Private Foundations and Charitable LLCs

Since 2015, when Facebook CEO Mark Zuckerberg announced he would transfer 99 percent of his Facebook shares to the new Chan Zuckerberg Initiative, we have seen increasing interest in philanthropies using LLCs to make grants. This contrasts with the more traditional private foundations, such as the Bill & Melinda Gates Foundation, which are organized as 501(c)(3)s under the tax code. So, what is the difference between a limited liability corporation (LLC) and a private foundation?

First, private foundations are tax-exempt organizations, while LLCs are not. Unlike public charities, which fundraise from the general public, private foundations are generally funded by a single family, corporation, or individual. Though private foundations cannot lobby or participate in partisan political activity, they can engage in a range of advocacy activities, including educational activities, organizing, and litigation. However, all private foundation expenditures must be for a charitable purpose. Most private foundations are required to make annual distributions of 5% of the foundation’s prior year’s average net investment assets. The benefits of private foundations include an income tax deduction (20% for securities; 30% for cash), a limit on investment income tax of 2%, and protection of assets from the estate tax. Some of the concerns with private foundations are that all their disbursements and activities must be related to their charitable purpose, and they are required to disclose information regarding highly compensated employees, disbursement of funds, and other activities on their IRS Form 990-PF. They also cannot engage in lobbying or partisan political activity. These limits may be decisive factors for organizations thinking about the structure that would most benefit them.

However, while most private foundations are created to make grants to other nonprofits, if donors want to engage in charitable activities themselves, they can organize as an operating foundation. These are similar to private foundations but are more involved with their own charitable activities, such as operating a research facility or museum. These foundations are required to spend 85% of their investment income to conduct their charitable operations and are still subject to the same restrictions as private foundations.

In contrast, LLCs act as pass-through entities and provide limited liability to their members. LLCs are usually formed by an individual or group of individuals, and the profits and losses incurred by the LLC are transferred to the members. So, if the LLC makes money, its members will receive the money and pay taxes on it. If the LLC makes a charitable distribution, its members will receive the charitable deduction. While the LLC does not directly provide a tax benefit to its members (the members will only receive a deduction when the LLC makes a charitable contribution, not when the member gives money to the LLC), the LLC can engage in more advocacy than a private foundation, including lobbying and partisan political activity. Again, this could be a decisive factor for organizations exploring their options.  Furthermore, while private foundations must operate solely for their charitable purpose, LLCs are not required to do so. Other benefits of LLCs include no requirement for minimum distribution and more control for the LLC founder(s). LLCs are not required to publicly disclose information regarding their activities or compensations. However, some concerns about LLCs include a potential additional income tax for members if the LLC posts income, a delay on any charitable deductions (as the donor only receives the deduction when the LLC makes a charitable distribution), and a lower overall tax benefit (only funds distributed to charities may be tax-deductible, while operating costs and overhead will not be deductible).

You may have seen the expression “charitable LLC” used to refer to LLCs engaging in philanthropy or advocacy. Currently, there is no legal definition of “charitable LLC.” This is an informal term used to refer to LLCs that engage in charitable or philanthropic endeavors.

If you have further questions regarding private foundations, LLCs, or advocacy in general, please do not hesitate to contact Bolder Advocacy at either 866-NP-LOBBY or advocacy@afj.org.