To start a family foundation, you form a nonprofit corporation or charitable trust under state law, draft governing documents containing the specific provisions the IRS requires of private foundations, obtain an Employer Identification Number, and apply for federal tax-exempt status by filing Form 1023 with a $600 user fee. Once the IRS issues a favorable determination letter, the foundation must meet a permanent set of obligations that don’t apply to most other charities: distribute at least 5% of its investment assets each year, pay a 1.39% excise tax on investment income, file Form 990-PF annually, and avoid any financial transaction between the foundation and the family members who created or run it.
Pick a Legal Structure
The first decision is whether the foundation will be a nonprofit corporation or a charitable trust. Most family foundations incorporate. A nonprofit corporation offers limited liability protection for board members and follows familiar corporate governance rules. A charitable trust is governed by a trust agreement, can be simpler to establish, and may offer somewhat more privacy, but it lacks the corporate liability shield and can be harder to modify once created.
The choice controls which state laws govern internal operations and which document you’ll use to satisfy the IRS. A corporation files Articles of Incorporation with the state; a trust executes a trust indenture. The IRS publishes sample language for both formats.1Internal Revenue Service. Private Foundations – Required Provisions for Organizing Documents
Draft the Governing Documents
Whichever structure you pick, the organizing document must include provisions specific to private foundations: a commitment to distribute income to avoid the undistributed-income tax, a bar on self-dealing, a limit on business holdings, a prohibition on investments that would jeopardize the foundation’s charitable purpose, and a bar on taxable expenditures like lobbying.1Internal Revenue Service. Private Foundations – Required Provisions for Organizing Documents
You also need a dissolution clause stating that if the foundation ever shuts down, its remaining assets go to another 501(c)(3) organization or to a government entity for a public purpose. Without this language, the IRS will reject the application for tax-exempt status.2Internal Revenue Service. Dissolution Provision Required Under Section 501(c)(3)
If you choose the corporate structure, you’ll also need bylaws covering how often the board meets, how votes work, what officers the foundation has, and how vacancies are filled. Bylaws aren’t filed with the IRS, but Form 1023 asks about governance procedures.
Assemble the Board and Adopt Basic Policies
Every private foundation needs a governing body: a board of directors for a corporation, trustees for a trust. Minimum size varies by state, but three members is a common standard, and the IRS generally expects at least that many. Unrelated members strengthen governance and help avoid the appearance that the foundation serves private interests.
You can pay board members or officers, but the rules are strict. Any payment to a founder, family member, or other “disqualified person” is technically self-dealing. The only exception is reasonable compensation for personal services genuinely necessary to carry out the foundation’s mission.3Internal Revenue Service. Paying Compensation Overpaying a family member who serves as executive director is one of the fastest ways to trigger IRS scrutiny.
The IRS strongly encourages foundations to adopt a written conflict of interest policy, and Form 1023 asks whether you have one. A workable policy requires board members to disclose any financial interest that conflicts with the foundation’s mission and to recuse themselves from voting on any matter where a conflict exists.4Internal Revenue Service. Form 1023 – Purpose of Conflict of Interest Policy
File with the State and Get an EIN
If you’re forming a nonprofit corporation, submit Articles of Incorporation to the Secretary of State where the foundation will be organized. Filing fees vary by state but generally fall somewhere between $30 and a few hundred dollars. This filing legally creates the entity.
Before opening a bank account or filing anything with the IRS, you need an Employer Identification Number. Apply on Form SS-4, which can be submitted online for immediate results. The form asks for a “responsible party,” the individual who ultimately controls the entity and its assets, typically a founder or board chair.5Internal Revenue Service. Instructions for Form SS-4 You need an EIN even if the foundation will never have employees.
Apply for Tax-Exempt Status on Form 1023
Private foundations must use the full Form 1023. The streamlined Form 1023-EZ is not available. Form 1023 asks for a detailed description of planned charitable activities, information on every board member, and three years of financial data. If the foundation has been operating for less than a year, you provide projections based on good-faith estimates.6Internal Revenue Service. Instructions for Form 1023
Submit the application electronically through Pay.gov and pay the $600 user fee at the time of filing.7Internal Revenue Service. Form 1023 and 1023-EZ – Amount of User Fee Once submitted, the form cannot be edited; corrections have to be mailed as supplemental information to the IRS Correspondence Unit in Cincinnati.8Internal Revenue Service. Frequently Asked Questions About Form 1023
Processing is slow. As of early 2026, the IRS issues 80% of Form 1023 determinations within about 191 days, and recently submitted applications may not yet be assigned to a reviewer.9Internal Revenue Service. Where’s My Application for Tax-Exempt Status When the review is done, you’ll receive a determination letter confirming exempt status and private foundation classification. Keep it permanently.
Understand the Deduction Limits Before You Fund It
Private foundations follow different donor deduction rules than public charities, and founders regularly miss this. Cash donations to a private foundation are deductible up to 30% of your adjusted gross income; the public charity limit is 60%. For appreciated property such as stock or real estate, the private foundation limit is 20% of AGI, versus 30% for public charities.10Office of the Law Revision Counsel. 26 U.S. Code 170 – Charitable, Etc., Contributions and Gifts
Contributions exceeding these limits aren’t lost. Excess amounts can be carried forward and deducted over the next five tax years. Founders planning a large initial endowment often benefit from spreading contributions across multiple years or mixing cash with appreciated securities to make the most of the ceiling.
