How to Set Up a Private Foundation: Essential Steps and Key Considerations

Creating a private foundation is a significant undertaking that requires careful planning, legal work and compliance oversight. Unlike public charities, which are funded by diversified public sources, private foundations are primarily supported by a single donor or family. They tend to be the most complex type of charitable giving structure, but they offer the most control, tax-planning opportunities and potential for long-term family engagement in philanthropy.

Establishing a private foundation involves taking a variety of steps, from forming a legal entity and obtaining tax-exempt status to drafting bylaws and appointing a board. If you’re evaluating how to set up a private foundation and whether doing so aligns with your broader charitable giving strategies, it can be helpful to compare this approach with other options, like donor‑advised funds and public charities as part of a comprehensive charitable planning discussion.

However, not all private foundations are the same. They come in two main types: non-operating and operating. Non-operating private foundations primarily focus on making grants to other organizations, while operating foundations actively run their own charitable programs. This article focuses exclusively on non-operating private foundations, outlining key steps and important considerations for their successful establishment and management.

1. Decide Whether a Private Foundation Is Right for You

The first step in establishing a private foundation is deciding if the structure is best for your situation. Private foundations are often established by high-net-worth and ultra-high-net-worth individuals with two primary goals. First, they want a structured, long-term approach to charitable giving that can be passed down through generations. Second, they want significant control over how their philanthropic assets are used.

However, private foundations require significant administrative, legal and tax oversight. They also come with substantial costs and strict compliance rules, even as they can provide tax benefits such as current‑year charitable deductions and long‑term control over a dedicated foundation investment portfolio. Whether the costs outweigh the benefits will depend on your situation and preferences.

A wealth advisor experienced with legacy planning for high-net-worth clients can help you weigh the pros and cons, which can be complex and may intersect with business transition planning, estate strategies and other charitable giving strategies.

2. Consider Alternatives, Such as Donor-Advised Funds and Other Structures

Private foundations are powerful tools for hands-on, long-term philanthropy, but they’re best suited for donors who value control enough to justify the added complexity, cost and oversight. Before moving forward, consider alternative structures that may better help you achieve your charitable giving goals, such as:

• Donor-advised fund (DAF) – This is a charitable account held at a sponsoring public charity, where you can donate and recommend how grants are made. While sponsors generally follow donor recommendations, they have the final say. A DAF doesn’t require forming a legal entity, managing operations, filing separate tax returns or meeting ongoing compliance requirements, and costs are generally much lower than those of private foundations.
• Public charity (501(c)(3)) – This is a charitable organization that requires legal formation and is supported by the public through broad fundraising and active charitable programs. While founders and major donors may remain involved, governance and decision-making must be independent. Wealthy donors often choose this structure when they want to build and scale impact without the long-term compliance burden and family control obligations of a private foundation. Public charities also generally offer higher deduction limits than private foundations.
• Private operating foundation – This is a private foundation structure focused on operating charitable programs directly, rather than primarily making grants. While it offers similar levels of control to a non-operating private foundation and still carries private foundation compliance obligations, it also requires more active management than donor-advised funds or public charities.
• Supporting organization – This is a public charity structured to support one or more designated public charities rather than operating broadly or making fully discretionary grants like a private foundation. While it avoids private foundation rules and taxes, it must meet strict relationship and governance requirements.
• Fiscal sponsorship – In this structure, a project is housed within an existing public charity instead of forming a private foundation or standalone nonprofit. It eliminates most compliance and setup requirements but offers limited control, and it’s typically best suited for short-term or pilot initiatives rather than permanent charitable vehicles.
• Charitable trust – This is a trust-based charitable structure that holds and distributes assets for charitable purposes rather than operating as a nonprofit corporation. While often simpler than private foundations, charitable trusts offer less flexibility and are governed by state trust laws. They’re generally better suited for specific, long-term charitable goals rather than evolving or hands-on philanthropic strategies.

The best structure for your situation will depend on what balance of control, complexity and permanence is most attractive to you. A wealth advisor experienced in legacy planning for high-net-worth individuals can help assess your situation and compare different solutions.

3. Define the Foundation’s Mission, Vision and Giving Strategy

Before diving into the legal and operational aspects, it’s crucial to define a clear mission, vision and giving strategy for the foundation. The mission statement should succinctly describe the foundation’s purpose, the issues it aims to address and the population it intends to serve.

The vision should provide a long-term view of what the foundation hopes to achieve. The giving strategy should outline how the foundation will give to achieve the mission and vision, including a grantmaking calendar, preferred charitable giving strategies and how you’ll measure impact. Together, these elements form the basis of the foundation and later inform written grantmaking policies and evaluation criteria.

