Charitable giving is evolving. Today, donors, entrepreneurs, and families have more options than ever to structure their philanthropy. Whether you are exploring the control and legacy of a private foundation or the flexibility of donor-advised funds and fiscal sponsorship, understanding the applicable federal and state laws is critical.
This comprehensive guide, based on current federal and state regulations, explores the legal landscape of private foundations and introduces alternative charitable structures.
Private Foundations: The Gold Standard of Donor Control
A private foundation is a distinct legal entityâusually organized as a nonâprofit corporation or a charitable trustâcreated for the sole purpose of making grants to other charities or operating its own charitable programs. It offers donors maximum control, but that control comes with significant compliance obligations.
I. Federal Law Framework
A. Classification Under the Internal Revenue Code
Under IRC § 501(c)(3), all charities are either public charities or private foundations. Private foundations are defined primarily through the âsupport testâ and the definitions in IRC § 509(a). Private foundations do not have the broad public support that characterizes public charities; they are typically funded by a single donor, family, or corporation.
An organization is presumed to be a private foundation unless it timely notifies the IRS otherwise using Form 1023. Strict deadlines apply.
B. Governing Instrument Requirements
A private foundationâs governing instrument (e.g., articles of incorporation) must contain specific provisions to maintain tax-exempt status.
IRC § 508(e) requires that the instrument contain provisions that effectively require the foundation to:
- Make minimum distributions each year (avoiding tax under IRC § 4942)
- Prohibit self-dealing between the foundation and âdisqualified personsâ (avoiding tax under IRC § 4941)
- Avoid retaining excess business holdings (avoiding tax under IRC § 4943)
- Refrain from making investments that jeopardize its charitable purpose (avoiding tax under IRC § 4944)
- Avoid making taxable expenditures (avoiding tax under IRC § 4945)
Historically, a private foundation could rely on state law alone to satisfy these requirements if its state of incorporation had laws that effectively imposed the same obligations. However, Revenue Ruling 2024â10 (May 24, 2024) obsoleted the old Revenue Ruling 75â38 because many state laws have changed materially. Foundations must now ensure that their governing instruments contain the required language unless they have verified that current state law continues to impose identical restrictions. The IRS has issued Program Manager Technical Advice (PMTA 2024â03) to help practitioners navigate which statesâ current laws still suffice.
C. Excise Taxes and Compliance Burdens
Most domestic private foundations pay a 1.39% excise tax on net investment income under IRC § 4940. Penalties for nonâcompliance can be severe.
Key operational restrictions:
| Requirement | Statutory Authority | Key Details |
| Minimum distribution | IRC § 4942 | Must distribute roughly 5% of net investment assets annually, subject to certain adjustments |
| Selfâdealing prohibition | IRC § 4941 | Most transactions between the foundation and disqualified persons are strictly prohibited. There is no de minimis exception, and penalties apply even to inadvertent violations |
| Excess business holdings limitation | IRC § 4943 | Generally cannot own more than 20% of a business enterprise |
| Jeopardizing investments | IRC § 4944 | Must avoid investments that could jeopardize the carrying out of exempt purposes |
| Taxable expenditures | IRC § 4945 | Grants to nonâqualified individuals or noncharitable organizations may trigger penalties. Grants to foreign organizations require a preâgrant inquiry, written agreement, and reporting. Grants to individuals require IRS pre-approval |
D. Annual Reporting Obligations
All private foundations must file Form 990âPF annually, regardless of whether they had taxable income. The return is due by May 15 for calendarâyear foundations. The Form 990âPF is publicly available and requires detailed disclosures of all grants, compensation, and financial activities.
II. State Law Governance and Fiduciary Duties
Although the IRS sets the federal tax-exemption framework, private foundations are incarnated under state law. Most are formed as nonâstock corporations or charitable trusts under the laws of a particular state.
A. State Attorney General Oversight
The attorney general of the state of incorporation has supervisory authority over charitable assets and can enforce fiduciary duties against directors and officers. Some states have broad powers to investigate and even remove directors for mismanagement.
B. Fiduciary Duties
Under state corporate or trust law, board members (and often officers) owe the organization:
- Duty of Care â Acting in good faith, with the care an ordinarily prudent person in a similar position would exercise.
- Duty of Loyalty â Acting in the best interests of the charity and avoiding conflicts of interest.
- Duty of Obedience â Ensuring the charity adheres to its stated mission and applicable law.
These duties are often codified in state nonâprofit corporation acts and may be reinforced by the Restatement of the Law, Charitable Nonprofit Organizations (2021).
C. UPMIFA â Uniform Prudent Management of Institutional Funds Act
UPMIFA has been adopted by every state except Pennsylvania and governs the investment and management of charitable funds. It imposes a prudent investor standard, requires diversification, and mandates that fiduciaries make decisions in good faith and with the care of an ordinarily prudent person. UPMIFA also provides rules for endowment spending, eliminating the concept of âhistoric dollar valueâ and giving charities more flexibility while still respecting donor intent.
Because each state may modify the uniform act, specific legal advice for the relevant jurisdiction is essential.
Alternative Charitable Events and Giving Vehicles
Not every philanthropic goal requires the formal structure of a private foundation. Several alternatives offer lower administrative burdens and sometimes greater tax efficiency.
