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Ike Leighty likes to joke that starting a family foundation is like catching a porcupine – first you throw a washtub over it and that gives you something to sit on while you figure out what to do next.

He should know. In 1985 the successful entrepreneur from Waterloo, Iowa, set up his own private foundation.

“I was accumulating more money than I needed or could spend and knew that at some point my own assets would grow and the kids would have to deal with it at some point in time,” he says. “So I got them involved off the bat and told them I was setting up a foundation and we would give the income away each year to worthy causes.”

For his daughter, Jane Leighty Justis, executive director of The Leighty Foundation, this was an opportunity for the family to define its passions.

Last year philanthropy was in the spotlight as never before following Warren Buffett’s historic $31bn donation to the Bill & Melinda Gates Foundation. His bequest made 2006 a banner year for US charitable giving.

With some Americans getting wealthier every year, more money is destined to end up in family foundations and donor advised funds (DAFs) – intermediary vehicles that grant money to charities designated by the donor. A key question for many aspiring philanthropists is how to structure their charitable giving. Some choose to establish a private family foundation while others opt for a DAF. Others want both. The decision usually rests on a donor’s motive and objective.

“What I do is try to find out their ultimate goal. Is it a tax deduction or a series of tax deductions or something that not only gives a tax deduction but also gives them an entity that will be a very important part of their family dynamic where they can have their children involved in philanthropy?” says David Scott Sloan, a partner at Holland & Knight and head of its private wealth services group.

In essence, private foundations allow the donor more control and visibility, but entail more work and cost. DAFs are simple to set up and run, are focused on grant-making, and have the advantage of being a public charity while shifting the investment responsibilities and paperwork to the fund administrators.

Community foundations pioneered DAFs but a number of financial services companies, universities and relief organisations now offer this service.

Karen Putnam, head of Bessemer Trust’s philanthropy and stewardship advisory and former president of the Central Park Conservancy, says discussions about setting up a private foundation or DAF should take place under a broader umbrella.

“We look at the philanthropy advice we give as part of a larger wealth stewardship plan where there are opportunities for clients to use philanthropy not only as a way of doing good and giving back to their community, but also as a way to teach the next generation the real life skills of planning, budgeting and evaluating a return on investment,” she says. “There is no driver for the advice other than the philanthropic desires of the clients, the tax considerations for their estate, the family involvement in philanthropy and the extent to which they want to define their legacy in terms of philanthropy.”

There are several areas where the difference between a private foundation and a DAF are stark, especially when it comes to control of the assets and the grant-making; the size of the tax deduction; and administration. However, for some considerations, such as family involvement, the differences blur.

The biggest point of departure is control. “With a private foundation, the donor family has complete control of all grant making and also control of investment decisions,” says Putnam. “A DAF is called ‘advised’ for a reason: in a DAF, the donor is requesting that a gift be made from the fund.”

In a DAF, the donor can make recommendations on how the money is invested and distributed to charities, but the ultimate choice lies with the administrators.

A private foundation must distribute at least 5 per cent of the fair market value of the investment assets annually; otherwise there is a 15 per cent tax on undistributed income. (Legislation pending in Congress would also require DAFs to distribute at least 5 per cent of their total assets each year.)

Private foundations are also subject to a 1-2 per cent annual excise tax on net income, depending on the level of grant-making from year-to-year.

Another key difference is the income tax deduction. “Donor advised funds are treated as public charities for tax purposes – so you get a more generous tax deduction,” says Matthew Brady, a managing director at Lehman Brothers’ wealth advisory group in San Francisco. “People making significant charitable donations would get a more immediate tax benefit by giving to a DAF.”

Gifts of cash are income tax deductible up to 30 per cent of the donor’s adjusted gross income (AGI) for private foundations, and 50 per cent of AGI for public charities. Donations of property held for more than one year are generally deductible at fair market value, but are subject to lower deduction limits – 20 per cent of AGI for private foundations, and 30 per cent for public charities. But the deduction for gifts of appreciated property to private foundations is limited to the lower of the property’s fair market value or the donor’s tax basis.

The administration of a family foundation is considerably more complex than setting up a DAF and can tip a donor’s decision.

