When philanthropists look to make a lasting impact, creating a private foundation often seems appealing. Having a dedicated entity that supports meaningful causes can be very attractive. However, there are disadvantages to private foundations that can make other options worth exploring, such as donor-advised funds. Below, we’ll take a closer look at understanding the disadvantages of private foundations to help donors make informed choices.
Administrative Costs and Complexity
Private foundations carry a some administrative and regulatory burden. Setting one up requires some costs and time. Legal and financial expertise are essential to meet federal and provincial regulations. Foundations must keep detailed records. They also need to submit annual financial and activity reports to the CRA. Disbursement quotas must be met as well. These requirements increase operating costs and put some burden on philanthropists who might not excel with administration. Smaller donors may find that legal and accounting fees reduce the funds available for donations.
On top of these costs, managing a private foundation involves handling detailed governance and oversight structures. Unlike public charities, which have built-in governance through boards and annual audits, private foundations must be vigilant in managing compliance themselves. While these hurdles don’t diminish the value of private foundations, they are a factor to consider, particularly for those with limited resources.
Restrictions on Grantmaking to Foreign Entities
The restrictions on international grantmaking are another important disadvantage of private foundations. Canadian private foundations are limited in their ability to donate to foreign charities. They can only grant funds to international entities if the recipient meets specific CRA disbursement requirements. This restriction poses a challenge for donors looking to support causes outside Canada. They may find it hard to navigate the compliance regulations necessary to fund foreign charities.
In contrast, certain donor-advised funds and public charities may have more capacity when it comes to international giving and programs in place to manage the compliance risks. For donors who want their funds to reach global causes, the disadvantages of private foundations in this area might steer them toward more flexible options such as donor advised funds who specialize in gifts to non-qualified donees.
Delays in Tax Benefits for Non-Qualifying Securities
One often-overlooked disadvantage of private foundations is the restriction on receiving immediate tax benefits for donations of non-qualifying securities (NQS). Private foundations must sell or “monetize” these types of assets to issue a tax receipt. This rule applies particularly to shares in private companies or other non-publicly traded securities. Thus meaning donors may face a delay before realizing tax benefits for their gifts.
While publicly traded securities can be donated without these additional steps, those who own significant private shares may find this restriction frustrating. Particularly if market conditions make it unfavourable to sell their shares within the required time frame. Donors who prefer to gift privately-held securities directly and receive immediate tax benefits might find that the disadvantages of private foundations in this area are a meaningful barrier.
Limits on Corporate Holdings
The CRA places limits on how much of a single company a private foundation may hold. This rule exists to prevent donors from using foundations as a way to indirectly control corporate assets for private benefit. The restriction helps ensure foundations operate solely for charitable purposes. However, it does mean that foundations may need to diversify their investments even if holding a large portion of a single company’s stock would be profitable. The disadvantages of private foundations include needing to comply with this rule, even if it’s not financially advantageous.
If a foundation’s holdings in a single corporation exceed the threshold, it may be required to divest some of its assets, which could create tax or financial implications. This is a limitation that donors might want to consider if they are focused on a particular company or investment strategy, as it could disrupt their philanthropic plans.
Disbursement Quotas and Ongoing Operational Requirements
One of the disadvantages of private foundations that can surprise donors is the mandatory annual disbursement quota. In Canada, private foundations are required to distribute a minimum of 3.5% to 5% of their assets each year depending on the size of the foundation to qualified donees. This rule ensures that funds are being put to work in the community rather than simply accumulating interest or appreciating in value, but it can be restrictive.
For example, if a foundation’s assets experience a decrease in value, such as during a market downturn, the annual disbursement could force it to sell assets at an inopportune time to meet CRA requirements. This quota adds to the foundation’s operational complexity and can make it harder to sustain long-term goals. By contrast, many donor-advised funds generally do not have specific disbursement requirements, allowing donors greater flexibility to adapt to market conditions.
Weighing the Options
Private foundations offer advantages such as donor control and lasting impact. However, the disadvantages highlight the need for careful consideration and planning. Donors who want to avoid administrative burdens, compliance costs, and restrictions on grants to international charities may find donor-advised funds to be a more flexible alternative.
For those set on a private foundation, partnering with experienced legal and financial advisors can help navigate these challenges and ensure compliance. However, it’s essential to keep in mind the disadvantages of private foundations and to explore whether other charitable giving vehicles might better align with one’s philanthropic goals and resources.
By understanding the limitations alongside the benefits, philanthropists can make the best choice for achieving their charitable goals while managing the requirements that come with running a foundation.
