Yes, donations to a private foundation are tax-deductible, but the rules are much stricter than for other charities. The main problem comes from a specific rule in the U.S. tax code. Internal Revenue Code § 170(e)(1)(B)(ii) limits your tax deduction for gifts of certain valuable property, like private company stock or real estate, to what you originally paid for it, not its current high value. This rule creates a huge financial hurdle for successful people who want to fund a family foundation with their best assets, often leading to a tiny tax benefit for a very large gift.
Despite these rules, giving remains a core part of American life. In 2024, a full 81% of wealthy households gave to charity, with an average gift of $33,219. Understanding the specific rules for private foundations is key to making sure your generosity helps both the charity and your own finances as much as possible.
Here is what you will learn in this guide:
- ✅ The “Yes, But…” Answer: Find out exactly when a donation is fully deductible and when it is limited to what you originally paid for it.
- 💰 Asset-by-Asset Breakdown: Learn the different tax rules for donating cash, public stock, private stock, and real estate to your foundation.
- 🚫 How to Avoid Crippling IRS Penalties: Discover how to navigate the strict IRS “self-dealing” rules that can trigger massive taxes for simple mistakes.
- ⚖️ Foundation vs. DAF Showdown: Get a clear, side-by-side comparison of a private foundation and a donor-advised fund (DAF) to see which is right for you.
- 📝 Your Foundation Blueprint: Follow a clear, step-by-step guide to starting a private foundation, from state paperwork to filing with the IRS.
Meet the Key Players: Understanding the World of Private Foundations
To understand the rules, you first need to know the players. The world of charitable giving involves a few key groups defined by the Internal Revenue Service (IRS), the U.S. government agency that collects taxes. The relationship between these groups decides how your donations are treated for tax purposes.
What Exactly Is a Private Foundation?
A private foundation is a nonprofit organization that is usually funded by a single source. This source is often one person, a family, or a company. Think of the Bill & Melinda Gates Foundation; it was started by one family. Because the money and control come from a small group, the IRS has very strict rules to make sure the foundation helps the public, not just the founders.
Under U.S. tax law, any new charity that applies for tax-exempt status under IRC § 501(c)(3) is automatically called a private foundation. The organization must then prove to the IRS that it should be a public charity to get out of the tougher private foundation rules. This is a key distinction that affects everything from your tax deduction to how the organization must operate.
There are two main types of private foundations:
- Non-Operating Foundations: This is the most common type. These foundations do not run their own charitable programs. Instead, their main job is to make grants, which means giving money to other charities.
- Operating Foundations: This type is much less common. An operating foundation uses its money to actively run its own charitable programs, like a museum or a research center funded by one family. Because they act more like public charities, donations to operating foundations get better tax treatment.1
What Makes a Public Charity Different?
A public charity is also a 501(c)(3) nonprofit, but it gets its money from many different sources.3 These sources include the general public, the government, and other charities.4 Groups like the American Red Cross, your local food bank, or a university are all public charities. They must prove they have wide public support to the IRS through a complex math problem called the “public support test” under IRC § 509(a).
Because they are funded and watched over by the public, the IRS rules for public charities are more flexible. The tax deductions for donating to them are also much more generous. This is the main reason why the choice between a private foundation and a public charity is so important for donors.
What Does the IRS Consider a “Charitable Contribution”?
The IRS has a very specific definition for a “charitable contribution.” It is a voluntary gift of money or property to a qualified organization where you get nothing of significant value in return. This definition has two critical parts that you must meet to get a tax deduction.
