The Shape of Tax to Come

A Tax & Estate Planning blog for 21st-century Texans

Private Foundations

Even in this down economy, many people want to give back to their communities. While giving to an established charity is the easiest course, some people want to be more involved in operations. As a result, they will establish their own private foundation so that they can direct the charitable operations. In this post, I’ll briefly discuss some of the benefits and burdens of private foundations.

Benefits of a Private Foundation

The biggest benefit of setting up a private foundation is that donors have more, if not complete, control of the charitable purpose if they remain involved in the foundation. If a donor wanted to give scholarships to children from a certain area and wanted to meet each applicant, it is possible to set up a private foundation to do that. Or, if the donor wanted to donate money, then hire someone else to ensure that the right people benefit, that can also be done.

A second benefit is that it allows donors to determine their level of recognition for their efforts. For example, if a donor named David Adams wanted to name his private foundation “The David Adams Children’s Education Foundation” to ensure that he received credit for his charitable efforts, then Mr. Adams could do that. Or, if he was not interested in the recognition, Mr. Adams could name his foundation “The Nueces County Educational Foundation.” In either case, Mr. Adams has the freedom to choose.

A third benefit of private foundations is that they provide a formal structure to administer a donor’s charitable giving. In effect, the foundation provides a strategic buffer between an affluent family and the many charities who seek contributions. This allows the family to direct all charitable requests to a single entity instead of dealing with each request as it comes in. If the family has a lot of requests, the time saved by establishing the private foundation may justify the expense.

While these are not all of the reasons, they encompass the big reason to set up a private foundation: greater control over the funds.

Burdens of a Private Foundation

While there are significant benefits to creating a private foundation, there are a lot of burdens that go along with it.

First, donations to a charitable foundation only qualify for the 30% charitable deduction instead of the 50% charitable deduction. This means that if a donor made a gift to a public charity, he would receive a greater charitable deduction on his taxes than he would if he made the same gift to a private foundation. So, if the charitable donation is part of the goal, a private foundation may not be the best answer.

Second, private foundations are subject to much tougher restrictions and penalties. Because Congress thinks that private foundations are more likely to abuse their tax-favored status, private foundations must comply with rules regarding self-dealing, excessive ownership of business interests, investments, income distribution requirements, and lobbying. This list is not exhaustive, but it gives you an idea of what to keep in mind when considering a private foundation.

Third, as implied above, a private foundation is neither a low-cost nor an easy option. Because of the costs involved in establishing and maintaining the tax-exempt status of a private foundation through various detailed tax filings, it may not be worth the cost in time and money for a donor.


Private foundations provide a lot of good in this country, and despite the burdens, many donors consider a foundation the best option for their charitable purposes. But before settling on a private foundation, a donor should consider whether the burdens will outweigh the benefits.

November 27, 2011 Posted by | Uncategorized | , | Leave a comment

How Long Should You Keep Records?

I was part of a recent twitter discussion about how long people should retain records. While most of the responses were three years, I thought that seven years was a better answer and that ecopies should be retained in any case.

Based on my experience as a tax attorney, I have dealt with this issue before, and explaining my reasons in 140 characters was not going work well. I understand why people will say three years, but I don’t agree, and I want spend a little digital ink to explain my answer.  I’ll finish with a recommendation on how you can avoid drowning in your paperwork.

Why Three Years Isn’t Wrong

Three years is not a wrong answer, but it isn’t the best answer. Three years comes up because the statute of limitations on reviewing a tax return is three years. This means that after you have filed your return, the IRS has three years to review your return and let you know if they have a problem. After the three years are up, the IRS can no longer review your return, even if your return has mistakes in your favor. This limit fosters administrative efficiency by keeping the IRS from getting bogged down in reviewing every return.

This time that the IRS has to review your return, known as the “limitations period,” will start running on the later of the date that you file your return, or the date that your return is due. So, if you file your 2011 tax return on January 1, 2012, and the return is due on April 15, 2012, the limitations period will expire on April 15, 2015. But if you file your 2011 return on June 30, 2012, the limitations period will not expire until June 30, 2015.

So, saying that three years is the answer is based on the basic limitations period. But the problem with this answer is that it does not take into account the IRS’s ability to extend the limitations period in some situations. Essentially, you’re betting that the IRS will not have, or will not look for, a reason to extend the limitations period. Granted, this does not affect most people, but it may affect you, in which case you will be glad that you still have your records. Well, how long can the IRS extend it?

Why Six Years Is a Better Answer

While three years is not wrong, it’s better to hold on to your records for at least six years. Even though the basic limitations period is three years, the IRS can extend it to six years if there is a 25%  deficiency between the amount that should be reported on the return and the amount that actually reported on the return. The IRS can extend the limitations period because the IRS has a harder time detecting these problems, and so they should have more time to investigate them.

As an example, if a taxpayer reported his gross income as $85,000, when he should have reported $160,000, this would be a deficiency of $75,000. As a result, the deficiency is 88% ($75,000/$85,000), and the IRS could extend the statute of limitations. However, if the taxpayer had reported his gross income as $85,000, but it should have been $89,000, there would be a deficiency of $4,000. Because this is a 4% deficiency ($4,000/$85,000), the IRS could not extend the limitations period.

I’m a bigger fan of six years over three years for two reasons. First, the IRS has been litigating cases recently to extend the limitations period to six years. Just knowing that they are fighting for this means that it is a possibility that they could make the same claim against you.

Second, my practice includes foreign tax compliance work, and we have used the six-year limitations period as a guide for how far back we should file amended returns. Because most Americans, and many accountants and tax attorneys, are unaware of the full range of required filings, it is not uncommon for people to find that they have filed incomplete returns for a particular year. So, as part of filing completed returns, we will file amended returns for six years to cover the six-year limitations period. We want to be upfront about the full situation when we file the returns, instead of possibly looking like we have something to hide.

Why I Said Seven Years

Before answering, I took a look at what the IRS has to say on the matter. On their website, the IRS recommends retaining records for seven years if you have claimed for a loss from worthless securities or bad debt deduction. While I don’t have direct experience with this particular limitations period, it may apply to some people. Due to the limitations of 140 characters, I didn’t point exactly to this reason, but there you are.

And Why You Should Really Keep Your Records Indefinitely

As you can see on the linked page, there are two situations in which the IRS recommends that you retain records indefinitely: if you don’t file a return or if you file a fraudulent return. These reasons should not cause concern for the vast majority of taxpayers, and they’re not the reasons I think that holding on to records indefinitely is the best answer. Instead, I think you need to hold on to records indefinitely because you just don’t know when you’ll need them.

Tax returns are a great source of information about what you were doing and what was happening in your life. Earlier this month, I reviewed four estate tax returns, totaling more than 1,000 printed pages, for a family to sort out which family members owned a particular piece property. Two of those estate tax returns were filed in 1992. If we didn’t have those records on hand, I simply could not have figured out who owned the property. So, by keeping those records around, I able to solve our clients’ problem.

Managing Your Records

Right now, you’re thinking that you don’t have space for all of your records. That would be true if you had to keep physical copies of everything. But that is no longer the case.

Computers can easily store vast amounts of information. With a scanner, you can import and save your documents. If you don’t want to hold on to the documents any longer, you have a scanned copy to rely on, and you can dispose of the original. If you are going this route, I’d suggest having an online backup of the document just in case. Personally, I use Evernote to store my documents. Another alternative is to email your documents to a dedicated gmail account.

November 27, 2011 Posted by | Uncategorized | , , | Leave a comment


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