How to Properly Set Up a Private Foundation

A private foundation is a distinct legal entity established for charitable purposes, typically funded by a single individual, family, or corporation. Unlike public charities that rely on broad public support, a private foundation usually derives its funding from a limited number of sources, often from its founders. This structure provides a framework for philanthropy, allowing founders to pursue their charitable interests and create a lasting legacy.

These foundations are classified by the IRS as 501(c)(3) organizations, making them tax-exempt entities. While they can operate their own programs, many private foundations primarily function as grant-making organizations, providing financial support to other charities. This enables them to act as philanthropic partners, channeling funds towards various causes and initiatives.

Preliminary Planning and Decisions

Establishing a private foundation begins with a clear articulation of its mission and vision. This involves defining the specific charitable purpose the foundation will serve, identifying its target beneficiaries, and outlining its long-term goals. A well-defined mission statement provides a guiding framework, ensuring the foundation’s activities remain aligned with the founders’ philanthropic aspirations.

When determining the legal structure, founders typically choose between a charitable trust or a non-profit corporation. A charitable trust is formed through a trust agreement, where assets are held by trustees for the benefit of charitable purposes. This structure can offer flexibility in governance and may be simpler to establish, particularly for foundations with a narrow focus.

Alternatively, a non-profit corporation is formed by filing articles of incorporation with the state. This structure provides a separate legal identity, limited liability for its directors, and a more formal governance framework, often preferred for larger foundations. The choice between a trust and a corporation depends on factors such as the desired level of formality, governance preferences, and long-term operational complexity.

The funding strategy is another important consideration. Private foundations are typically endowed with assets from the founder, which can include cash, appreciated securities, or real estate. The concept of an “endowment” refers to the principal amount of funds held by the foundation, the income from which is then used to support its charitable activities. This capital ensures the foundation has the resources to fulfill its mission without relying on public fundraising.

Establishing the governance structure involves defining the roles and responsibilities of the individuals who will oversee the foundation’s operations. For a non-profit corporation, this means forming a board of directors, while for a charitable trust, it involves appointing trustees. These individuals are responsible for managing the foundation’s assets, making grant decisions, and ensuring compliance with legal and charitable obligations. Selecting qualified individuals for these roles is important for oversight and adherence to the foundation’s mission.

Finally, selecting a unique and appropriate name for the foundation is a practical step. This name should reflect the foundation’s purpose and be checked for availability within the chosen state to avoid conflicts.

State-Level Legal Establishment

The formal establishment of a private foundation begins at the state level by creating the legal entity. For those choosing a non-profit corporation, this involves drafting and filing Articles of Incorporation with the appropriate state agency, typically the Secretary of State. These articles must include essential information such as the foundation’s name, its specific charitable purpose, the name and address of its registered agent (who receives legal and tax documents), and the names of the initial directors.

For a charitable trust, the foundational document is the Trust Agreement. This agreement identifies the settlor (the person establishing the trust), the trustees who will manage the assets, the beneficiaries (the charitable purposes or organizations), and detailed provisions regarding the trust’s purpose, duration, and how it will be funded and administered. Both the Articles of Incorporation and the Trust Agreement are crucial as they legally define the foundation’s existence and operational parameters.

Once the governing documents are prepared, they must be formally filed with the state. Filing fees apply, which can vary by state, generally ranging from approximately $25 to $300. The processing time for these filings can also vary, from a few days to several weeks.

After the state-level legal entity is established, the foundation must obtain an Employer Identification Number (EIN) from the Internal Revenue Service (IRS). An EIN is a nine-digit number assigned to employers, but it is also required for non-profit organizations for tax purposes, such as filing tax returns, and for opening bank accounts in the foundation’s name. Applying for an EIN is a straightforward process that can be completed online, by fax, or by mail through IRS Form SS-4.

Following the legal establishment and EIN acquisition, the foundation needs to adopt internal governing documents. For a corporation, these are the bylaws, which detail the internal rules and procedures for the organization’s operation. Bylaws typically outline provisions for board meetings, voting procedures, officer roles and responsibilities, and other operational guidelines. For a trust, similar internal operating agreements may be developed to guide the trustees’ actions.