First, the gift must go to a qualified organization. This is a nonprofit that the IRS has officially recognized as tax-exempt under IRC § 501(c)(3). Second, you cannot get a major benefit for your gift. If you pay $500 for a charity dinner ticket and the meal is worth $150, your deductible contribution is only $350.5
Why So Strict? The Ghost of the 1969 Tax Reform Act
The complicated rules for private foundations were not created by accident. They are the direct result of the Tax Reform Act of 1969, a major law passed by Congress to stop widespread abuses. Before 1969, wealthy families could set up foundations to get huge tax breaks while using the foundation’s money for their own benefit.8
Investigations by Congressman Wright Patman and the Treasury Department found that some foundations were used to control family businesses and pay personal expenses.8 President Truman even called them a “cloak for speculative business ventures”.10 The 1969 law was designed to stop these practices by building a wall between a foundation’s money and the private interests of its founders.10 This history is why the IRS watches private foundations so closely today.
The Rules of the Game: Your Definitive Guide to Deduction Limits
The amount you can deduct for a donation to a private non-operating foundation depends on two things: your Adjusted Gross Income (AGI) and the type of asset you donate. The limits are almost always lower than for donations to public charities. If you donate more than the annual limit, you do not lose the extra deduction; you can “carry over” the excess amount for up to five future tax years.11
| Asset Type | Donation to Private Foundation | Donation to Public Charity / DAF |
| :— | :— |
| Cash | Deductible up to 30% of your AGI.12 | Deductible up to 60% of your AGI.16 |
| Publicly Traded Stock (held >1 year) | Deductible at Fair Market Value, up to 20% of your AGI.12 | Deductible at Fair Market Value, up to 30% of your AGI. |
| Private Stock / Real Estate (held >1 year) | Deductible at Cost Basis Only, up to 20% of your AGI. | Deductible at Fair Market Value, up to 30% of your AGI. |
| Art & Collectibles (held >1 year) | Deductible at Cost Basis Only, up to 20% of your AGI. | Deductible at Fair Market Value (if related use), up to 30% of AGI. |
Donating Cash: The Simplest Gift
This is the most straightforward type of donation. When you give cash to a private foundation, you can deduct the amount up to 30% of your AGI for that year.12 This is exactly half the limit for public charities, which allow a deduction of up to 60% of your AGI.16
Donating Publicly Traded Stock: The Powerful Exception
This is the most tax-smart way to fund a private foundation. When you donate “qualified appreciated stock,” which is publicly traded stock you have owned for more than one year, you get a huge double tax benefit. This is the primary reason many wealthy families choose to start a foundation.
First, you can deduct the full fair market value (FMV) of the stock on the day you donate it. Second, you pay no capital gains tax on the stock’s growth in value. For example, if you donate stock worth $100,000 that you bought for $10,000, you get a $100,000 tax deduction and avoid paying tax on the $90,000 of growth. Your deduction for this type of gift is capped at 20% of your AGI for the year.12
Donating Private Stock and Real Estate: The Harsh Reality
Here is where the restrictive rule of IRC § 170 hits the hardest. For most other types of valuable property donated to a private foundation, your deduction is limited to your cost basis, which is what you originally paid for the asset. This rule effectively removes the tax incentive for donating your most appreciated assets to your own foundation.
For example, if you are a business founder and donate $1 million worth of your private company stock that has a cost basis of only $10,000, your tax deduction is just $10,000. The same harsh rule applies to donations of real estate. This is why many entrepreneurs choose to donate these specific assets to a public charity or a donor-advised fund, where they can deduct the full fair market value.17
The Five Deadly Sins: How to Avoid Crippling IRS Penalties
The IRS enforces the strict rules from the 1969 Tax Reform Act with a set of powerful penalties called the Chapter 42 excise taxes. These are designed to be so punishing that foundations will avoid certain behaviors at all costs. They are often called the “five deadly sins” of private foundations.
Sin #1: The Absolute Ban on Self-Dealing
This is the strictest rule of all. IRC § 4941 creates an absolute ban on almost any financial transaction between the foundation and its “disqualified persons.”18 Disqualified persons include you (the founder), your family, and businesses you control.18 Prohibited acts include selling property to the foundation, leasing office space from yourself, or having the foundation pay for personal travel. Breaking this rule results in a 10% tax on the disqualified person and a massive 200% tax if the transaction is not undone.18
Sin #2: The Mandate to Distribute Income
To stop foundations from just holding onto money, IRC § 4942 requires private non-operating foundations to pay out about 5% of their assets for charitable purposes each year. This is called the “minimum distribution requirement.” Failing to meet this payout results in a 30% tax on the amount that was not distributed.
