Private foundation - How Millionaires Live

A private foundation is a US tax-exempt charitable organization funded and controlled by a single donor, family, or company, which must distribute roughly 5% of its investment assets for charitable purposes every year and pays a 1.39% federal excise tax on its net investment income.

In plain terms

It is charity as an institution the donor still runs. A public charity has to raise money from the public and answer to a broad board; a private foundation is funded by one source and governed by whoever that source appoints, usually the family. In exchange for keeping control, the donor accepts a smaller tax deduction, an annual spending requirement, a tax on investment returns, and a set of prohibitions on dealing with the foundation’s own money. The alternative that skips almost all of this — and almost all of the control apparatus with it — is a donor-advised fund.

How it works

The default assumption in US law is that a section 501(c)(3) organization is a private foundation unless it proves otherwise by showing broad public support. That default triggers a rulebook that public charities never see: prohibitions on self-dealing with insiders, limits on how much of an operating business the foundation may own, and a tax on grants made outside approved channels.

The core obligation is the payout. Section 4942 requires a foundation to make qualifying distributions equal to its minimum investment return — in practice about 5% of the average value of its non-charitable-use assets — by the end of the following year. Miss it and the IRS imposes a 30% excise tax on the shortfall, rising to 100% if it is still undistributed when the correction period closes.

Every foundation files Form 990-PF annually regardless of size, and that return is public. Grants, trustee compensation, investment holdings, and the founding family’s travel reimbursements are all readable by anyone.

The numbers

Excise tax on net investment income: 1.39%, a flat rate since the two-tier 1%/2% system was repealed for tax years beginning after December 20, 2019.
Annual payout requirement: ~5% of average net investment assets.
Penalty for missing it: 30% of the undistributed amount, then 100%.
Deduction ceiling, 2026: 30% of AGI for cash and 20% for appreciated property — against 60% and 30% for the same gift to a public charity.
Appreciated property: deductible only at cost basis, not market value, except for publicly traded “qualified appreciated stock.”
Self-dealing penalty: 10% of the amount involved on the self-dealer and 5% on a knowing manager, rising to 200% if not corrected.
Scale: US private foundations held roughly $1.6 trillion and granted more than $100 billion in 2024, according to FoundationMark’s estimates.

What people get wrong

That the 5% payout means 5% of the money reaches charities. It does not. Qualifying distributions include reasonable and necessary administrative costs — staff salaries, trustee fees, office rent, program travel, legal and audit work — so a foundation with an office and a professional staff can satisfy the requirement while a real fraction of that 5% never leaves the building. The deeper point is structural: 5% is a floor on spending, not a ceiling on growth. A portfolio returning more than about 6.4% a year clears the payout and the excise tax and still compounds, which is why a foundation designed to run in perpetuity usually does, and why the largest ones are meaningfully richer now than on the day they were funded.

In plain terms

How it works

The numbers

What people get wrong

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