A foundation answers to the public; a trust answers to its beneficiaries.

People often frame this as a choice between two legal forms. In fact a United States private foundation can itself be set up as a trust, and so can a charity in England and Wales. The real choice is about who may benefit, and who may look.

Published by ArtisDomus, written by Polina Surina.

Under United States federal tax law, section 501(c)(3) of the Internal Revenue Code exempts corporations and any community chest, fund or foundation. They must be organised and operated exclusively for religious, charitable, scientific, public-safety testing, literary or educational purposes. No part of the net earnings may benefit any private shareholder or individual.

Section 509(a) then defines a private foundation as any organisation, domestic or foreign, described in section 501(c)(3), except the categories it lists. So the definition fixes a tax status and leaves the legal form open. An estate that sets up a trust and obtains recognition under section 501(c)(3) has created a private foundation. So has an estate that incorporates and obtains the same recognition.

The real divide is between a private trust, which exists for named or identifiable people, and a charitable vehicle, which exists for a purpose the public can claim. Everything below follows from that.

The Uniform Trust Code is a model act. It has legal force only in a state that has enacted it, and each such state gives it its own numbering. Thirty-seven of the fifty-three jurisdictions on the Uniform Law Commission’s list have enacted it, including the District of Columbia.

Under D.C. Code section 19-1304.02 (Uniform Trust Code section 402), a trust is created only if all of these conditions are met. The settlor must have capacity and must show an intention to create the trust. The trust must have a definite beneficiary, or be a charitable trust, a trust for the care of an animal or a trust for a non-charitable purpose. The trustee must have duties to perform. And the same person cannot be both sole trustee and sole beneficiary.

A charitable trust is excused from the definite-beneficiary rule because it exists for a purpose, and serves no identifiable people. D.C. Code section 19-1304.05 (Uniform Trust Code section 405) lists what it may be for. It may relieve poverty, advance education or religion, promote health, serve governmental or municipal purposes, or pursue other purposes whose achievement benefits the community. If the terms name no purpose or beneficiary, the court may choose one.

England and Wales draws the same line in statute, and more strictly. A charity is an institution established for charitable purposes only and subject to the High Court’s jurisdiction over charities (s. 1(1), Charities Act 2011). The list of purposes includes the advancement of the arts, culture, heritage or science (s. 3(1)(f)). That is where an artist’s foundation sits.

The key requirement is in section 4: the purpose must be for the public benefit. Under section 4(2), no purpose is presumed to be for the public benefit because of its description. So advancing the arts is not enough on its own; the public benefit has to be shown.

These obligations are excise taxes, set out in chapter 42 of the Internal Revenue Code. A tax-exempt private foundation pays 1.39 per cent of its net investment income for each taxable year (s. 4940(a)). Ordinary trusts and public charities do not pay it.

Section 4942(e)(1) sets the minimum investment return at 5 per cent of the total fair market value of the foundation’s assets, less acquisition debt. Assets used, or held for use, directly for the exempt purpose are left out. Income still undistributed at the start of the second taxable year after the year in question, or any later year, is taxed at 30 per cent (s. 4942(a)).

A further tax of 100 per cent applies to the amount still undistributed at the close of the taxable period (s. 4942(b)). Under Internal Revenue Service guidance, the 100 per cent tax applies if the foundation does not make up the shortfall within 90 days of being notified.

Section 4941 bans self-dealing between the foundation and a disqualified person. It lists six acts.

The rates show why the list matters. The self-dealer pays a tax of 10 per cent of the amount involved (s. 4941(a)(1)). A foundation manager who knowingly takes part pays 5 per cent (s. 4941(a)(2)). If the act is not corrected within the taxable period, a further tax of 200 per cent of the amount involved applies (s. 4941(b)(1)). A manager who refused to agree to the correction pays 50 per cent (s. 4941(b)(2)).

Section 4946(a)(1) sets who is a disqualified person. It includes a substantial contributor and a foundation manager. It also includes an owner of more than 20 per cent of an entity that is a substantial contributor, and a family member of any of them. Family means the spouse, ancestors, children, grandchildren and great grandchildren, and the spouses of children, grandchildren and great grandchildren (s. 4946(d)). Brothers and sisters are not on that list. So a sibling trustee is in a different position from a child trustee.

The foundation’s governing document must also contain these restrictions (s. 508(e)(1)). It must require income to be distributed so that no tax arises under section 4942. It must prohibit self-dealing under section 4941(d), excess business holdings under section 4943(c), investments taxed under section 4944 and taxable expenditures under section 4945(d). The deed has to say so.

In England and Wales the control is public supervision, where the United States uses excise tax. Every charity must be registered unless subsection (2) applies (s. 30(1), Charities Act 2011). Subsection (2) exempts three groups: exempt charities; charities excepted by order or regulations whose gross income is £100,000 or less; and charities whose gross income is £5,000 or less. An artist’s foundation of any real size registers.

Under the Charity Commission’s guidance on setting up a charity, a charity cannot mix charitable and non-charitable purposes. Each purpose must fall within a listed description and be for the public benefit. The Commission recommends at least three unconnected, unrelated trustees with a good range of skills.

The guidance names four main structures: the charitable incorporated organisation, the charitable company limited by guarantee, the unincorporated association and the trust. So a trust is simply one way to set up a charity.

A charity must file its annual return within 10 months of the end of its financial year. What it files depends on income. Under £10,000, it reports income and spending only. Between £10,000 and £25,000, it answers the annual return questions. Over £25,000, it also files trustee reports and accounts.