Sin #3: The Prohibition on Excess Business Holdings
This rule, under IRC § 4943, stops a foundation and its disqualified persons from controlling a for-profit business. Generally, your foundation and your family together cannot own more than 20% of the voting stock of a company. Owning more than this triggers a 10% tax on the excess holdings.21
Sin #4: The Bar on Jeopardy Investments
Foundation managers must be careful with the foundation’s money. Under IRC § 4944, they cannot make speculative or very risky investments that could put the foundation’s charitable mission in danger.18 This rule requires foundation managers to use ordinary business care and good judgment.
Sin #5: The Restriction on Taxable Expenditures
Finally, IRC § 4945 prohibits foundations from spending money on certain activities. These “taxable expenditures” include lobbying to influence laws, participating in political campaigns, or making grants to individuals without getting advance approval from the IRS. Making a taxable expenditure results in a 20% tax on the foundation.
Real-World Philanthropy: Three Scenarios That Show the Stakes
Seeing how these rules play out in real life makes them easier to understand. Here are three common scenarios that show what can go right and what can go horribly wrong.
Scenario 1: The Smart Stock Donation
| Donor’s Action | Financial Consequence |
| Sarah, a retired executive, donates $500,000 worth of publicly traded stock to her new foundation. She has owned the stock for 15 years, and her original cost was only $50,000. | Success. Sarah gets a charitable deduction for the full $500,000 (subject to the 20% AGI limit). She pays zero capital gains tax on the $450,000 of growth. The foundation can sell the stock and use the cash for grants. |
Scenario 2: The Private Stock Problem
| Donor’s Action | Financial Consequence |
| Mark, a tech founder, donates 5% of his private company stock, valued at $2 million. His cost basis in the stock is a mere $20,000. | Unfavorable Tax Outcome. Because this is privately held stock, IRC § 170 limits his deduction to his cost basis. Mark’s charitable deduction is only $20,000, not the $2 million value of his gift. He gets almost no tax benefit for his generous donation. |
Scenario 3: The Real Estate Disaster
| Donor’s Action | Financial Consequence |
| David donates an office building worth $1 million to his foundation. The building has a $400,000 mortgage, which the foundation agrees to take over. | Disaster. The foundation assuming the mortgage is a prohibited act of self-dealing. David faces a 10% excise tax ($40,000) on the mortgage amount. If not corrected, the penalty on David could jump to 200% ($800,000). |
The Great Debate: Private Foundation vs. Donor-Advised Fund (DAF)
For many people who want to be strategic with their giving, the main choice is between a private foundation and a donor-advised fund (DAF). A DAF is like a charitable savings account held at a large public charity, such as Fidelity Charitable.22 The choice comes down to a simple trade-off: control versus simplicity.24
| Feature | Private Foundation | Donor-Advised Fund (DAF) |
| :— | :— |
| Structure | A separate, independent legal entity that you create and run.24 | An account held within a larger public charity.24 |
| Control | You have full legal control over investments and grantmaking.25 | You have “advisory privileges” to recommend grants; the sponsor has final approval.22 |
| Tax Deductions | Less favorable. 30% AGI limit for cash; 20% for stock. Cost basis for private stock/real estate.22 | More favorable. 60% AGI limit for cash; 30% for stock. Fair market value for private stock/real estate.26 |
| Anonymity | No. All grants are public record on the annual Form 990-PF tax return.26 | Yes. You can choose to make grants anonymously.26 |
| Costs | High. Requires legal fees to set up, plus ongoing accounting and administrative costs.22 | Low. No setup fees and low annual administrative fees.22 |
| Annual Payout | Yes. Must distribute ~5% of assets annually.28 | No. There is no federally required annual payout.22 |
| Excise Tax | Yes. A 1.39% tax is paid on net investment income each year.26 | No. Investment growth is completely tax-free.26 |
Weighing Your Options: The Pros and Cons of a Private Foundation
Before jumping in, it is critical to weigh the advantages and disadvantages of starting a private foundation. While they offer great control, they also come with significant responsibilities.
