How do private foundations work?

A private foundation is a tax-exempt charity controlled by a family or company. It pays a 1.39% excise tax on net investment income under IRC §4940, must distribute roughly 5% of its investment assets each year under §4942, and cannot engage in self-dealing with you or your family under §4941. Donors get lower deduction limits than for public charities, and Form 990-PF is public.

A private foundation is a charitable organization that receives most of its funding from one family, individual, or company rather than from the public. It lets donors keep control over investments and grants, involve family members, and build a lasting charitable program.

That control comes with excise taxes, a minimum payout, strict limits on dealings with insiders, and public reporting.

Foundations come in two main types. Most are nonoperating foundations that make grants to other charities. Private operating foundations run their own charitable programs, such as a museum or research program, and have different payout rules and higher donor deduction limits.

Setting up a foundation usually involves forming a nonprofit corporation or trust under state law, adopting governing documents, applying for exemption, and registering with state charity regulators where required.

IRC §4940(a) imposes a tax equal to 1.39% of a private foundation's net investment income, which includes interest, dividends, rents, royalties, and net capital gains. Proposals to raise this rate were not included in P.L. 119-21.

IRC §4942 requires a nonoperating foundation to distribute its distributable amount, generally 5% of the fair market value of assets not used for charitable purposes, reduced by the §4940 tax. Income not distributed by the end of the following year is subject to a 30% initial tax, and a 100% additional tax applies if it is not corrected. Section 4941 imposes taxes on self-dealing between the foundation and disqualified persons.

Sections 4943, 4944, and 4945 restrict excess business holdings, jeopardizing investments, and certain expenditures.

A foundation must meet these requirements:

Most states also require foundations to register and report, and state attorneys general can enforce the founder's charitable commitments.

Donors contribute cash or property and take a charitable deduction, subject to lower limits than for public charities: generally 30% of AGI for cash and 20% for capital gain property. Gifts of appreciated property other than publicly traded stock are generally deductible only at basis. For 2026 and later, itemized charitable deductions count only to the extent they exceed 0.5% of AGI, and for donors in the 37% bracket the tax benefit of itemized deductions is capped at 35%.

The foundation invests its assets, pays the 1.39% excise tax on investment income, and makes grants. Distributions include grants to public charities and reasonable administrative expenses for charitable activities, but grants to donor-advised funds require care and do not always count.

Qualifying distributions include grants to public charities, direct charitable spending, and reasonable and necessary administrative costs. A foundation that pays out more than required can carry the excess forward for five years to reduce later distribution requirements.

Grants to individuals for travel, study, or similar purposes require advance IRS approval of the foundation's procedures.

The IRS examines self-dealing, payout shortfalls, grants to individuals without approved procedures, and personal benefits, such as foundation payment of a family member's pledge or event tickets. Self-dealing taxes apply to the disqualified person and, in some cases, to foundation managers, and apply even if the transaction was fair to the foundation.

A private foundation is not a fit for modest annual giving, where a donor-advised fund is simpler and cheaper, or for donors who want their giving kept private. It is never an option for routing personal expenses through a charity.

Foundations that cannot meet the payout rule, whose founders expect to sell assets to or buy assets from the foundation, or whose families want to be paid for board service without providing necessary services, will find the rules difficult to live with.

We compare a foundation with a donor-advised fund for your giving plan, prepare Form 990-PF, track the payout requirement, and review proposed transactions for self-dealing. We coordinate with your attorney, who drafts the legal documents.

Book a $497 Case Analysis to have Ebot Mbi, CPA, EA review your facts before you act.