4. Choose a Legal Structure and State of Incorporation

Next, you’ll need to make key planning decisions that shape how the foundation will operate long term. Most private foundations are formed as nonprofit corporations, but you can also opt for a trust. Both structures are subject to the same IRS rules and offer tax advantages, but nonprofits tend to offer greater flexibility and a clearer governance framework. A trust is usually preferable only if your charitable goals are highly specific and unlikely to change over time.

You’ll also need to select the state in which you’ll incorporate or set up a trust and identify the individuals you’d like to appoint to the board of directors or as trustees. Requirements for private foundations vary greatly by state, so it’s important to consider the differences when making your decision and understand how state law interacts with federal private foundation regulations.

5. Incorporate the Foundation and Draft Bylaws

Incorporating the foundation as a nonprofit corporation is the typical next step. The process involves filing articles of incorporation with the Secretary of State’s office, which include the foundation’s name, purpose, planned duration and planned dissolution information as well as contact information for the incorporator and the board of directors. This filing provides the foundation with legal recognition, allowing it to enter into contracts and helping protect the foundation’s founders from personal liability.

You’ll also need to establish the foundation’s bylaws, which are the internal rules that govern your nonprofit and serve as your foundation’s operating manual. They typically address:

• The size and composition of the board of directors
• Procedures for electing and removing directors
• The roles and responsibilities of officers
• The process for holding meetings and voting
• Conflict of interest policies
• Procedures for amending or restating the bylaws

Your bylaws should be drafted carefully to ensure they comply with both state law and IRS regulations. They should lay a solid foundation for operations by providing guidance on governance, role clarity, succession planning and meeting cadence. Many foundations also use bylaws to set high-level parameters for board composition, such as balancing family members with independent directors, which can help support long-term credibility and compliance.

6. Obtain an Employer Identification Number (EIN)

An Employer Identification Number (EIN) is required for tax reporting and banking purposes, whether you choose to have employees or not. You can obtain an EIN from the IRS online or by submitting Form SS-4.

When you apply, beware of scams. Applying for an EIN should always be free, despite many third-party sites that offer the service for a fee. Once approved, your EIN is typically issued and available within minutes.

7. Apply for Federal Tax-Exempt Status

Next, you’ll need to apply for federal tax-exempt status to establish your organization as a 501(c)(3) private foundation. To do so, file Form 1023 or Form 1023-EZ (if eligible). The full Form 1023 is a comprehensive document that requires detailed information about the foundation’s structure, mission, governance, financial projections and planned activities. It allows the IRS to assess whether your organization meets its stringent private foundation regulations, which are designed to ensure you serve public, rather than private, interests.

If approved, the foundation will be recognized as a tax-exempt entity, meaning it won’t pay federal income tax on income related to its exempt purposes. The approval process may take anywhere from three to 12 months, but the foundation may begin operations during this period of pending approval — and can often take deductions retroactively once recognition is granted. Donors to the foundation may also be eligible for tax deductions, subject to private foundation deduction limits.

8. Fund Your Private Foundation

Once set up, private foundations require funding. In most cases, new foundations are funded with endowments of at least $1 million from a single primary source. That threshold helps ensure the foundation can cover setup and administrative costs while generating enough investment income to pay excise taxes and meet the annual 5% minimum distribution rule.

Funding can come in the form of cash or publicly traded securities, such as stocks, bonds, ETFs and mutual funds. Foundations can also be funded with illiquid assets, such as real estate, tangible personal property, and restricted, control or privately held securities.

When deciding how to fund your private foundation, be sure to consider tax deduction limits. For example, donors can generally deduct up to 30% of their AGI per year in cash contributions and 20% of their AGI per year when donating appreciated securities. Donations beyond these thresholds can generally be carried over for up to five subsequent tax years. The way you structure the foundation’s investment portfolio will also influence its long‑term sustainability and ability to support your charitable giving strategies.

9. Understand the 5% Payout Rule and Other IRS Requirements

As you prepare to begin operating a private foundation, it’s important to understand a few core rules. First, the IRS imposes a 5% minimum distribution (or payout) rule on private, non-operating foundations to ensure they provide meaningful support to charities. You must make annual qualifying distributions equal to at least 5% of the average fair market value of the foundation’s non-charitable use assets (after subtracting any debt used to acquire them).

Failing to meet this requirement results in a 30% excise tax that applies to the undistributed income each year the deficiency remains uncorrected. A 100% additional tax can apply if the foundation doesn’t correct the deficiency within 90 days of receiving an IRS notice.