An audit is required if gross income in the financial year exceeds £1 million (s. 144(1)). It is also required if gross income exceeds the accounts threshold and total assets, before liabilities, exceed £3.26 million at the year end. An endowment of works crosses the asset limit long before the income limit.

A trustee can be paid, under conditions (s. 185). The section covers payment for goods or services from a charity trustee, or from a person connected with a trustee where the trustee might benefit. It allows payment only if four conditions are all met. The amount is set out in a written agreement and is no more than is reasonable in the circumstances. The trustees are satisfied it is in the charity’s best interests. The paid trustees are not a majority. And the governing document does not forbid it.

A family that expects to work for the foundation should read that section before the deed is drafted.

The most useful provision for a United States art foundation is the exclusion in section 4942(e)(1). The 5 per cent is worked out on assets other than those used, or held for use, directly for the exempt purpose. A collection that is genuinely exhibited, lent and studied sits outside the base. A collection held because it should rise in value sits inside it. It then creates a yearly distribution duty that has to be met in cash.

The counterpart is section 4941(d)(1)(E). Transferring the foundation’s income or assets to a disqualified person, or letting one use or benefit from them, is self-dealing. So a picture the foundation owns cannot hang in the founder’s house. Section 4941(d)(1)(A) closes the other route: a sale or exchange of property between the foundation and a disqualified person is also self-dealing. That is why the way works reach the foundation must be settled in advance.

The tax deduction is where families lose most money, and the rule surprises people. Under Internal Revenue Service Publication 526, gifts of capital gain property to a private non-operating foundation are capped at 20 per cent of adjusted gross income. The cap is 30 per cent for capital gain property given to a 50 per cent limit organisation. And for capital gain property given to a private non-operating foundation, the deduction is cut from fair market value to the donor’s cost basis.

So a family that gives its own appreciated pictures to its own grant-making foundation deducts what the pictures cost. A private operating foundation, as defined in section 4942(j)(3), is treated differently from an ordinary private foundation (s. 170(b)(1)(F)). A foundation that actually runs a museum is built on that distinction.

The United Kingdom reaches the same result through an exemption. Transfers of value are exempt to the extent they are attributable to property given to charities or registered clubs (s. 23(1), Inheritance Tax Act 1984). The exemption is unlimited in amount, and it comes with conditions.

The exemption is lost in two cases (s. 23(4)). In the first, land or a building is given with a reserved interest that lets the donor or a connected person occupy it rent free or below market rent. In the second, other property is given with a reserved interest that substantially affects the recipient’s enjoyment of it. Giving the pictures and keeping the walls is exactly the case this subsection targets.

Under section 6104(b) of the Internal Revenue Code, the information filed under sections 6033, 6034 and 6058 is open to the public. The Secretary may not disclose the name or address of any contributor. But the section expressly takes private foundations out of that protection.

The same goes for the organisation’s own duty to show its returns on request: the exception for contributors’ names and addresses does not cover a private foundation (s. 6104(d)(3)(A)). The annual return must be open for inspection during regular business hours (s. 6104(d)(1)). Copies must be supplied on written request, for no more than a reasonable fee for copying and postage.

A private trust reports to fewer people, and tells them more. Under D.C. Code section 19-1308.13 (Uniform Trust Code section 813), the trustee must keep the qualified beneficiaries reasonably informed about the administration. That includes the material facts they need to protect their interests. The trustee must supply a copy of the trust instrument on request.

The trustee must also notify the qualified beneficiaries within 60 days of accepting the trusteeship, and within 60 days of learning that the trust has become irrevocable. Each year the trustee reports the trust property, liabilities, receipts, disbursements and distributions, including the source and amount of the trustee’s pay. The report lists the trust assets, with their market values where feasible.

The difference is the reader. The trust tells the beneficiaries what the trustee is paid. The foundation tells anyone who asks who gave it the works.

Enforcement follows the same logic. Under D.C. Code section 19-1304.05(c), the settlor of a charitable trust, among others, may bring proceedings to enforce it. In England and Wales, supervision comes from the High Court’s jurisdiction preserved by section 1(1)(b) of the Charities Act 2011, and from the Charity Commission’s register. A family that wants the last word on how a collection is used cannot have it in a charitable vehicle, whatever its form.

It all comes down to one question: who may benefit? If the family must be able to benefit, the vehicle is a private trust. The tax reliefs are then unavailable: the exemption in section 23 of the Inheritance Tax Act 1984 and the deduction in section 170 of the Internal Revenue Code. Nothing has to be published. If the public must be able to benefit and the family may not, the vehicle is charitable. The exemptions are then available, and the obligations above apply for good.

Plans that try to have both fail. Two rules target the case where the works are given away and the benefit is kept. One is section 4941(d)(1)(E) in the United States. The other is section 23(4) of the Inheritance Tax Act 1984 in the United Kingdom.

Once that is answered, two more questions set the shape. The first is whether the works will actually be exhibited, lent and studied. In the United States, that takes them out of the section 4942 payout base, and it marks a private operating foundation under section 4942(j)(3). The second is where the works will be. Moral rights survive the artist in the United Kingdom (s. 95, Copyright, Designs and Patents Act 1988) and end with the artist in the United States (s. 106A(d)(1)).

In the estates we assess, the deciding fact is the one least often written down. It is whether anyone outside the family is expected to see the work, and how often. It is a question about a programme, though families ask it as a question about structure.

This entry summarises published law and is not legal or tax advice.