Non-Cash Contributions Need an Appraisal
Funding a foundation with real estate, closely held stock, or artwork triggers appraisal requirements. If the total claimed deduction for donated property exceeds $5,000, you must obtain a qualified appraisal from a credentialed appraiser and attach Form 8283 to your tax return. For donations exceeding $500,000, the full appraisal itself must be attached.11Internal Revenue Service. Publication 561 – Determining the Value of Donated Property
Meet the 5% Annual Payout Requirement
Once the foundation is operating, federal law requires it to distribute at least 5% of the average fair market value of its investment assets each year. The calculation covers all foundation assets except those used directly for the charitable mission, such as an office building the foundation operates from.12Office of the Law Revision Counsel. 26 USC 4942 – Taxes on Failure to Distribute Income Most distributions are grants to other charities, though direct charitable expenditures and reasonable administrative costs also count.
Missing the payout target triggers a 30% excise tax on the undistributed amount. If the shortfall isn’t cured within 90 days of an IRS notice, an additional 100% tax applies.13Internal Revenue Service. Taxes on Failure to Distribute Income – Private Foundations Foundations can set aside funds for up to 60 months for major projects, and excess distributions in one year can be carried forward for five years to cover future shortfalls.
File Form 990-PF and Pay the Investment Income Tax Every Year
Every private foundation must file Form 990-PF annually, due by the 15th day of the fifth month after the end of the foundation’s tax year. For a calendar-year foundation, that’s May 15. The return reports investment income, operating expenses, grants paid, officer compensation, and compliance with the distribution requirement. Form 990-PF is a public record.14Internal Revenue Service. Instructions for Form 990-PF
As part of the filing, the foundation calculates and pays a 1.39% excise tax on net investment income, including interest, dividends, rents, royalties, and net capital gains from the sale of investment assets.15Office of the Law Revision Counsel. 26 USC 4940 – Excise Tax Based on Investment Income The tax is flat and applies no matter how much the foundation distributes.
Late filing carries real penalties. For foundations with gross receipts under roughly $1.3 million, the penalty is $25 per day; for larger foundations, $130 per day.14Internal Revenue Service. Instructions for Form 990-PF A foundation that fails to file for three consecutive years automatically loses its tax-exempt status, and getting reinstated means starting the application over.16Internal Revenue Service. Automatic Revocation of Exemption
Stay Out of Self-Dealing
The self-dealing rules have the sharpest penalties in private foundation law, and they’re absolute. There is no “reasonable amount” exception for most transactions between the foundation and its disqualified persons. Disqualified persons include the foundation’s substantial contributors, its managers, their family members, and businesses they control.17Internal Revenue Service. Disqualified Persons
Prohibited transactions include selling or leasing property between the foundation and an insider, lending money in either direction, and providing the foundation’s goods or services to an insider. Reasonable compensation for necessary personal services is the only meaningful carve-out.
Violations trigger an initial tax of 10% of the transaction amount on the disqualified person for each year the deal remains uncorrected, plus 5% on any foundation manager who knowingly participated. If the transaction isn’t unwound during the correction period, the additional tax on the disqualified person climbs to 200% of the amount involved, and the manager’s additional tax reaches 50%.18Office of the Law Revision Counsel. 26 USC 4941 – Taxes on Self-Dealing The safest approach is to keep every financial dealing between the foundation and its insiders completely separate, with the sole exception of documented, reasonable compensation for real work.
Watch the Other Operating Restrictions
Grants to Individuals
If your foundation plans to award scholarships, fellowships, or other grants directly to individuals, you need advance IRS approval of your grant-making procedures before making any awards. The procedures must show that grants are awarded on an objective, nondiscriminatory basis and that the foundation will supervise grantees to confirm the funds are used as intended.19Internal Revenue Service. Advance Approval of Grant-Making Procedures
Grants to Non-Charities
When the foundation grants money to an organization that is not itself a 501(c)(3), it must exercise “expenditure responsibility.” That means getting a signed written agreement from the grantee committing to use the funds only for the stated charitable purpose, return any unused portion, submit annual progress reports, and refrain from using the money for lobbying, political activity, or grants to individuals.20Internal Revenue Service. Terms of Grants – Private Foundation Expenditure Responsibility
Lobbying and Campaigns
Private foundations face what functions as a ban on lobbying. Money spent to influence legislation triggers an excise tax the IRS itself describes as operating like a prohibition, covering contact with legislators, urging the public to contact them, and advocating for or against specific bills at any level of government.21Internal Revenue Service. Lobbying Activity of Section 501(c)(3) Private Foundations Participation in political campaigns for or against any candidate is absolutely prohibited for all 501(c)(3) organizations.
Business Holdings and Investment Risk
The foundation and its disqualified persons together can generally hold no more than 20% of the voting stock in any business corporation. Exceeding that threshold triggers excise taxes that escalate sharply if the excess isn’t divested.22Office of the Law Revision Counsel. 26 U.S. Code 4943 – Taxes on Excess Business Holdings A separate rule taxes “jeopardizing investments” that put the charitable mission at risk. The statute doesn’t list specific prohibited investments; the IRS evaluates each one against whether the foundation used ordinary care and prudence.23Office of the Law Revision Counsel. 26 U.S. Code 4944 – Taxes on Investments Which Jeopardize Charitable Purpose
Don’t Forget State-Level Compliance
Federal tax-exempt status does not eliminate state obligations. Most states require nonprofit corporations to file an annual or biennial report with the Secretary of State, along with a filing fee. Missing these filings can lead to administrative dissolution of the entity, which creates serious problems even if federal status is intact.
If the foundation solicits donations from the public, most states also require a separate charitable solicitation registration before any fundraising begins. Even family foundations that primarily receive contributions from family members should check state rules, since the definition of “solicitation” can be broad.
Between the federal Form 990-PF, the state annual report, potential solicitation filings, and the internal bookkeeping needed for the payout requirement and investment income tax, the administrative load is substantial. Many families hire an accountant or foundation administrator from the start, and that professional cost is a legitimate administrative expense that counts toward the 5% payout requirement.