Bank Private Foundations—An Overview

Drew Cheney, Tax Principal
June 2014

For both philanthropic and business reasons, most banks conduct an institutional charitable giving program. While some banks prefer to house their charitable giving programs within the bank itself, other banks have set up their own private foundations to conduct their charitable giving programs. The purpose of this article is to discuss some of the advantages and possible pitfalls of using the private foundation approach. Please be aware that this article is oversimplified and is designed to provide a basic overview of this topic.

What Is a Private Foundation?

A private foundation is a type of charitable tax-exempt organization established under Internal Revenue Code Section 501(c)(3). What typically distinguishes it from a public charity is that the private foundation receives donations from a very narrow donor base. Also, a private foundation generally does not carry out a charitable program directly; instead, its activities consist solely of making grants to public charities such as local hospitals, schools, or municipalities. (A minority of private foundations are set up as private operating foundations, and these do engage in the direct conduct of charitable programs.)

Private foundations are subject to several taxes and special requirements that do not apply to public charities:

  • A 1% or 2% tax on net investment income.
  • An obligation to make annual minimum charitable distributions under a complex formula which is designed to ensure that the foundation makes average annual charitable distributions, over time, of 5% of the value of its assets.
  • Complex “expenditure responsibility” rules for grants that are made other than to public charities, such as grants to an individual, to a business, or to another private foundation.
  • Pre-approval by the IRS of scholarship programs conducted directly by the foundation. (This requirement does not apply if the foundation funds a scholarship program at a school, with the school retaining ultimate control over the program.)

How Does A Bank Private Foundation Typically Operate?

To establish a private foundation, a separate legal nonprofit entity must be incorporated under state law. The entity needs to have directors, which, depending on state law requirements, are drawn from bank employees and directors and/or from the community at large.

The entity then needs to file Form 1023 with the Internal Revenue Service (IRS) to request 501(c)(3) status. As long as the filing takes place by the end of the 27th month after the entity is legally formed, the 501(c)(3) status will be retroactive to the date of formation.

It is very difficult to predict how long the IRS will take to approve the Form 1023 application. Currently, there is a huge backlog, but the IRS is attempting to “fast-track” applications that are relatively uncomplicated, as is typically the case for bank private foundations.

The foundation needs to establish a process for making grants. Some foundations have an application process, while others give only to organizations selected and approved entirely by the foundation itself. The foundation also typically establishes the following policies: a gift acceptance policy, a conflict of interest policy, and an investment policy.

Once the foundation is established, there are regular board meetings and regular reviews of possible grants. When functioning as foundation directors, bank employees and directors have a fiduciary obligation to promote the interests of the foundation, even if those interests conflict with those of the bank.

The foundation needs to file a Form 990-PF annually with the IRS and needs to provide a copy of the 990-PF to the state attorney general. In addition, several states have additional annual reporting requirements.

What Are Some of the Reasons for Using a Private Foundation?

The following are some of the possible advantages of using a private foundation:

  • There might be a significant public relations benefit to conducting charitable activities through a well-known foundation that is associated in the public’s mind with the bank.
  • The bank can recruit key members of the community to serve on the foundation’s board of directors.
  • The bank can use the foundation to control the timing of its charitable contributions and the related deduction. For example, if the bank has had a profitable year and would benefit from the contribution deduction, it can simply make a contribution to the foundation by year end, as opposed to performing all of the steps to make a number of small individual contributions by year end.
  • The bank can refer all contribution requests to the foundation, rather than having to deal with them directly.

What Are Some Issues to Keep in Mind for Bank Private Foundations?

Private foundations require time, effort, and cost to establish and maintain. The bank will typically incur professional fees for the foundation’s incorporation, its Form 1023 preparation, and its annual IRS Form 990-PF filing.

The Internal Revenue Code contains a number of very strict and complex rules designed to ensure that private parties do not benefit at the expense of the foundation. The easiest way to comply with these rules is to bend over backwards to ensure that all transactions between the foundation and the bank or other insiders are at absolutely no cost to the foundation.

A private foundation is relatively easy to operate as long as it makes grants only to public charities. However, the operation is much more complex if grants are made to (a) other types of entities, including private foundations or (b) individuals, for example say in the form of a scholarship or as direct disaster assistance relief. Therefore, most bank private foundations choose to give grants only to public charities.

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