Private family foundations let you do incredible philanthropic work while enjoying serious tax benefits. But there’s a catch. The IRS watches these organizations like a hawk because they’re tax-exempt entities that remain under family control. That combination makes the agency nervous, and rightfully so.
Our friends at Patterson Bray PLLC work extensively with families who establish and run charitable organizations. A private family foundation lawyer can help you set things up correctly from the start and avoid the mistakes that draw unwanted attention.
Self-Dealing Will Get You in Trouble Fast
This one’s serious. Self-dealing happens when foundation assets benefit disqualified persons, which includes you as the founder, substantial contributors, foundation managers, and all your family members. The IRS doesn’t mess around with these violations. You might think you’re being reasonable, but these common scenarios all qualify as self-dealing:
- Paying your kids above-market salaries for their trustee roles
- Renting office space from your family business, even at fair rates
- Making loans to family members or their companies
- Buying or selling property between the foundation and insiders
- Using foundation credit cards or assets personally, even if you plan to reimburse
Here’s what makes self-dealing particularly dangerous. Intent doesn’t matter. You could have the best intentions and charge perfectly fair prices, but if the transaction fits the definition, you’re facing automatic excise taxes. The IRS won’t care that you didn’t know or that you were trying to help the foundation.
Missing Your Distribution Requirements
Every private foundation must give away at least five percent of its investment assets each year for charitable purposes. According to the IRS Publication 578, this requirement exists to make sure foundations actually do charitable work instead of just hoarding wealth. Fall short of this threshold consistently, and you’re putting a target on your back. The IRS reviews these calculations on every annual return. They’re looking for foundations that manipulate the numbers or claim questionable expenditures to meet the minimum. Don’t try to get creative with what counts as a qualifying distribution.
When Your Overhead Looks Too High
Sure, you can pay reasonable expenses to run your foundation. But when do administrative costs start rivaling or exceeding your actual charitable giving? That raises eyebrows. Watch out for these patterns:
- Spending more than 15-20% of your total expenditures on administration
- Claiming luxury travel or entertainment as necessary business expenses
- Compensating family members way above what similar positions pay elsewhere
- Running up professional fees that seem excessive for your foundation’s size
A small foundation doesn’t need a massive budget for operations. If your numbers tell a different story, expect questions.
Sloppy Grant-Making Practices
The IRS scrutinizes how you distribute grants because they want to confirm that you’re supporting legitimate charitable work. Giving money to individuals without a proper scholarship program? Red flag. Making grants to foreign organizations without following expenditure responsibility rules? Problem. Anything that even hints at political activity? Major issue. You need detailed files for every grant. That means documentation showing how you vetted recipients, what the grant money’s for, and how you’re monitoring compliance. Show up to an audit without these records, and the IRS will assume the worst about your grant-making.
Terrible Recordkeeping Sends a Message
Your Form 990-PF tells the IRS a lot about how you run things. Late filings, amended returns, missing schedules, basic math errors… these all suggest you either don’t know what you’re doing or you’re hiding something. Neither impression helps you. Maintain thorough records of everything. Board meeting minutes, grant applications, distribution decisions, transaction receipts. When questions come up during an audit, documentation is what proves you followed the rules.
Hiding Related Party Transactions
Doing business with related entities isn’t automatically illegal. Your foundation can hire your family’s accounting firm or invest in a family-owned business. But these transactions require full disclosure and arm’s length terms. You need extra documentation proving fair market value and legitimate business purposes. What you can’t do is fail to disclose these relationships. When auditors discover undisclosed related party transactions, they start assuming you’ve got self-dealing problems. Then they dig deeper, looking for other violations you might’ve hidden.
Keeping Your Foundation on Track
Nobody wants to deal with an IRS audit. They’re disruptive, expensive, and can threaten your foundation’s tax-exempt status if serious violations come to light. Most audit triggers are completely avoidable with proper planning and consistent compliance practices. If you’re worried about how your foundation operates or you’re already facing IRS examination, getting legal counsel who understands foundation law can make all the difference in protecting what you’ve built and making sure your charitable work continues.