The charitable donor who wants to make more than a “one shot” gift and instead to set up a fund to support long-term giving has the choice of creating a Private Foundation or placing his funds with a charity (such as a community foundation) to set up a Donor Advised Fund (“DAF”).
- Private Foundations have existed since the early 20th century when industrialists like Russell Sage, John D. Rockefeller and Henry Ford set up foundations. Perceived widespread abuses in the 1960s led to the passage of the “Private Foundation” rules under sections 4941-4947 of the Code. 26 U.S.C. § 4941, 4942, 4943, 4944, 4945, 4946, 4947. These rules were meant to combat, in particular, self-dealing and political activity by foundation principals, especially for charities that did not engage in a public activity (say, run a museum open to the public), but rather acted as a private pool of charitable money. Those foundations which are classed “private non-operating foundations” also have to pay an excise tax on investment income and, perhaps most importantly have to pay out 5% each year of foundation asset values.
- A donor with a big budget (say, $5 Million or more) may find it worthwhile to put up with the regulatory burden and create her own private foundation—and to pay the start-up costs of incorporation, filing for a tax exemption (IRS Form 1023)[1], and onerous annual filings of IRS Form 990 PF[2] and New York’s CHAR 500.[3] These forms are available for public inspection.
- A donor with a smaller budget who does not have to control her charitable enterprise can make gifts to a DAF sponsored by a community foundation (like the Community Foundations of the Hudson Valley), affinity group (like the Jewish Communal Fund) or a financial firm (like Fidelity Charitable). If the donor does this, she will be able, more or less, to help direct future gifts, from “her fund,” without having to comply with the burdensome rules governing private foundations. But there are trade-offs. So, let’s look at pros and cons of private foundations vs. DAFs:
Private Foundation Advantages:
- Control: Donors retain significant control over investments, grantmaking, and the foundation’s mission. Family members can get reasonable salaries and perks.
- Legacy: Foundations can exist in perpetuity, allowing families to create a lasting philanthropic legacy and involve future generations.
- Flexibility: Subject to further regulations, there are broader giving options, not just grants to public charities.
Private Foundation Disadvantages:
- Complexity and Cost: Establishing and maintaining a private foundation requires legal setup, ongoing governance, annual tax filings, and often substantial professional fees, making it best suited for larger gifts.
- Minimum Payout: Private foundations must distribute at least 5% of assets annually, which can be burdensome for smaller foundations.
- Public Disclosure: Private foundations must file detailed annual reports (Form 990-PF), making financial and operational information public.
- Less Tax Efficiency: Deduction limits for contributions are lower than DAFs, and there’s a 1-2% excise tax on investment income.
DAF Advantages:
- Simplicity and Lack of Liability: DAFs are easy to set up and maintain, with the sponsoring organization handling administration, investments, and compliance.
- Tax Benefits: Immediate tax deduction for contributions, including on appreciated assets, and potential to avoid capital gains taxes.
- Flexibility: Donors can recommend grants to qualified charities at their own pace, allowing for strategic and long-term giving.
- Privacy: Grants can be made anonymously if desired.
- Low Cost: Lower set-up and ongoing fees compared to private foundations, but there are still annual fees for management.
DAF Disadvantages:
- No Control: Donors can only recommend (not direct) grants; the sponsoring organization has final approval and manages investments.
- Restrictions: Grants can only go to IRS qualified charities, not individual or international organizations (without intermediaries).
- No Legacy Structure: DAFs generally do not provide the same opportunities for family governance or long-term legacy as private foundations, though they, importantly, can provide for successor donor advisors.
Is there a break point in the pros and cons above?
- The Private Foundation route offers independence and control for large dollar donors—say $5 Million and up—who want to install themselves as controllers and even to pay family members (within reason) to be officers and directors. Big donors looking to make a big impact are willing to witness the creation of immense private foundations (Gates, Bloomberg, etc.) even after the private foundation rules in 1969.
- The DAF route is altogether superior for smaller donors who want to have a say in how their charitable donations get spent, but who do not want to run things or be responsible for compliance.
- Local DAFs run by community foundations also provide “boots on the ground” as to local charitable needs (e.g., the Community Foundation of the Hudson Valley was especially good during the COVID Pandemic). Financial firms like Fidelity charge less for annual management but provide no local services or advice (but persons involved with the financial industry like them, as the assets stay with the sponsoring financial firm). (Community foundations can also let donors keep their investment advisors if they manage a certain minimum amount—like $500,000.)
[1] Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, IRS Form 1023 (Rev. Dec. 2024), https://www.irs.gov/pub/irs-pdf/f1023.pdf (last visited May 29, 2025); Instructions for Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, Internal Revenue Serv., https://www.irs.gov/instructions/i1023 (last visited May 29, 2025).
[2] Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation, IRS Form 990-PF (Rev. 2024), https://www.irs.gov/forms-pubs/about-form-990-pf (last visited May 29, 2025); Instructions for Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation, Internal Revenue Serv., https://www.irs.gov/instructions/i990pf (last visited May 29, 2025).
[3] Annual Filing for Charitable Organizations, N.Y. Charities Bureau Form CHAR500 (2024), https://ag.ny.gov/resources/government-organizations/charities-nonprofits-fundraisers/charities-annual-filing-char500 (last visited May 29, 2025).