At Abelaj Law, PC, we guide donors and families in New York and New Jersey through each stage of establishing a private foundation, from the initial decision through the governance structure that will guide it for years to come.

Decide Whether a Private Foundation Is the Right Vehicle

Before forming a private foundation, a family should evaluate whether the structure fits its charitable goals. A private foundation offers advantages that alternatives do not, including direct control over investments and grantmaking, the ability to employ family members in certain circumstances, and a permanent, visible institution that can carry a family name across generations. A donor-advised fund, by comparison, involves less administrative burden and lower cost, but offers less control and no separate legal identity.

Choose the Legal Structure and Draft Governing Documents

A private foundation may be organized as a nonprofit corporation or as a charitable trust. A nonprofit corporation is typically governed by a board of directors under bylaws, offers liability protection consistent with other corporate forms, and can be more adaptable over time. A charitable trust is governed by trustees under a trust instrument and offers more limited flexibility once established, though some families prefer it for reasons tied to control or existing estate documents.

Whichever structure is chosen, the foundation needs formal organizational documents, a certificate of incorporation and bylaws for a corporation, or a trust agreement for a trust, addressing charitable purpose, selection of the board or trustees, decision-making procedures, and a conflict-of-interest policy governing transactions involving insiders. Because private foundations are frequently governed by family members, this policy is not a formality. It is a practical safeguard against the self-dealing issues discussed below.

Apply for Tax-Exempt Status

To operate as a tax-exempt organization, the foundation must apply for recognition of exemption from the Internal Revenue Service, generally by filing Form 1023. Most newly formed charitable organizations are presumed to be private foundations under Internal Revenue Code Section 509(a) unless they qualify for public charity status, and an organization funded primarily by one family or a small group of related donors will typically be classified as a private foundation from the outset.

The application requires a detailed description of the foundation’s proposed activities, governance structure, and projected finances, and its accuracy forms the basis for the exemption granted.

Fund the Foundation

A private foundation can be funded during the founder’s lifetime, through a will or trust at death, or a combination of both, and funding decisions should be coordinated with the family’s estate plan. Cash and publicly traded securities are the most common funding assets, though closely held business interests or other illiquid assets raise additional valuation and compliance considerations that should be reviewed before the transfer.

Understand the Excise Tax Rules Under Chapter 42

Private foundations are subject to a distinct set of excise taxes under Chapter 42 of the Internal Revenue Code.

• Self-dealing. Section 4941 prohibits most financial transactions between the foundation and “disqualified persons,” including substantial contributors, foundation managers, and certain family members. Even a transaction that seems fair, such as a below-market lease, can be treated as prohibited self-dealing.
• Minimum distribution requirement. Section 4942 generally requires distribution of approximately five percent of average investment assets each year, with an excise tax on any shortfall.
• Excess business holdings. Section 4943 limits the extent to which a foundation and its disqualified persons may hold interests in a business enterprise, a particular concern where a foundation is funded with closely held business interests.
• Jeopardizing investments. Section 4944 imposes an excise tax on investments that jeopardize the foundation’s charitable purposes, requiring managers to exercise ordinary business care and prudence.
• Taxable expenditures. Section 4945 restricts certain expenditures, including grants to individuals or to non-public-charity organizations, unless the foundation follows procedures such as expenditure responsibility.
• Net investment income excise tax. Section 4940 imposes a tax on net investment income, currently 1.39 percent for most domestic tax-exempt private foundations.

Establish Ongoing Compliance Practices

A private foundation’s obligations do not end once it is formed and funded. It must file Form 990-PF annually, regardless of size, which requires detailed financial reporting and is subject to public disclosure. Ongoing attention to recordkeeping, board minutes documenting grant decisions, and consistent application of the conflict-of-interest policy all help demonstrate compliance.

Frequently Asked Questions

How long does it typically take to receive tax-exempt status after filing Form 1023?

Processing times vary with the complexity of the application and the Internal Revenue Service’s current workload. Straightforward applications are sometimes approved within a few months, while others take considerably longer.

Can a family member be paid for working at the foundation?

Yes, in certain circumstances. Reasonable compensation for services rendered is generally permitted and is not treated as self-dealing, but the amount must be reasonable and documented, and the arrangement should be reviewed against the disqualified person rules.

Can a private foundation make grants to individuals rather than only to other charities?

Yes, but grants to individuals for travel or study generally require the foundation to follow a specific, IRS-approved procedure. Making such grants without that procedure can result in the grants being treated as taxable expenditures.

Coordinate the Foundation With the Family’s Estate Plan

For many families, a private foundation is one component of a broader legacy plan that also includes wills, trusts, and lifetime gifting strategies, and coordinating the foundation’s governing documents with the estate plan helps ensure that funding commitments, succession of board or trustee roles, and the family’s charitable intent are documented consistently.

Because the excise tax rules leave little room for informal or after-the-fact correction, families are well served by involving experienced counsel before the foundation is formed rather than after a compliance issue arises.

At Abelaj Law, PC, our practice is led by attorney and CPA Jennifer V. Abelaj, whose combined legal and tax background allows her to advise families on both governance structure and tax posture from day one.

If your family is considering establishing a private foundation, we invite you to contact Abelaj Law, PC to discuss your charitable goals and how a foundation might fit within your broader estate plan.

From the moment an award letter arrives, a nonprofit takes on legal and administrative obligations that, if handled carelessly, can create tax problems, jeopardize public charity status, or strain the relationship with the funder.

