Private foundations are typically set up in one of two ways: a nonprofit corporation or a trust. They are created by drafting articles of incorporation (corporation) or articles of organization (trust). Traditionally, private foundations were created as trusts, particularly when their founders were individuals. Most often they were used as an estate planning tool. The main advantage of using a trust is the opportunity to put strict controls in place. Their governance provisions often cannot be changed without a judge's approval.
While the trust form is still used today, it is more common and preferable to establish a private foundation as a nonprofit corporation. There are three distinct advantages which are listed below:
- Better Liability Protection
- Better Administrative Flexibility
- Better UBIT Rate
- Better Banking Options
1. Better Liability Protection
The directors and officers of a nonprofit corporation have less exposure to personal liability than the trustees of a trust. Trustees are a fiduciary, which means that they are held to a high standard of care. A fiduciary is expected to pay more attention to the trust’s investment and management than they would pay to their own personal accounts or assets. That’s not to say that directors and officers can run wild but they have limited personal liability due to state-specific corporate laws. A nonprofit corporation can also acquire Directors & Officers Insurance which could cover liability claims.
2. Better Administrative Flexibility
Unlike a trust, the nonprofit corporation’s articles of incorporation can be changed by existing directors. This type of entity usually includes a set of operational rules called bylaws which can also be changed by existing directors. There have been famous cases where foundations that were set up as a trust had very strict grant requirements that couldn’t be fulfilled years after the founders death. In those cases, state courts typically dissolve the assets and disburse the funds to other nonprofit organizations of their choosing. Had those foundations been set up as a nonprofit corporation, the directors could have simply amended the governing documents and continued to make an impact.
3. Better UBIT Rate
UBIT = Unrelated Business Income Tax. UBIT is a rule in place to prevent foundations from having an advantage over for-profit organizations. They are limited in their ability to directly conduct or invest in an unrelated trade or business. For example, a foundation couldn’t start manufacturing and selling cars because their tax exemption would provide them an advantage over other manufacturers.
More often than not, if a foundation has to pay UBIT, it’s due to an investment. The tax rate is dependent on the foundation's type of entity. Since 2018, the tax rate for nonprofit corporations is a flat 21%. For trusts, there are different rates based on the threshold as illustrated below:
If a foundation had annual unrelated business income (UBI) of $100,000, the corporation would pay $21,000 in tax while the trust would pay about $35,000. Since foundations can operate in perpetuity, it’s not uncommon for them to amass millions of dollars of UBI over time. As you can imagine, the advantage of the corporate form continues to increase as the UBI does.
4. Better Banking Options
Through experience we have found that most banking institutions are much easier to work with when opening an account as a corporation versus a trust. It’s a simple matter of how often they interact with each entity type. This is not just for bank accounts but also for opening up credit cards, acquiring loans, purchasing assets, etc. The financial institutions feel more comfortable doing business with a corporation than a trust.
Foundation Launch Uses The Corporate Form
We incorporate foundations in the state of Delaware. Regardless of your own state of residency, there are many unique benefits to setting up a foundation as a Delaware corporation. A key aspect is that Delaware allows for sole-director corporations. This means the founder may be the sole individual involved in the foundation, if he or she chooses. They also allow annual meetings to be held electronically which is beneficial when family members live far apart. Foundation Launch also works with foundations set up by your attorney as well as existing foundations regardless of state of incorporation or organizational form. Delaware is a very friendly state for corporations, whether they’re for-profit or not-for-profit:
- Delaware has well-defined statutory provisions in place with respect to the indemnification of officers and directors.
- Delaware’s corporate law also explicitly provides that a corporation may maintain its minutes in an electronic format.
- The Delaware Chancery Court has developed an unparalleled body of case law that is frequently cited as precedent in other state courts.
- Corporate filings in Delaware can be completed quickly and at less expense than in other states.
While many other states impose cumbersome filing requirements on exempt organizations, in Delaware, the requirements are light: A private foundation need only file a copy of its annual tax return with the attorney general and pay a small annual franchise tax to the Secretary of State with a basic corporate report each year.
Corporation > Trust
This is not an exhaustive list of the advantages of the nonprofit corporation over the trust, but it covers some of the main points. We have found great success in setting up foundations as corporations. If you have a foundation that was set up as a trust, do not fret. In most cases, as long as you are the founder, you have the opportunity to convert it to a corporation.
