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Strategies to start a corporate foundation | Baker Tilly
Article
Corporations can boost brand and do good with a corporate foundation
April 4, 2024 · Authored by Wendy Campos, Steve Talbot
A corporate foundation is a philanthropic organization created and financially supported by a corporation. Corporate foundations are generally set up as private foundations and are a legal entity separate from the corporation itself.
Organizations that qualify for tax exemption under Internal Revenue Code (IRC) Section 501(c)(3) are, by default, a private foundation unless they qualify as a public charity. A corporate foundation is a type of foundation that generally differs from family foundations in funding and governance.
Why start a corporate foundation?
A corporate foundation can:
Raise brand awareness
Increase employee engagement
Provide flexibility and control over giving
Provide tax benefits
Allow an organization to give back to the community
Alternative methods of corporate giving include corporate giving programs, product donations, in-kind donations, employee gift matching programs, and volunteering programs.
A corporation could also create a separate entity structured as a public charity to carry out its philanthropic goals. Public charities require broad contribution support from the public, beyond any funding from the corporation.
How do you start a corporate foundation?
To start a corporate foundation, first form the entity then apply for tax-exempt status.
Establish a legal entity
For a private foundation organized as a non-stock corporation, which is most common, articles of incorporation should be created and filed with the state of incorporation.
Bylaws should be created and approved by the board of directors. A conflict-of-interest policy should be developed. Engage an experienced attorney to draft these documents.
Apply for tax-exempt status
Once the organization is legally formed, the corporate foundation will need to apply for tax exemption with the IRS by filing Form 1023 or Form 1023-EZ for small foundations.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.
A user fee is due with the application for tax exemption — this fee is $600 for Form 1023 or $275 for Form 1023-EZ, as of Spring 2024 — and the Form 1023 must be filed within 27 months after the end of the month in which the foundation is formed.
There might also be separate state exemption applications or other charitable registrations that need to be filed, depending on the state the foundation is organized or operates in.
Before applying for exemption, the following items should be determined:
Type of foundation
Exempt purpose and planned activities
Board of directors or trustees
Compensation potentially paid to any board members or foundation managers
Four-year financial budget
If grants will be given to individuals for study, travel, or other similar purposes
What’s the difference between nonoperating and operating foundations?
Section 501(c)(3) organizations that can’t be classified as public charities are private foundations. The types of private foundations recognized by the IRS are private nonoperating foundations and private operating foundations.
Most private foundations apply for their status as nonoperating or operating foundations and receive an IRS exemption letter stating they’ve been classified as such.
Private nonoperating foundations
Most corporate foundations are private nonoperating foundations, focused on grantmaking. They’re allowed to conduct charitable programs or activities themselves, but these aren’t often significant activities. Private nonoperating foundations are required to make a certain amount of qualifying distributions each year — learn more in the distribution requirements section.
Private operating foundations
If a corporate foundation’s main activity is running one or more charitable programs, it can be classified as a private operating foundation.
A private operating foundation conducts charitable activities rather than solely making charitable grants. Because of this emphasis on charitable activities, a private operating foundation receives many of the same tax benefits as a public charity without needing to adhere to the public support test requirements.
A private operating foundation must pass both an income test and one alternate test — the assets, endowment, or support test. The private operating foundation must pass these tests in any three years of a four-year period or in aggregate over that same four-year period. The four-year period ends with the current tax year. During the first three years of a private operating foundation’s existence, it must pass the tests on an aggregate basis.
Exempt operating foundations
Some private operating foundations request IRS recognition as exempt operating foundations. Exempt operating foundations aren’t subject to the tax on net investment income.
To qualify as an exempt operating foundation, an organization must:
Qualify as a private operating foundation
Have been publicly supported for at least 10 years
Contain no officers who are disqualified individuals
Have a governing body broadly representative of the general public, and at least 75% must not be disqualified individuals
Governance practices for corporate foundations
An effective governance model provides foundation leadership with the tools needed for decision making and delivering the mission of the organization.
Board of directors
Every not-for-profit organization has a board of directors to provide leadership, oversight, and accountability for staff. The responsibilities of a corporate foundation’s board of directors include engaging in strategic planning, establishing policies, providing fiscal oversight, and representing the foundation to external audiences.
The board of directors of a corporate foundation is often populated with executives of the corporation. Outside board members, such as community representatives and other professionals with relevant experience and expertise, can also sit on a corporate foundation board.
Strategic planning
An organization should define and clearly articulate the mission, vision, and values of the corporate foundation within a strategic plan. A strategic plan can serve as a road map for a foundation, provide a framework for decision-making, and guide the foundation’s approach to grantmaking and other allocations of resources.
Key policies
Expectations for board members and general rules for daily operation should be documented in a set of clear and up-to-date corporate foundation policies. Some key policies for a corporate foundation may include:
Investment policy
Conflict of interest policy
Expense policy
Recordkeeping and document retention policy
Compensation policy
Whistleblower policy
Staffing a corporate foundation
A corporate foundation can hire and pay employees to carry out its mission. Compensation must be reasonable and should be established via compensation benchmarking. If employees of the existing corporate organization are used to staff the corporate foundation, good timekeeping practices should be in place, so the foundation entity pays only expenses related to foundation activity.
