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Updated on Thursday, April 18, 2019
As your business finds its footing and becomes profitable, you might think about ways to give back. Whether you want to help members of your community or donate to a specific cause, a corporate foundation can manage your charitable giving.
Rather than making one-off donations, a corporate foundation would allow you to focus your company’s charitable efforts and maximize your impact, said Heather Tunis, an independent consultant to philanthropic and nonprofit organizations who was most recently a senior strategist with CNM in Los Angeles.
“Having a more formal approach to philanthropy helps people be more thoughtful and strategic in investing back in their community,” Tunis said.
Continue reading to learn more about how a foundation or an alternative fund can integrate with your business’s charitable strategy to make the most of your philanthropic work.
What is a foundation?
A corporate foundation is a legal entity that operates separately from your business, said Suzanne Friday, managing director of national standards and vice president of legal affairs for the Council on Foundations in Washington, D.C.
“One of the misconceptions is the foundation is another one of the company’s assets,” Friday said. “But that is not the case. It is truly its own legal entity.”
A foundation is a private, tax-exempt organization that is typically designated as a 501(c)(3) organization by the IRS. A private foundation must follow the same regulations as other 501(c)(3) entities. Like nonprofits, foundations must be incorporated at the state level and follow the same compliance measures, such as establishing a board of directors and holding regular board meetings, Friday said. (We’ll provide more on this later.)
Once a foundation is set up, a company can start donating to the foundation, which can then grant money to other charitable organizations, Friday said. The company would be able to deduct those charitable contributions to the foundation.
Private foundations are different than public charities because foundations receive funds from a single source, such as a corporation, and charities rely on contributions from the general public. The IRS requires private foundations to distribute at least 5% of their income each year for charitable purposes. Private foundations are also expected to pay excise taxes. Failing to distribute the minimum amount could result in penalties, such as increased excise taxes or a tax to terminate your status as a private foundation.
An owner of any type of business can form a private foundation, Friday said. She said she’s seen companies establish a foundation after going public, older corporations start foundations in honor of company founders or retired executives and small, family-owned businesses create a foundation in the family name before selling the company to new owners.
“It’s really all over the place as far as when and why,” she said.
Because a foundation stands alone, it can carry on without the company if the business is sold or dissolves, Friday said. Any money gifted to the foundation belongs to the foundation indefinitely, except for the 5% that must be distributed each year.
Benefits of a corporate foundation
Companies don’t need to form a foundation to be philanthropic, said Jessica Hardin, an attorney at Robinson Bradshaw in Charlotte, N.C. You could set up a division within your company that could manage the business’s charitable donations without the added responsibility of maintaining a foundation. But there are benefits of starting a corporate foundation that make the trouble worthwhile.
Income tax deductions
The company can deduct donations made to the private foundation. The foundation can then make donations for the company, Friday said, although they won’t be tax deductible. For instance, companies can’t deduct contributions made to international charities, but the company can deduct the donation made to the foundation and it can then give money to the foreign charity, she said. This would help companies that do business in foreign countries build a reputation in those areas.
Consistent philanthropic efforts
Continuously donating to the corporate foundation would ensure that the company can maintain its philanthropic presence in the community, Friday said. Even during years when the company isn’t making enough money to give, the money would already be invested in the foundation to be distributed to charities.
“This ensures a nice, steady, year-after-year program of giving,” she said.
Visibility in the community
Companies can rely on corporate foundations to boost their status in the community, Tunis said. Often, companies will choose to donate to well-known causes and charities, including American Red Cross and Boys & Girls Clubs of America.
“It gives them the opportunity to be doing good in the community and be identified with that,” Tunis said. “It’s a way to get visibility.”
How to start a foundation
Establishing a private foundation requires the same actions as creating other tax-exempt entities, like nonprofit organizations. Because foundations are highly regulated and scrutinized, it’s important to take the right steps from the start.
Step 1: Start planning
Before creating a legal entity, you should map out how the foundation will operate alongside the business. Consider your goals for the foundation and how you plan to achieve them. Understanding the needs of the foundation will help you find staff members who can carry out the vision.
Step 2: Meet filing requirements
State governments regulate the formation of foundations, and requirements vary by state. Generally, you must file articles of incorporation with your state’s secretary of state. The articles of incorporation is a document that asks for data about the foundation, such as the address and statement of purpose. You’d need to submit this file before applying for tax-exempt status.
To become tax-exempt, you must file Form 1023 with the IRS. The application would need to include a statement of your receipts and expenses, and a copy of your articles of incorporation. You would also need to write a narrative explaining the purpose of your foundation, as well as bylaws that your foundation’s board of directors must follow.
You could be required to meet additional local filing requirements if you want to be exempt from state income taxes or if you plan to solicit public donations. For instance, private foundations in California must apply for tax exemption with the Franchise Tax Board and submit proof of federal tax exemption from the IRS.
Step 3: Assemble a board of directors
Like a nonprofit, a foundation needs a board of directors to act as its governing body. It’s common for company employees to be involved with the foundation as long as they donate their time. The foundation cannot support the company’s employee salaries or pay for anything else that benefits the business. It may be a good idea to have outsiders on the foundation’s board. They could put accountability structures in place to keep the company’s philanthropic efforts in check. While a public charity must have a board of directors comprised of members that reflect the community it serves, private charities don’t face the same obligation. Company employees or family members can act as directors on a private foundation’s board.
Step 4: Distribute funds
The IRS requires private foundations to distribute at least 5% of income each year for charitable purposes. Grants are common distribution avenues for corporate foundations. But before you give out money, you need to develop a process for reviewing and selecting grant proposals. You should prepare a policy detailing the criteria for choosing grant proposals and how you plan to disburse funds, whether it’s in installments or one lump sum.
Ongoing requirements of a corporate foundation
A private foundation requires continuous upkeep to remain compliant, much like a nonprofit organization or a for-profit corporation.
“The ongoing maintenance is where foundations become burdensome,” Hardin said.
After setting up your foundation, be prepared for the following:
- Corporate regulations: Foundations must follow the same formalities as a corporation. Those include quarterly or annual board meetings. Any events, such as a board vote, must be recorded in meeting minutes.
- IRS forms: Private foundations must annually file Form 990-PF with the IRS. The form asks for information about the foundation’s operations, expenses and grants.
- Additional legal compliance: Foundations must adopt internal practices to protect against prohibited activities like self-dealing. The foundation must also distribute the correct amount of their investment assets on an annual basis, as mentioned earlier.
Consider a donor-advised fund
A simpler alternative to a corporate foundation is a donor-advised fund. You would be able to make a tax-deductible donation to a public charity of your choice and give guidance on how you’d like the charity to spend your donation. It can be a viable option for large or small businesses that have philanthropic aspirations but don’t want added compliance obligations, Hardin said.
“It’s really just making the transaction of funds either once or on an ongoing basis and making decisions on how the funds are distributed,” she said.
The public charity would be responsible for managing your fund and distributing the money. You could work closely with the staff to determine the best way that the charity could help you reach your goals.
No matter what avenue you choose, you should take your philanthropic efforts as seriously as your business operations, Tunis said. Business owners sometimes think of corporate philanthropy as a side project that doesn’t need much thought, but it requires careful consideration to effectively benefit your company, she said.
“If you do it well and thoughtfully, it can be a real value add and a real bonus,” Tunis said.