Foundations and Charities
Foundations and charities are institutional clients with unique investment constraints. The exam tests the distinctions between private foundations, public charities, and donor-advised funds.
Private Foundations
- Typically funded by a single source (individual, family, or corporation)
- Tax-exempt under Section 501(c)(3) of the Internal Revenue Code
- Must distribute at least 5% of net investment assets annually for charitable purposes
- Subject to excise tax on net investment income (1.39%)
- More restrictive rules than public charities (limits on self-dealing, excess business holdings)
- Donors receive a tax deduction, but with lower adjusted gross income (AGI) limits than donations to public charities (30% of AGI for cash, vs. 60% for public charities)
- Must file Form 990-PF annually
Exam Tip: Gotchas
- The 5% distribution requirement applies to private foundations only. NOT public charities or donor-advised funds.
- The 1.39% excise tax on investment income applies to private foundations only.
- "Which client type has a mandatory annual distribution?" The answer is a private foundation (5%).
Public Charities
- Receive funding from the general public, government grants, or other public sources
- Also tax-exempt under Section 501(c)(3)
- No minimum distribution requirement
- Donors receive more favorable tax deduction limits (up to 60% of AGI for cash contributions)
- Subject to less regulatory scrutiny than private foundations
Donor-Advised Funds (DAFs)
- Charitable giving vehicle administered by a sponsoring organization (usually a public charity)
- Donor receives an immediate tax deduction at the time of contribution
- Donor recommends (but does not control) grants to qualified charities
- No required minimum distribution or timeline for granting
- Cannot benefit the donor or donor's family (no self-dealing)
- Simpler and cheaper to establish than a private foundation
Exam Tip: Gotchas
- A donor-advised fund (DAF) donor cannot legally compel a grant; they can only "recommend."
Private Foundation vs. Public Charity vs. DAF
| Feature | Private Foundation | Public Charity | Donor-Advised Fund |
|---|---|---|---|
| Funding source | Single source (family/corp) | General public | Individual donor |
| Required distribution | 5% annually | None | None |
| Tax deduction limit (cash) | 30% of AGI | 60% of AGI | 60% of AGI |
| Control | Full board control | Board governance | Donor recommends only |
| Setup complexity | High | High | Low |
| Excise tax on investment income | Yes (1.39%) | No | No |
Exam Tip: Gotchas
- Private foundations MUST distribute at least 5% of net investment assets each year for charitable purposes. Public charities and DAFs have no such requirement.