Does Foundations Really Serve A Great Purpose?

Does Foundations Really Serve A Great Purpose?

Under current law, an estate owner can establish a private foundation while living or at death and any contributions made to a private foundation are tax deductible. Although highly regulated to stem and prevent "self-dealing" strategies, the tax benefits are indeed tempting.

The tax deduction allowed for contributions to a private foundation cannot exceed 30% of your adjusted gross income while living. On the other hand, there is no limit on the deduction your estate can make after your death.

Reduce Estate Taxes, Buy a Piece of Immortality, and Serve a Great Cause

Let's look at an example. Let's say a husband and wife has a $10,000,000 dollar estate. Today, they elect to establish a private foundation designed to benefit under privileged children and single mothers.

Of the $10,000,000, they take $4,000,000 and contribute it to the private foundation. As far as the IRS is concerned, their taxable estate is now only $6,000,000 and they've saved over $2,000,000 in estate taxes by this one simple maneuver.

The husband and wife placed their children as the directors of the foundation, of which they will draw annual salaries.

Each year, the foundation is required to distribute 5% of its assets to known charities. This give the donors and the children who run it great leverage and prestige in the community in which they reside.

Quintuple Tax Play

Again, let's look at another example of how to use a private foundation combined with some of the other strategies we've examined earlier in our site.

Let's say Bob and his wife who are now in there late 60's. Bob starting buy stock in his late 20's and was a buy and hold, valued-oriented investor. Today, their stock portfolio is valued at over $6,000,000. If they were to sell their shares, they would incur huge capital gains tax liability. If they elect to continue holding the shares until he and the wife pass away, estate taxes will consume over 55%.

To avoid the inevitable, Bob and his wife established a charitable remainder income trust, a tax free inheritance (insurance) trust and a private family foundation.

Bob and his wife donated the $6,000,000 of stock to the charitable remainder trust and as acting trustees, they liquidated the stock holding and incurred no capital gains taxes. The proceeds were invested in government paper, which earned approximately 7%. The charitable remainder trust paid Bob and his wife $420,000 annually.

As you may recall, assets donated to a charitable remainder trust eventually wind up in the possession of a charitable organization or foundation. Hence, at their death, the $6,000,000 dollars that remained went to the Bob Johnson Foundation, which he and his wife created long ago.

The foundation distributes 5% of it's income annually ($300,000), which leaves another $120,000 to pay for the foundation's expenses including salaries to the children who serve as directors.

The one drawback to this strategy lies in the fact that Bob's children stand to lose $3,000,000 dollars, assuming he and his wife held his stock instead of transferring it to the charitable trust.

To ensure that his children get their share, he used the Tax-Free Inheritance (insurance) trust to purchase a $3,000,000 million dollar Survivorship Life insurance plan on he and his wife. The deduction that Bob and his wife received for making the original contribution to the charitable trust is more than enough to cover the cost of the insurance premiums.

In Summary

Bob and his wife established a charitable trust and transferred the stock to avoid the capital gains taxes and estate taxes.

They established a private family foundation to serve as the eventual recipient of the charitable trust proceeds.

The foundation is run by his children/grandchildren at they are paid handsomely for doing so.

The children receive the death benefit from the tax free inheritance (insurance) trust 100% income and estate tax free.

And the foundation distributes 5% of its assets to charitable causes it supports.