Maximizing Contributions to your Private Foundation – A Conduit Foundation
Private foundations have long been used to drive wealthy individuals’ and their family’s philanthropic goals.
The benefits of these foundations include an upfront tax deduction for the donor, income tax free return on contributed assets (subject to an excise tax of 1% or 2%) and control of the foundations assets, along with the various non-tax benefits of creating a family legacy that can last multiple generations. However, one main disadvantage of a private foundation is the AGI limitations imposed on contributions to foundations as compared to a public charity or donor advised fund (30% vs 50% for cash contributions, 20% vs 30% for noncash contributions). If any portion of the contribution is not deductible due to these limitations in the current year, that portion will carry over for five years, and is then lost if not used. However, there is a little known exception to these rules that allows an individual to receive the benefit of increased AGI limitations for contributions to private foundations called a conduit foundation.
Under Sec. 170(b)(1)(F)(ii), a private non-operating foundation will qualify as a conduit foundation if by the fifteenth day of the third month after the end of the tax year (March 15th for calendar year end returns) the foundation makes qualifying distributions out of corpus equal in value to 100% of the value of the contributions received in such year. To be qualifying distributions, the distributions must be made to an organized charity that is not controlled directly or indirectly by the foundation or another private foundation. For the contributions to qualify as out of corpus, the foundation must distribute the annual required amount of minimum investment return under Sec. 4942 and 100% of the contributions received in the current tax year. Minimum investment return is defined as 5% of the fair market value of all foundation assets other than those used in carrying out the foundation’s exempt purpose. A private foundation is eligible for this status on a year-to-year basis and does not require any prior approval by IRS.
To ensure the foundation qualifies a statement should be attached to the foundation’s tax return to include the calculation for status as a conduit foundation. The foundation may use any portion of the excess distributions (distributions over the minimum investment return amount) from prior years to satisfy the distribution requirements stated above. In addition, an election must be made on the foundation’s current year tax return and signed by the foundation manager. The taxpayer claiming the charitable deduction will receive the increased AGI limitation amount, but must also obtain documentation from the foundation that the conduit status was achieved.
A separate election must also be made to include any portion of distributions made during the 2 ½ month period after the end of the year as if it were made out of corpus of the prior year. To qualify, these distributions cannot be treated as made out of undistributed income of the immediately preceding taxable year. This election must also be attached to the foundation’s return and signed by the foundation manager.
X is a private foundation on a calendar year basis. As of January 1, 2015, X had no undistributed income for 2014. X's distributable amount for 2015 was $600,000. In July 2015, A, an individual, contributed $500,000 (fair market value determined at the time of the contribution) of appreciated property to X (which, if sold, would give rise to long-term capital gain). X did not receive any other contribution in either 2014 or 2015. During 2015, X made qualifying distributions of $700,000, which were treated as made out of the undistributed income for 2015 and $100,000 out of corpus. X will meet the conduit foundation requirements 2015 if it makes additional qualifying distributions of $400,000 out of corpus by March 15, 2016.
The increased AGI limitations for donors to a conduit foundation requires the foundation to retain complete and accurate records. Donors also must receive sufficient evidence from the foundation showing the foundation made the required qualified distributions within the time prescribed to attach to their income tax return. In general, a copy of the foundation’s tax return will meet this requirement.
In addition to the increased AGI limitation for contributions made to private foundations, there is another potential benefit for donations to a conduit foundation. Generally speaking, a donor can only get a deduction equal to the basis of property contributed to a private foundation, rather than its fair market value (FMV), unless that property is qualified appreciated stock (stocks traded on the open market). A contribution to a conduit foundation however, allows a donor to get a deduction equal to FMV even if the contributed property is not qualified appreciated stock. When receiving long-term capital gain property, the foundation must use the FMV of the contribution on the date it is received in its calculation to satisfy the conduit foundation requirements.
While there are many non-tax reasons a taxpayer may want to donate to their foundation, maximizing tax efficiencies at the same time is never a bad idea. Under the right circumstances, a conduit foundation can increase a donor’s deduction for making the exact same contribution. When executed properly, a conduit foundation can be extremely beneficial.