| Pros | Cons |
| Total Control: You and your family decide the mission, investments, and grants. | High Costs: You must pay for legal setup, accounting, and annual administration.30 |
| Family Legacy: A foundation can exist forever, carrying your family’s name and values for generations.32 | Complex Rules: You are subject to the strict IRS excise tax rules, which are complicated and carry heavy penalties. |
| Grant Flexibility: You can make grants to individuals (like for scholarships) and even foreign charities if you follow specific IRS procedures. | Lower Tax Deductions: The AGI limits for deductions are lower than for public charities, and gifts of complex assets are limited to cost basis. |
| Employ Family: You can legally pay reasonable salaries to family members for necessary work they do for the foundation.33 | No Privacy: All of your foundation’s grants and financial details are made public every year on your tax return.34 |
| Tax Benefits: You get an immediate income tax deduction and can avoid capital gains and estate taxes.25 | Time Consuming: Running a foundation requires real work, including holding board meetings and keeping detailed records.30 |
Your Foundation Blueprint: A Step-by-Step Startup Guide
If you decide the control and legacy of a private foundation are right for you, starting one is a formal legal process. It is highly recommended that you work with an attorney who specializes in nonprofit law to guide you.36
Step 1: Form a Legal Entity in Your State
Before you can talk to the IRS, your foundation must exist as a legal entity under state law.18 You have two main choices:
- Nonprofit Corporation: This is the most common structure. It is more formal and requires articles of incorporation and bylaws, but it protects you from personal liability.30
- Charitable Trust: This is less common and run more informally. However, it can be much harder to change the terms of the trust later on.30
Step 2: Draft Your Governing Documents
Your articles of incorporation or trust agreement are the legal rulebook for your foundation. These documents must contain specific language required by the IRS to get tax-exempt status.18 Most importantly, under IRC § 508(e), the documents must explicitly require the foundation to follow all the Chapter 42 excise tax rules (the “five deadly sins”). Many states have laws that automatically apply these provisions, which can satisfy the IRS requirement.
Step 3: Get an Employer Identification Number (EIN)
An EIN is a nine-digit number the IRS assigns to organizations for tax purposes. You need an EIN to open a bank account, hire employees, and file tax returns.30 You can apply for one for free on the IRS website by filing Form SS-4.30
Step 4: File Form 1023 with the IRS
This is the most important step. Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3),” is a long and detailed application that you must file with the IRS to be officially recognized as a tax-exempt charity. The IRS review process can take six to 12 months.18
Key parts of Form 1023 include:
- Part I: Identification of Applicant. This is basic information about your foundation, like its name, address, and EIN.
- Part II: Organizational Structure. You must attach a copy of your organizing document (like your articles of incorporation) that shows it was filed with your state.
- Part IV: Narrative Description of Your Activities. You must describe in detail what your foundation plans to do. Be specific about how you will make grants and achieve your charitable mission.
- Part V: Compensation and Financial Arrangements. You must tell the IRS about any planned payments to officers, directors, family members, or key employees. This is where the IRS looks for potential self-dealing issues.
- Part VIII: Your Specific Activities. You must answer detailed questions about your planned activities, including fundraising, grantmaking, and any political activities (which are banned).
- Part X: Public Charity or Private Foundation Status. This is where you officially tell the IRS that you are a private foundation.