The IRS also has several other notable rules for private foundations, including:

• Self-dealing – Private foundations can’t participate in “self-dealing,” which means conducting certain transactions with disqualified persons, such as family members, foundation managers or substantial contributors. If discovered, the disqualified person owes 10% of the amount involved and the foundation manager owes 5% of the amount involved. If the issue isn’t corrected within the taxable period, the disqualified person may owe 200% of the amount and the foundation manager may owe 50% of the amount.
• Excess business holdings – Private foundations and their disqualified persons are generally limited to 20% ownership in a business enterprise. The initial penalty for excess business holdings is a 10% tax on the foundation, with an additional 200% tax if the issue isn’t fixed during the taxable period.
• Jeopardizing investments – Private foundations aren’t allowed to make investments that financially jeopardize their ability to carry out their exempt purpose. The penalty is a 10% excise tax on the amount involved for both the foundation and any foundation manager who participated, with an additional 25% excise tax on the foundation and 10% on any manager who refuses to correct the investment.
• Taxable expenditures – If you spend money on non-charitable purposes or grants to individuals without proper procedures, the IRS can impose a 20% tax on the amount to the foundation, plus 5% for foundation managers and additional taxes if the expenditure isn’t corrected.
• Late filing of Form 990-PF – Form 990-PF (Return of Private Foundation) is an annual information return that private foundations in the United States must file with the IRS. If you don’t file it on time, you may owe a penalty of $20 ($120 for large organizations) per day for each day the return is late, up to $12,500 ($60,000 for large organizations) or 5% of your organization’s gross receipts for the year. If you fail to file for three consecutive years, your organization loses its federal tax exemption.

This isn’t an exhaustive list. Penalties can add up quickly, so it’s important to work with your advisory team to understand all legal requirements and ongoing compliance obligations.

10. Build Financial, Governance and Grantmaking Policies

Sound financial management is essential for a foundation’s sustainability and compliance with legal requirements. It starts with establishing financial policies and procedures early on to help ensure transparency and accountability. Key policies often include:

• Grantmaking policy – Defines who’s eligible for grants, how funding decisions are made and how grants are monitored
• Expense approval and documentation procedures –Outlines who can approve expenses and what documentation is required
• Investment policy –Establishes guidelines for investing assets, including risk tolerance, liquidity needs and oversight
• Recordkeeping and reporting standards –Specifies how financial records, grant files and tax documents are maintained
• Gift acceptance policy –Defines the types of donations the foundation will accept and under what conditions

Together, these governance and financial practices help new foundations manage common challenges, such as role confusion, inconsistent grant decisions and compliance gaps, forming the backbone of effective private foundation management.

11. Understand Ongoing Compliance for Private Foundations

Maintaining tax-exempt status and complying with legal requirements is an ongoing responsibility. Private foundations must file an annual Form 990-PF with the IRS, which provides detailed information about finances, operations and grantmaking activities. Foundations may also need to register and file annual reports with one or more states, often through the state attorney general or a similar regulatory body. State filing obligations can depend on where the foundation is legally formed as well as where it operates and solicits charitable activity.

Ongoing compliance may also include state corporate filings, maintaining proper governance and financial records, and periodically revisiting policies as regulations or philanthropy trends evolve.

12. Work With a Registered Financial Advisor

Establishing a private foundation is a complex endeavor that will touch nearly every part of your financial life, from your investments and taxes to your estate planning. Because of the complexity and potential for costly mistakes, it’s a good idea to consult with a registered financial advisor who’s experienced with helping high-net-worth individuals integrate charitable giving strategies into their broader wealth plans.

Creative Planning, for example, offers family office, charitable planning and institutional investment services. Our team can not only help you set up a private foundation but also support your foundation’s board and operations long term, including investment strategy, governance best practices and compliance with private foundation rules.

FAQs About Starting a Private Foundation

How much money do I need to start a private foundation?

There’s no legal minimum to start a private foundation, but advisors generally recommend at least $1 million for the structure to be cost-effective and sustainable. Private foundations carry fixed administrative and compliance costs and must distribute at least 5% of their assets each year for charitable purposes. If too little is available for charitable giving, the foundation can end up spending more money running itself than supporting the causes it was created to serve.

What’s the difference between a private foundation and a family foundation?

A family foundation is a type of private foundation, not a separate legal category. The term “private foundation” is the IRS and legal term for a charitable entity that’s typically funded by one donor, family or company and subject to private foundation rules. “Family foundation” is an informal label that usually refers to a private foundation funded and governed primarily by members of the same family.

Can a private foundation pay a salary to family members?

Yes, a private foundation can pay a salary to family members, but only under strict conditions. Compensation must be for real, necessary work and reasonable compared to similar roles at other organizations. Family members can’t be paid simply for serving on the board or because of their relationship to the donor. To avoid self-dealing issues, compensation should be carefully documented and approved by board members who don’t have a conflict of interest, where possible.

We’re Here to Help

If you’re considering whether a private foundation is the right solution for your philanthropic planning, or evaluating alternatives like donor-advised funds and public charities, the team at Creative Planning is ready to help. We can guide you through the process of finding the best structure for your situation using an integrated approach that takes your broader wealth, tax and estate planning goals into account.

Schedule a conversation today.