1. DonorâAdvised Funds (DAFs)
A DAF is not a separate legal entity. Instead, it is an account maintained by a sponsoring public charity (e.g., a community foundation or the charitable arm of a brokerage). The donor makes an irrevocable contribution, receives an immediate tax deduction, and can recommend grants to other public charities over time. The sponsoring organization has the ultimate authority over distributions.
Comparison of DAFs and Private Foundations
| Feature | Private Foundation | DonorâAdvised Fund |
| Legal structure | Separate legal entity | Account within a public charity |
| Establishment time | Several months | One hour to one day |
| Minimum funding | Often $1â5 million recommended | As low as $5,000â25,000 |
| Administration | Donor (or hired staff) performs compliance, filing, and grant management | Sponsoring charity handles all administration, compliance, and reporting |
| Minimum payout | 5% of net assets annually | None required |
| Tax deduction for cash | Up to 30% of AGI | Up to 60% of AGI |
| Excise tax on investment income | 1.39% | None |
| Public disclosure | All grants reported publicly on Form 990âPF | Individual fund details generally not disclosed publicly |
| Control over investments | Full control | Limited to menu offered by sponsor |
DAFs cannot make grants to private foundations (except in limited circumstances), cannot benefit donors or advisors personally, and generally cannot make grants to individuals.
2. Fiscal Sponsorship
Fiscal sponsorship allows a charitable project or startup to operate under the taxâexempt umbrella of an existing 501(c)(3) organization. The sponsor legally receives donations, provides administrative support, and ensures grant funds are used for charitable purposes. The project itself does not need to obtain its own taxâexempt status. This arrangement is common for documentary films, community arts programs, and new charitable initiatives.
Federal requirements: The sponsoring charity must retain discretion and control over the fundsâit cannot act as a mere passthrough. Revenue Ruling 2024â10 highlighted that state laws have changed, but the sponsorâs need for a compliant governing instrument remains unchanged and falls under the same principles applicable to private foundations. New legislation (the SPONSOR Act) has been introduced that would impose significant liability on fiscal sponsors for certain downstream activities, underscoring the importance of careful due diligence.
3. Crowdfunding and Donation Platforms
Online platforms such as GoFundMe, Kickstarter, and numerous others have become popular fundraising tools. These platforms can be powerful but present unique legal issues:
- Fund ownership: In some hybrid or nonprofitâplatform structures, the platform receives the donation as a completed gift and then regrants to the designated charity. Donors must understand that their gift may not be made directly to the intended charity.
- Donor tax deductions: Crowdfunding contributions are only deductible if made to a qualified 501(c)(3) organization. Many generalâpurpose platforms offer no deduction at all.
- Unconsented listings: Some platforms have automatically created donation pages for nonprofits using publicly available IRS data, raising significant legal and ethical concerns. Recent backlash and attorney general inquiries have prompted the Association of Fundraising Professionals (AFP) to develop âNonprofitâFirst Considerationsâ for platforms, including fee transparency, data portability, and prohibition of unconsented promotion.
Private foundations must be particularly cautious when using crowdfunding platforms for their own fundraising or grantmaking. Any payment from a foundation to a platform-administered account must comply with self-dealing and taxable expenditure rules.
4. Social Enterprises and Impact Investing
Social enterprises blend charitable purpose with business activities. While a private foundation can make ProgramâRelated Investments (PRIs) âinvestments that further the foundationâs charitable mission even if they produce a financial returnâpure forâprofit social enterprises do not offer taxâdeductible donations. Donors should seek professional advice to structure such investments appropriately.
Key Compliance Takeaways
Regardless of which vehicle you choose, always remember:
- Verify taxâexempt status for any grantee using IRS Publication 78 data and retain documentation for three to seven years.
- Maintain a conflictâofâinterest policy and have directors and officers complete annual disclosure forms.
- Document all grantâmaking decisions in writing, including the charitable purpose and, for foreign or nonâ501(c)(3) grantees, the required expenditureâresponsibility steps.
- Never assume that a prior yearâs verification or a granteeâs own receipt is sufficientâan organizationâs tax status can change without notice.
- Review every transaction involving the foundation for potential selfâdealing. Use separate payment accounts labeled for foundation use only to avoid accidental misuse.
Turning Your Vision Into Action
Choosing between a private foundation, a donorâadvised fund, fiscal sponsorship, or a crowdfunding strategy depends on your financial resources, desired level of control, administrative capacity, and longâterm charitable goals. Many families and corporations use a combination: a private foundation for legacy and direct programming, a DAF for anonymous or experimental grants, and fiscal sponsorship for temporary projects.
No matter which path you choose, compliance with federal and state law is nonânegotiable. Tax penalties for selfâdealing, failure to distribute, or taxable expenditures can be severe, and state attorneys general have broad powers to enforce fiduciary duties.
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Disclosure
This post provides general information only and does not constitute legal advice. Laws, regulations, and IRS guidance change frequently. State laws also vary significantly and are subject to amendment. You should not act upon this information without consulting qualified legal counsel familiar with your specific situation. For questions or to schedule a consultation, contact: Alan Goldstein
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