Private foundations can be excellent philanthropic vehicles for spouses and family members to collectively pursue their charitable objectives. Serving as members of the foundation's board provides a unique opportunity for spouses to lead an organization together, for parents to teach their children about charitable giving and for family members to work together to carry on the family's philanthropic traditions. However, when spouses split or other family conflicts arise, the collaborative pursuit of charitable objectives may no longer be desired or feasible. In these cases, the parties may consider, among other options, dividing the foundation and distributing its assets to one or more newly created private foundations so the parties may pursue their charitable goals independently.
Tax-Free Division of a Private Foundation’s Assets
Distributions from private foundations, including to divide the foundation, must comply with numerous rules under the federal tax code to avoid potential excise tax penalties. As most foundation managers are aware, a foundation’s distributions to public charities are considered qualifying distributions. On the other hand, distributions to other private foundations are taxable, unless the distributing foundation exercises “expenditure responsibility”—i.e., enhanced pre-grant due diligence, continued oversight and reporting to the IRS to ensure that the grant is spent only for its intended charitable purpose. Expenditure responsibility is relatively easy to satisfy when making a grant to a private foundation for a specific project, but it would be burdensome when the distributing and receiving foundations want to go their separate ways. Distributions that effectively terminate a private foundation also can trigger a termination tax under Internal Revenue Code Section 507, which applies upon termination or forfeiture of private foundation status.
So how are foundation founders or board members with significant or irreconcilable differences to proceed? Fortunately, Code Sec. 507 provides an avenue that eliminates the expenditure responsibility requirements and avoids a potential termination tax upon the division of a private foundation. In instances when a foundation makes a “significant distribution” of its assets pursuant to any liquidation, merger, redemption, recapitalization, organization, reorganization or other adjustment (such as division of the foundation), the expenditure responsibility requirements and Code Sec. 507 termination tax will not apply. To constitute a significant distribution and qualify for the exception, the private foundation must distribute 25% or more of its assets to one or more other private foundations.
Dividing to Resolve Family Conflict
Divorcing spouses may use the Code Sec. 507 framework to divide the assets of their existing foundation without incurring tax on the transaction. The most straightforward and practical approach is for the transferor foundation to remain active and to distribute half its assets to a transferee foundation newly established by one of the spouses, which will constitute a significant distribution pursuant to a liquidation, reorganization, etc., under Code Sec. 507. In some instances, however, the soon-to-be ex-spouses may both prefer a “fresh start” for their charitable goals. In this case, the divorcing parties would (1) each establish their own new separate private foundation, (2) equally distribute all the assets of the existing foundation between the new foundations and (3) dissolve the original foundation. Either scenario results in two foundations holding an equal share of the assets and liabilities of the initial transferor foundation without the imposition of expenditure responsibility or a termination tax. For divorcing parties, this division results in a fair and equitable distribution of the original foundation and enables each of the parties to continue carrying out their own individual charitable objectives post-divorce.
Apart from divorce, family foundations may experience internal conflicts as the charitable objectives of multiple siblings or other family board members diverge over time. A division under Code Sec. 507 may also be an appropriate solution in these cases, as the existing foundation can make a significant distribution of assets to multiple foundations without incurring a termination tax, enabling family board members to pursue their separate charitable interests independently.
Alternatively, distributions made when dividing a private foundation may be directed to one or more donor advised funds selected by the parties. However, parties considering this route must be aware of the frequently changing laws governing donor advised funds. In fact, Congress is currently considering legislation (HR 6595 and its companion bill, S 1981, the Accelerating Charitable Efforts Act) that would, under certain circumstances, exclude distributions to donor advised funds as a type of qualifying distribution.
Costs Associated With Division
Although federal law provides a potentially tax-free path forward for dividing a foundation, costs may be incurred pre- and post-division to establish the new transferee foundation(s) and to potentially dissolve the transferor foundation.
- Establishing a Transferee Foundation. The costs associated with establishing a new foundation will include startup costs, staffing needs, state registration fees and legal, accounting and filing fees (IRS and state agencies).
- Dissolving the Transferor Foundation. If the division results in complete distribution of the assets of the original foundation, the fees for its dissolution will depend upon the law of the state(s) in which the foundation is incorporated and operated. In addition, the transferor foundation may incur costs associated with winding down its operations.
Consultation Prior to Division
In the event of divorce or conflicting charitable interests among family board members, dividing the assets of a private foundation may, in certain circumstances, be a wise solution. Those considering this path should consult qualified legal counsel before doing so to understand the potential costs and ensure compliance with the tax laws and other requirements associated with the division.