At Abelaj Law, PC, we counsel nonprofit organizations, boards, and executives on the full lifecycle of grant funding, from evaluating award terms through satisfying the reporting obligations that follow.

Read the Grant Agreement Before Accepting It

Every grant comes with terms, whether stated in a formal, signed agreement or embedded in an award letter that incorporates the funder’s published guidelines. Before spending any funds, the organization should clearly understand what the grant permits, requires, and prohibits. Key provisions typically address:

• The specific purpose for which the funds may be used
• Any timeline for spending the funds or completing associated activities
• Reporting requirements, including financial reports, narrative updates, or outcome data
• Restrictions on administrative or overhead costs
• What happens if the funds are not used as intended, including repayment obligations

Grant terms form a binding commitment, and a nonprofit that accepts an award without reading the underlying terms may unknowingly agree to conditions the organization cannot practically meet.

Restricted Versus Unrestricted Funds

One of the most consequential distinctions in grant management is whether an award is restricted or unrestricted. Unrestricted funds may generally be used for general operations. Restricted funds are earmarked for a specific program, project, or purpose, and using restricted funds for anything else can constitute a breach of the grant agreement and, depending on the circumstances, a breach of fiduciary duty by the board.

Nonprofits should track restricted funds separately from general operating funds. Under generally accepted accounting principles for nonprofit organizations, restricted and unrestricted net assets are reported separately, and an auditor or accountant will expect documentation showing that restricted funds were spent consistently with the funder’s restrictions.

Board Acknowledgment and Internal Approval

Depending on the size of the grant and the organization’s governance structure, the board or an authorized committee may need to formally accept the award, particularly where it carries reporting obligations, matching requirements, or multi-year conditions. Board minutes reflecting this acceptance, along with a summary of the grant’s material terms, create a documentation trail that can prove valuable if questions arise later from an auditor, the funder, or the Internal Revenue Service.

Government Grants Carry Additional Obligations

Grants funded, in whole or in part, by federal, state, or local government sources often bring compliance obligations beyond those found in private grants. Organizations receiving federal funds, directly or as a subrecipient, may be subject to the Uniform Guidance found at 2 C.F.R. Part 200, which addresses cost principles, procurement standards, and audit requirements, including a single audit requirement once federal expenditures exceed a specified threshold in a fiscal year.

Government grant agreements frequently include recordkeeping and allowable cost provisions that differ meaningfully from private foundation or corporate grant terms.

Grants From Private Foundations May Involve Expenditure Responsibility

When the funder is a private foundation, additional considerations can arise, particularly if the grant is not made to another public charity in the ordinary course. Private foundations are generally required to exercise expenditure responsibility over certain grants under Internal Revenue Code Section 4945, which involves a pre-grant inquiry, a written grant agreement with specific required terms, and periodic reports from the grantee describing how the funds were used.

A nonprofit receiving this type of grant should expect, and be prepared to satisfy, these documentation requests, since a foundation’s failure to obtain them can expose it to excise taxes on what the Code treats as a taxable expenditure.

Consider the Effect on Public Charity Status

For organizations classified as public charities under Internal Revenue Code Sections 509(a)(1) and 170(b)(1)(A)(vi), maintaining that status depends in part on receiving a sufficiently broad base of public support, measured under the public support test. A single, unusually large grant can, in some circumstances, affect this calculation, particularly for smaller or newer organizations. The tax code provides certain exceptions and averaging rules across a five-year measurement period, but an organization receiving a substantial grant should still evaluate, with its accountant or counsel, whether the award affects its public support percentage.

Reporting the Grant on Form 990

Grants received by a tax-exempt organization must generally be reported on the organization’s annual Form 990. Even where a nonprofit is solely a grant recipient, the funds received, and often the identity of significant funders, must be reflected accurately in its public filings.

Why Legal Guidance Matters After an Award

A grant award is an opportunity that comes with obligations extending well past the initial celebration. Reviewing grant terms, structuring internal accounting and reporting practices, and understanding how an award interacts with the organization’s tax-exempt status all benefit from careful legal and tax analysis. At Abelaj Law, PC, we work with nonprofit boards and executives to review grant agreements, advise on compliance obligations, and coordinate with the organization’s accountants so that a grant strengthens the organization rather than creates unexpected complications. If your organization has recently been awarded a grant, or if you would like guidance before accepting one, we invite you to contact Abelaj Law, PC.

Frequently Asked Questions

Can a nonprofit use grant funds for administrative overhead?

It depends on the terms of the specific grant. Some funders permit a percentage of the award to be allocated toward administrative or indirect costs, while others restrict funds exclusively to direct program expenses. The grant agreement or award letter should specify what is permitted.

What happens if a nonprofit cannot spend a restricted grant as originally planned?

Organizations facing this situation should contact the funder before reallocating the funds. Many funders will consider a request to modify the permitted use, but using restricted funds differently without the funder’s consent can constitute a breach of the grant agreement.

Do grant funds count as taxable income to the nonprofit organization?

Generally, grants that further a tax-exempt organization’s exempt purpose are not treated as unrelated business taxable income. However, if a grant closely resembles payment for services rendered under a contractual arrangement, the analysis can differ, and the specific facts should be reviewed with tax counsel.

Does accepting a grant require a formal contract between the funder and the nonprofit?

Not always. Some grants are documented through a signed grant agreement, while others are conveyed through an award letter that incorporates the funder’s published guidelines by reference. Regardless of the format, the terms are generally binding on the recipient organization.