Staff the corporate foundation with individuals who possess adequate not-for-profit experience, knowledge, and capacity to devote attention to foundation operations.
In some cases, an organization may benefit from outsourcing operational responsibilities and processes of the corporate foundation to a third party that specializes in providing services that include grant, fiscal, and investment management.
Distribution requirements for a corporate foundation classified as a private nonoperating foundation
To determine how much to distribute, foundations need to look at:
Required minimum distribution
Minimum investment return
Qualifying distributions
Required minimum distribution
Corporate foundations classified as private nonoperating foundations are required to distribute approximately 5% of the average market value of their noncharitable-use assets each year.
If the corporate foundation distributes more than the distributable amount, the foundation can carry over the excess distribution amount for five years and use it toward future distribution requirements.
If the foundation distributes less than the required minimum distribution in a year, this undistributed income amount must be distributed within 12 months after that year ends. If it’s not distributed within that time frame, the undistributed amount is subject to an excise tax.
Minimum investment return
Minimum investment return (MIR) is the required amount that must be distributed before certain adjustments, such as net investment income excise tax and unrelated business income tax, to reach the distributable amount.
The MIR is 5% of the sum of the average monthly cash balance, the average monthly fair market value of securities, and the fair market value of all other noncharitable-use assets — less acquisition indebtedness related to these assets.
Qualifying distributions
Qualifying distributions by corporate foundations in general are amounts paid to accomplish religious, charitable, scientific, literary, or other public purposes.
Qualifying distributions generally include grants to public charities and exempt operating foundations that aren’t controlled by the grantor foundation.
Other direct expenses for charitable purposes, which may include a portion of administrative expenses, can be treated as qualifying distributions. Qualifying distributions also include amounts paid for assets acquired to be used directly in carrying out a foundation’s exempt purpose and program-related investments.
Taxes and penalties
There are several taxes, penalties, and restrictions associated with corporate foundations.
Excise taxes
Most private foundations, including corporate foundations, are subject to an excise tax on investment income, less related, and allocable expenses. The net investment income excise tax rate is 1.39%. An exempt operating foundation isn’t subject to this tax.
Self-dealing
Corporate foundations are subject to restrictions on self-dealing between corporate foundations and disqualified persons, such as substantial contributors and board members. Excise taxes may also be imposed on foundation managers when self-dealing occurs.
Disqualified persons
Disqualified persons include:
Substantial contributors to the foundation, which is any person or entity that gives more than $5,000 to the foundation, if that amount is more than 2% of the total contributions the foundation has received since inception
Those with greater than 20% ownership interest in an organization that’s a substantial contributor
Foundation managers including officers, directors, and trustees
Family members of those listed above
Organizations of the individuals listed above, where the individual holds more than a 35% interest
Other restrictions
In addition to the excise tax on net investment income, other excise taxes are imposed if the corporate foundation doesn’t comply with IRS requirements. In addition to the restriction on self-dealing, other requirements and restrictions include:
Requirements that the foundation must annually distribute income for charitable purposes to meet the distributable amount
Limits on their holdings in private businesses, known as excess business holdings
Provisions that the foundation may not make jeopardizing investments
Provisions to assure expenditures further exempt purposes or are otherwise treated as taxable expenditures
Taxable expenditures include amounts paid to:
Attempt to influence legislation, or lobbying
Influence any public election or carry on a voter registration drive, unless certain requirements are met
Make a grant to an individual for travel, study, or similar purposes, unless the grant program has IRS approval
Make a grant to another private foundation or for-profit entity without exercising expenditure responsibility
Unrelated business income taxes (UBIT)
Like public charities, private foundations including corporate foundations are subject to UBIT rules. This helps to prevent tax-exempt organizations from getting an unfair advantage over their corporate and trust counterparts. Tax-exempt organizations are required to pay taxes when engaged in commercial activities outside the scope of their exempt purposes.
UBIT is reported separately on Form 990-T.
To what extent are contributions to a corporate foundation deductible for individual donors?
An organization can receive a charitable tax deduction benefit when donating to its corporate foundation. Generally, the total amount a corporation can claim for a charitable contribution deduction can’t be more than 10% of taxable income. Charitable contributions over the 10% limit can’t be deducted for the tax year but can be carried over to the next five tax years.
In addition, individual donors can generally deduct contributions to corporate foundations classified as private nonoperating foundations to the limit of 30% of the donor’s adjusted gross income.
Donations to corporate foundations structured as private operating foundations or public charities are deductible to the extent of 50% of the donor’s adjusted gross income (AGI). The 50% AGI limitation was temporarily increased to 60% for tax years beginning before Jan. 1, 2026, by the Tax Cuts and Jobs Act of 2017.
