The Case for Reforming Private Foundations

Charitable giving has changed over the past century. The traditional idea of a charitable donation – an outright gift to a working charity – has given way to the increasing use of charitable financial vehicles, such as private foundations and donor-advised funds, which according to recent data now receive about 25% of all charitable donations. While private foundations have long existed as important funding sources to be granted out over time to charities, the current tax structure fails to adequately incentivize private foundations to transfer funds to working charities that provide important services to communities.

American tax policies must reflect the original intent behind charitable tax laws – to provide a tax benefit to ensure more resources are going toward the public good and our nation’s working charities. With over $1 trillion in assets, private foundations are a tremendous resource to help address the needs of American communities – from funding shelters to providing grants for afterschool programs.

For there to be meaningful tax policies for private foundations, we need to take a closer look at how to improve our existing laws. At the moment, a private foundation must payout 5% of its assets’ value each year. The purpose of this payout requirement is to spur payments to working charities that can be used to fund their mission. However, today’s rules allow private foundations to meet this payout requirement in ways that do little to spur direct funding to charities. Some examples include grants to donor-advised funds (which by definition await further distribution by the advising private foundation) and salaries or travel expenses of foundation family members. While foundations may fund these expenses at their discretion, these types of administrative costs should not count as charitable grants. Doing so risks crowding out actual grants to working charities.

Closing the tax loopholes for the 5% payout rate is just one side of the equation. Tax policies should also incentivize increased giving to charities. Right now, for too many foundations, the five percent rule operates as a ceiling, not a floor on their giving. IACG proposes rewarding foundations that give seven percent or more in a year with an exemption from that year’s excise tax (a tax that normally applies to their investment income). We also propose eliminating the excise tax for new foundations that embrace distributing their assets to working charities within 25-years.

The Initiative to Accelerate Charitable Giving’s policy reforms build on the pivotal role of private foundations in the charitable ecosystem by fixing the flaws in existing payout regulations so that resources are used toward actual grants for charities. We believe these types of policy solutions will strengthen the philanthropic sector and get much-needed funds to the charities that serve communities across this country.

Read more about IACG’s policy proposals for private foundations, donor-advised funds and individual taxpayers here.