“The drawback of a family foundation is that you are creating a living, breathing entity,” says Sloan. “It has to do things and give way 5 per cent and file tax returns and there are administrative costs. When the foundation files tax returns the income is tax exempt but there is potential for some small excise taxes on net investment gains. Foundations also have to be very careful about self-dealing rules.”

The rules against self-dealing prohibit any direct financial transaction between the foundation and nearly all the people closely related to it. Private foundations have more extensive tax reporting requirements than public foundations. With a DAF, the onus is on the supporting organisation to file to the IRS. No separate tax return is required from the donor.

One of the disadvantages of this paperwork is that private foundations’ tax returns are public information. “It is much harder to make an anonymous gift through a family foundation,” says Putnam.

There is another housekeeping consideration: When a donor uses a DAF, the fiduciary responsibility lies with the fund, not the donor. With a private foundation, the trustees or board or directors have full fiduciary responsibility. Sloan says donors who set up a private foundation may want to consider director’s and officer’s liability insurance.

These types of administrative headaches are not an issue with a DAF. “A big plus of a DAF is that there is an existing sponsor organisation that administers it for you,” says Brady. “They will invest the money for you and take care of all the details. They take a lot of the administrative work out of the hands of the donor so it makes the whole process very simple for a donor.”

For Spencer Standish, former chairman of Albany International, this was one of the reasons behind his decision to set up a DAF with the Community Foundation for the Capital Region instead of a family foundation. “The community foundation had a very good record in the community and I felt it was a lot simpler than a private foundation,” he says.

Jim Donnellan, a principal at Edison Elementary School in Appleton, Wisconsin, established the Donnellan Family Fund within the Community Foundation for the Fox Valley Region. “It was as easy as opening a checking account,” he says.

Perhaps the biggest advantage of creating a fund through a community foundation is that they know, and live in, the community they serve.

But Leighty Justis says prospective donors shouldn’t think of foundations as an “either or”. Her father, for example, also established a DAF. This gave him the dual benefits of a public charity and a private foundation. The DAF also allowed him to take advantage of the community foundation’s due diligence process on grant applications while keeping him involved in his community.

When Mark and Karen Hill sold their software technology company a few years ago, they opted to open a DAF with the Central Indiana Community Foundation. “We wanted someone who was an expert rather than having to go out and get lawyers. It was much easier,” says Hill. “The key piece was expertise.”

Ken Strmiska, managing director of community foundation services for the Council on Foundations, says the community foundation “fits into a sphere of service in the way a CPA or private banker does in one’s life – a high level of expertise in a very small area”. Just as being involved in the community is important for donors who choose DAFs, family participation is paramount for family foundations.

Fred and Marian Pfister Anschutz created the Anschutz Family Foundation in 1982 after many years of successful gas and oil, real estate and ranching ventures. Today their daughter, Sue Anshutz-Rogers, is executive director, and four of the founders’ six grandchildren serve as trustees.

For many donors who establish a DAF, involving family is also key. Christine Standish, whose father set up the Standish Family Fund, says: “It has really brought the family together. It makes us focus and talk about the issues going on in our community and work together.”

With advantages and disadvantages to both private and public foundations, how does a prospective donor decide?

“In general what this almost always comes down to is the amount of money the family wants to donate to charitable causes over time and every one has their own threshold,” says Lehman Brothers’ Brady. “For a family foundation, we usually say $3m to $5m is an amount that makes sense in order to make the administration of your own fund worthwhile. Second is personality. A lot of people are very hands-on and that would tend to lower the dollar threshold.”

Sloan says he prefers not to set up a family foundation for less than $1m. “If you are giving 5 per cent a year, that’s $50k, then there are filing costs, tax reports, and an initial report with IRS to qualify for exempt status. It doesn’t make sense with a few hundred thousand dollars.”

By contrast, the minimum contribution for a DAF can be much lower – between $2,500 and $25,000 in cash, stock or other assets.

Strmiska says the decision to choose a family foundation over a DAF is analogous to why some people choose stocks while others choose mutual funds. The outcome, however, is the same. “You’re still doing good work either way, it is just how you want to achieve same result.”

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