For a non-profit corporation, an initial board meeting is held after the articles of incorporation are filed and bylaws are adopted. During this meeting, the initial officers are elected, and resolutions are passed to authorize necessary actions, such as opening bank accounts and applying for federal tax-exempt status. This meeting formalizes the internal governance.

Federal Tax-Exempt Status Application

After establishing the foundation at the state level and obtaining an EIN, the next step is to apply for federal tax-exempt status under Section 501(c)(3) of the Internal Revenue Code. This status allows the foundation to be exempt from federal income tax and for contributions made to it to be tax-deductible for donors. The IRS classifies all 501(c)(3) organizations as either public charities or private foundations. Unless qualifying as a public charity, a new 501(c)(3) organization is presumed to be a private foundation.

Private foundations, while tax-exempt, operate under specific regulations and are subject to certain excise taxes and restrictions that differ from those applicable to public charities. For instance, private foundations must distribute a minimum amount of their assets annually for charitable purposes, generally 5% of the average fair market value of their investment assets. They are also subject to rules regarding self-dealing, excess business holdings, and lobbying activities.

The primary application for recognition of exemption is IRS Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.” This form requires detailed information about the foundation’s purpose, activities, financial data, and organizational structure. Among the required attachments are the foundation’s organizing documents and bylaws. The application also requires a narrative description of the foundation’s past, present, and planned activities, demonstrating how they align with charitable purposes.

Financial data must be provided for the foundation’s most recent three years of operation, or for the period of its existence if less than three years, along with projected financial data for the next two years. This includes statements of revenue and expenses, and a balance sheet. The application also asks for information regarding compensation of officers, directors, and highly compensated employees. The user fee for filing Form 1023 is typically $600.

For smaller organizations, a streamlined application, Form 1023-EZ, “Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” may be available. To be eligible for Form 1023-EZ, an organization must certify that its gross receipts are normally $50,000 or less annually, and its total assets are normally $250,000 or less. This simplified form requires less detailed information than the full Form 1023, making the application process faster and less complex for eligible foundations. The user fee for Form 1023-EZ is generally $275.

After submission, the IRS reviews the application to determine if the foundation meets the requirements for 501(c)(3) status and private foundation classification. The processing time can vary significantly, ranging from a few weeks for a Form 1023-EZ to several months or even longer for a complex Form 1023. Upon approval, the IRS issues a determination letter recognizing the foundation’s tax-exempt status and its classification as a private foundation.

Initial Operational Setup

With federal tax-exempt status secured, the private foundation can proceed with its initial operational setup. A fundamental step is opening separate bank accounts in the foundation’s name. These accounts, typically a checking account and potentially investment accounts, are established using the foundation’s Employer Identification Number (EIN). Maintaining separate accounts is important for clear financial record-keeping and demonstrating the foundation’s distinct legal identity, separate from its founders’ personal finances.

Once bank accounts are established, the initial funding transfer takes place. This involves transferring the assets designated by the founder, such as cash, securities, or other property, into the foundation’s newly opened accounts. This action formally establishes the foundation’s endowment and provides the capital from which it will conduct its charitable activities and make grants.

Establishing record-keeping systems from day one is important for compliance and transparency. This includes setting up organized systems for financial transactions, grant applications and awards, donor information, and minutes from board meetings. The emphasis is on creating an organized framework that ensures all activities are properly documented and easily accessible for reporting and auditing purposes.

Developing initial grantmaking policies provides a basic framework for how the foundation will disburse its funds. These internal policies should outline fundamental aspects such as the process for receiving grant applications, the criteria for selecting eligible grantees, and the due diligence steps the foundation will undertake before awarding funds. These initial guidelines help ensure a structured and consistent approach to the foundation’s core charitable activity.

Finally, some states require separate registration for charitable organizations, even if they have already obtained federal tax-exempt status. This typically applies if the foundation intends to solicit funds, even if it’s primarily funded by a single source. These state-level charitable registrations ensure compliance with state oversight of charitable activities and may involve annual reporting requirements. Checking with the relevant state charity offices is a necessary final administrative step before the foundation fully commences its philanthropic operations.