charitable impact while fitting your personal values and situation.
Want to discuss whether a private foundation or another giving option is right for you? Get in touch. We’ve been helping clients create effective giving strategies for nearly four decades.
Common Questions About Private Family Foundations
How much money do I need to start a private foundation?
There’s no legal minimum, but advisors typically recommend at least $5 million to justify the setup and ongoing costs. Foundations with less than a few million dollars often find that expenses eat up too much of their assets.
Can I pay family members to work for the foundation?
Yes, but pay must be “reasonable” comparable to similar jobs, and the positions must be necessary. The IRS watches this closely to prevent abuse.
How much does a foundation have to give away each year?
Private foundations must give away about 5% of their investment assets annually. This can include grants and certain administrative expenses directly related to giving.
Can a foundation give money to individuals?
Yes, foundations can give scholarships, hardship assistance, or prizes to individuals—but only if they follow specific IRS procedures and get their grant process pre-approved.
What does it cost to set up and run a foundation?
Initial setup costs typically range from $5,000 to $25,000+ for professional fees. Annual costs generally run 2-5% of assets, covering administration, compliance, investment management, and the 1.39% excise tax on investment income.
Can I shut down a foundation if I change my mind?
Yes, but the remaining assets must go to qualified charities. The shutdown process requires IRS approval and can be complicated, so work with experienced advisors.
Can my foundation support organizations in other countries?
Yes, but you’ll need to take extra steps called “expenditure responsibility” or “equivalency determination” to ensure the foreign organization uses the money for charitable purposes that meet US tax law.
Is my foundation's information public?
Yes, private foundations must file Form 990-PF annually, which shows grants, finances, board members, and major donors. These forms are publicly available online.
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