Danger Zones: 6 Common Mistakes That Can Wreck Your Foundation
The path to running a successful foundation is full of potential traps. Knowing about them from the start can save you from major headaches and severe IRS penalties.
- Ignoring Self-Dealing Rules: This is the #1 mistake. Paying a family member too much, leasing office space from yourself, or even having the foundation pay you back for an expense can trigger huge penalties. The foundation should always pay its own bills directly.
- Failing to Define a Clear Mission: A vague mission can lead to confusion and make it hard to justify your grants to the IRS.36 This could cause you to lose tax deductions or even your tax-exempt status.
- Sloppy Record-Keeping: The IRS requires detailed records of all activities, including board meeting minutes and grant agreements. Your annual tax return, Form 990-PF, is a public document, and errors can hurt your reputation.40
- Improper Valuation of Donations: For non-cash gifts over $5,000, you must get a “qualified appraisal” and file Form 8283. Overvaluing a gift is a major red flag for the IRS and can cause your entire deduction to be disallowed.
- Forgetting State-Level Rules: In addition to the IRS, you must also follow your state’s rules for charities.36 Failing to register or file reports with your state can result in fines or prevent you from legally operating.
- Making Grants Improperly: You cannot just write a check to anyone. Grants to individuals or non-charities require special IRS procedures to ensure the money is used for charitable purposes.
The Philanthropist’s Playbook: Do’s and Don’ts for Foundation Management
| Do’s | Don’ts |
| Do get expert help. Hire a lawyer and an accountant who specialize in private foundations to make sure you stay compliant.36 | Don’t mix personal and foundation finances. Keep a completely separate bank account and records for the foundation.42 |
| Do hold regular board meetings. Keep detailed minutes of all decisions about grants, investments, and expenses.34 | Don’t assume a transaction is okay just because it helps the foundation. The self-dealing rules ban most transactions with insiders, no matter how fair they seem. |
| Do create a clear grantmaking process. Have clear, written rules for how you choose who gets grants to support your mission. | Don’t engage in any political activity. A private foundation is absolutely forbidden from supporting or opposing candidates for public office.30 |
| Do pay close attention to Form 990-PF. This annual tax return is public information and is a reflection of your foundation’s integrity.40 | Don’t forget about state-level requirements. You must also follow the rules of your state’s charity regulator, which is often the Attorney General’s office.42 |
| Do involve the next generation. A foundation is a powerful way to teach your family about giving and prepare them for a legacy of philanthropy. | Don’t pay excessive compensation. Any salaries paid to family members must be “reasonable and necessary” for the work they do for the foundation. |
Frequently Asked Questions (FAQs)
1. Is my donation to a private foundation tax-deductible?
Yes, your donation is tax-deductible if you itemize, but the deduction is limited. The limit is 30% of your adjusted gross income (AGI) for cash and 20% of AGI for property.44
2. Can I donate my private company stock and get a full deduction?
No. For a donation to a private non-operating foundation, your deduction for private stock is limited to what you paid for it (your cost basis), not its current higher value.
3. What is the best asset to donate to a private foundation?
Publicly traded stock held for more than one year. This is the major exception that allows you to deduct the full fair market value while also avoiding capital gains tax on the appreciation.
4. Can my foundation pay me a salary?
Yes, but only if the salary is “reasonable” compensation for “necessary” services you perform. Paying an excessive salary is a prohibited act of self-dealing and will result in significant penalties.
5. How much money do I need to start a private foundation?
There is no legal minimum. However, due to high setup and administrative costs, most advisors suggest you should have at least several million dollars to make it worthwhile. A DAF is more efficient for smaller amounts.34
6. Can my foundation give a scholarship to my grandchild?
No. This would be a clear example of self-dealing, as it provides a financial benefit to a family member. This is strictly prohibited and would trigger large excise taxes.18
7. Do I have to give away money every year?
Yes. Private non-operating foundations must distribute about 5% of their net investment assets each year for charitable purposes. This is known as the minimum distribution requirement.28