For many years, donors have utilized private foundations to make grants for charitable giving. Organized as either trusts or corporations, such entities have enabled substantial tax-deductible contributions while spreading out charitable grants over many years.
Private foundations (PFs) have provided a structure to enable donors and their families to consolidate and organize their giving for greater impact. Family members and financial advisors often find this to be a fulfilling process. Significant charitable impact has resulted from PF grantmaking or program-related investments. Many well-known names in philanthropy come to mind, and many communities are blessed with substantial contributions from these PFs.
However, there is a growing trend of considering donor-advised funds (DAFs) as alternatives to PFs to accomplish many of the same goals. While both charitable vehicles serve vital roles in philanthropy, converting a private foundation to a DAF is a worthwhile consideration for many donors.
Reasons Donors Are Choosing to Convert PFs to DAFs
Like private foundations, DAFs can offer immediate tax deductions while spreading out tangible contributions to charities over time. Much of the growing interest in DAFs as alternatives PFs is driven by donors’ desires to simplify the administration of their charitable giving.
The administrative burdens associated with federal and state laws on PFs have been of increasing concern to directors and trustees for some time, including the following:
- Regulations on authorized investments and compensation that can be paid to family members who administer the PFs.
- Annual reporting has become more cumbersome, resulting in accounting and administrative expenses that decrease the funds available for charitable giving.
- Most PFs need to pay investment income excise taxes.
- PFs need to meet an annual requirement for qualified charitable distributions.
Smaller foundations are especially concerned that the costs of maintaining a PF may outweigh the benefits, despite the control they retain.
DAFs are sponsored by nonprofits, such as American Endowment Foundation (AEF). They provide donors and their families an alternative structure for charitable giving that:
- Substantially reduces administrative burdens and costs.
- Allow anonymous donations when preferred.
- Enables relatively turnkey processing for grantmaking and grantee due diligence.
After converting to a DAF, the PF’s original directors and trustees can often retain advisory roles, allowing them to recommend investments and oversee grant distribution. This helps ensure that the DAF’s grants are consistent with the original PF’s mission and purpose. The family’s name can still be associated with the grants if desired, and often, the investment advisors of the PF can continue to manage the investments of the DAF. The family can also create separate DAFs with different advisors and purposes.
The growing use of DAFs as alternatives or complements to PFs reflects their growth in the philanthropic sector as a whole. National Philanthropic Trust’s 2024 DAF Report estimates $251.52 billion in DAF charitable assets and rising. DAFs will only continue to receive attention as donors’ net worths grow and tax rates climb. While DAFs offer the same or better tax benefits and sustainable charitable giving as PFs, they are simpler to establish and maintain.
How to Terminate a Private Foundation
Terminating a PF and transferring its balance to a new DAF requires careful adherence to federal law.* One must take care to avoid incurring a special federal termination tax. To help avoid the termination tax, the PF must either:
- Transfer its assets to a public charity as described in the Internal Revenue Code.
- Give notice and operate as a public charity as described in the Internal Revenue Code.
Additionally, it is important that the PF adheres to its own governing documents and applicable state laws for termination.
As always, be sure to consult a tax advisor and legal representative for guidance.
Finalizing the Termination of a Private Foundation
Whether the PF is a trust or a corporation, before final distribution to the DAF, the PF’s accountants, attorneys, and investment advisors should ensure that:
- Administrative expenses have been or will be paid.
- All liabilities are satisfied.
- All outstanding pledges will be paid.
Legal notices and guidelines for PFs and DAFs are subject to change at any time. Make sure to review the current laws and consult with an expert to ensure compliance.
Finally, as a courtesy, the PF should consider contacting grantees to inform them it’s converting to a DAF for future giving.
Conducting an Investment Review
Once the donor and financial advisors decide to terminate a PF and select a DAF sponsor, they should review the PF’s current investments to decide if they’re right for the DAF. Consider consulting the original PF’s investment policy to determine if the DAF can follow a similar approach.
See What a DAF Can Do for Charitable Giving
If donors want to see how a DAF works before terminating a PF, they may consider establishing a DAF with a relatively small initial contribution. Then, they can work with the sponsor to see how it works, including the processing of grant requests. This could be important if the PF is accustomed to quick turnaround times for satisfying grants or has grantees with time-sensitive cash needs.
There are many factors to consider before converting a private foundation to a donor-advised fund – especially if the PF has operated for a long time. However, with thoughtful planning, converting a PF to a DAF can result in easier administration of charitable giving for a donor and their family. DAF sponsors like AEF are well-equipped to help with the transition – and to ensure the DAF increases charitable giving and expands philanthropy.
If you or your client is interested in opening a DAF, contact AEF. Our team is dedicated to our mission – to expand philanthropy. Want to help us fulfill that mission? Reach out today.
NOTE: This article has been revised and updated from its original version written by Kirk Hoopingarner.
*The information provided herein is for informational purposes only and should not be interpreted to constitute legal and/or tax advice. Donors should consult their legal and tax advisors regarding their specific situations.