The basic rules for governing a family foundation

Part I: What every family foundation trustee should know.

Six major rules govern what a private foundation and its trustees must do each year. These requirements include important fiduciary responsibilities, and even if you and the other trustees engage professionals to perform some of these tasks, you bear the ultimate responsibility for all actions and omissions of the foundation.

Rule #1. Classify and value all foundation assets.

The value of your foundation’s assets determines how much money must be distributed annually in charitable grants (called the “payout”). Generally, a private foundation must pay out at least five percent of its assets each year (see Rule #2). Trustees must determine the exact type and amount of those assets to plan properly for grantmaking each year. Calculating the required annual payout is a fairly technical process, but help is not difficult to obtain. If you decide to make the determination without assistance, simply follow the process described in the Internal Revenue Code and tax regulations. If you need assistance, try contacting more experienced foundation trustees or staff in your city or area.

Rule #2. Distribute at least five percent of assets for charitable purposes.

This technical matter can be handled the same way you handled the valuation rule. Most foundation trustees rely on their professional advisors to help them determine payout requirements. This rule addresses the heart of the foundation matter: making the necessary charitable grants each year.

Rule #3. File the appropriate IRS returns and forms.

Foundations must report all their activities to the IRS each year. Form 990-PF asks for a detailed report on investments, and expenditures for administrative and grants purposes. It also requires a report on the board and its current members. Because of its technical nature, completing Form 990-PF is usually handled by the foundation’s accountant or attorney. Most states have additional filing and reporting requirements as well.

Rule #4. Pay the foundation excise tax on net investment income.

Tax-exempt foundations are required to pay a tax designed to cover the costs of IRS audits for all tax-exempt organizations. Currently, that tax is two percent of net investment income; under special circumstances, however, it can be reduced to one percent (i.e. demonstrating that the foundation has maintained a progressively rising proportional level of grantmaking according to a formula provided by the IRS).

Rule #5. Keep all required records.

One board member or foundation staff member should be assigned required record keeping. Ensure that the following records are retained:

• Records of all financial transactions, including information related to investments, income and expenditures;
• All records related to grants;
• Minutes of board and committee meetings;
• Tax returns and other information related to dealings with the IRS;
• Personnel records;
• Documentation of leases, capital purchases and sales; and
• Any special records required by the foundation’s activities, such as those related to the process of “expenditure responsibility.”

Rule #6: Invest the foundation's assets to preserve its grantmaking ability.

If, as is true with most private foundations, you are investing to exist in perpetuity, this rule is very important. Determine the purchasing power of your foundation endowment and invest funds prudently—this is an important part of your fiduciary responsibility (see the Prohibitions section for more information about investments).

Part II: Prohibited actvities for all family foundation trustees.

The IRS has established specific prohibitions by which foundations and their trustees must abide. These prohibitions are intended to uphold the integrity of the foundation and all of its activities.

Prohibition #1: Do not engage in “self-dealing.”

Self-dealing is perhaps the most significant restriction placed on family foundation trustees. It is defined as almost any financial or business transaction between the foundation and certain foundation insiders, called “disqualified persons,” and is intended to prevent the abuse of foundation assets. Certain necessary professional services, such as legal and accounting expenses or expenses incurred performing board services, are exempted from this prohibition if they are reasonable and necessary. For more details, refer to our Passages Issue Brief, “Avoiding Conflicts of Interest and Self-Dealing for Family Foundation Boards.”

Prohibition #2: Dispose of excess business holdings.

The total voting stock of a business corporation owned by a private foundation and its disqualified persons cannot exceed 20 percent of the voting stock of that corporation. This restriction also applies to a family foundation’s ability to own an interest in a partnership or other business venture. The purpose of this prohibition is to prevent tax-exempt organizations from engaging in unfair competition against for-profit businesses. It also helps prevent the trustees of a foundation from being distracted from charitable activities by the foundation’s business interests.

Prohibition #3: Do not make investments that jeopardize foundation assets.

A private foundation cannot invest its assets or income in a way that endangers the foundation’s ability to carry out its charitable purpose. This rule does not mean that a foundation cannot include some high-risk investments in its portfolio; however, the IRS can assess penalties if it finds that the foundation’s investments are excessively risky or speculative.

Prohibition #4: Do not engage in prohibited lobbying activities.

Private foundations are prohibited, generally, from trying to influence specific legislation at any level of government. Before engaging in any activity of this type, the board should confer with legal counsel. There are four exceptions to this rule:

• Engaging in nonpartisan analysis, study or research and making the results of this work available to the general public or to governmental authorities;
• Providing technical advice or assistance to a governmental body or agency in response to a written request;
• Appearing before or communicating with any legislative body on an issue that might affect the existence of private foundations themselves, such as tax-exempt status or the deductibility of gifts to the foundation; and
• Engaging in or funding the examination and discussion of broad social or economic problems, if these are problems the government might be expected to deal with.

Prohibition #5. Do not attempt to influence elections.

Private foundations cannot influence elections or support a political candidate for elected office. Under very carefully defined limits, however, a private foundation may engage in voter registration drives, if the activities of the foundation are nonpartisan, not confined to one specific election period, and carried out in five or more states. Requirements also cover the foundation’s sources of income for these activities and definitions of its required minimum expenditures for this and other charitable activities. Confer with legal counsel before engaging in any such activity.

Need more information?

This slide show presented a brief overview of the do’s and don’ts for family foundation board members. If you need more information, see these comprehensive resources from the National Center for Family Philanthropy:

• The Trustee Notebook
• Voyage of Discovery
• Splendid Legacy