--- title: "Foundation (Charitable Foundation) | Altss Glossary" description: "A foundation is a nonprofit entity, usually endowed by one donor, family or company, that invests its assets and spends the returns on charitable grants…" canonical: "https://altss.com/glossary/foundation" --- Glossary · Allocator type # Foundation (Charitable Foundation) A foundation is a nonprofit entity, usually endowed by one donor, family or company, that invests its assets and spends the returns on charitable grants or programmes; in US tax law many are private foundations, and a private non-operating foundation is subject to a minimum payout. Publisher: Altss LLC Published 2025-12-24 Content modified 2026-10-02 ALTSS-ALLOC-011 A foundation turns a gift of capital into a long-lived source of charitable spending. Unlike a university endowment, the foundation itself is the charity: its main activity is giving money away. In the US the tax code sets a floor on that giving for private foundations, plus rules on risky investments and business holdings, and those rules shape how much illiquidity the portfolio can carry. ### Formal definition Under 26 U.S.C. 509(a), a private foundation is any domestic or foreign organisation described in section 501(c)(3) other than: organisations described in section 170(b)(1)(A) (other than clauses (vii) and (viii)); organisations that normally receive more than one-third of their support from gifts, grants, contributions, membership fees and gross receipts from related activities (subject to limits) and not more than one-third from gross investment income plus net unrelated business income; supporting organisations of those charities; and organisations testing for public safety. ## Formula ### Minimum investment return and distributable amount (IRC section 4942) ``` MIR = 5% × (average fair market value of non-charitable-use assets − acquisition indebtedness); distributable amount = MIR + recoveries − taxes ``` `\overline{\mathrm{FMV}}_{\mathrm{nc}}` aggregate fair market value of assets other than those used (or held for use) directly in carrying out the exempt purpose; securities with readily available quotations are valued monthly `AI` acquisition indebtedness with respect to those assets `R` amounts described in section 4942(f)(2)(C), such as certain recoveries of prior qualifying distributions `T` taxes imposed on the foundation for the year under subtitle A and section 4940 Statutory formula: section 4942(e)(1) and (d). Treasury regulations govern valuation details and exclusions. The result is a floor on qualifying distributions, which must be made by the end of the following taxable year; it is not a spending policy. ## Jurisdiction and status The legal rules on this page are US federal tax law in the Internal Revenue Code (IRC): section 509(a) defines a private foundation, and sections 4940, 4942, 4943 and 4944 set the payout floor and the excise taxes that shape its portfolio. They are stated as in force on 2 October 2026. Outside the US, "foundation" is also a legal entity form under national law, and not every such entity is charitable; those regimes are not described here, so a non-US foundation is classified by purpose and tax status, not by name. ## Kinds of foundation - **Private non-operating foundations** are grant-makers funded mainly by one donor, family or company, and are subject to the minimum distribution rule. This is the usual form of a family or corporate foundation. - **Private operating foundations** spend their income running their own charitable programmes; section 4942 excludes them from its tax. - **Community foundations** pool gifts from many donors in a region. Where one qualifies as a publicly supported organisation under section 170(b)(1)(A)(vi), section 509(a)(1) excludes it from private-foundation status, and the payout and excise rules below do not apply to it as a private foundation; section 4943 does, however, treat any donor-advised fund it sponsors as a private foundation for the excess business holdings rule (section 4943(e)). "Private foundation" is the US tax classification under section 509(a); "foundation" as an allocator type is broader and also covers operating and non-US foundations. ## The 5% minimum distribution (US) Section 4942 sets the minimum investment return at 5% of the excess of the fair market value of non-charitable-use assets over related acquisition indebtedness. The distributable amount is that return, adjusted as the formula shows. If qualifying distributions do not reach it by the first day of the second following taxable year, the foundation pays an initial tax of 30% of the undistributed income, and 100% if the shortfall remains uncorrected. Qualifying distributions include amounts paid to accomplish charitable purposes and amounts paid to acquire assets used directly for exempt purposes. Treasury regulations list program-related investments (below) among qualifying distributions (26 CFR 53.4942(a)-3(a)(2)(i)); investments made for a market return, including mission-related investments, are not among the listed categories. ## Other private-foundation rules that shape the portfolio - **Excise tax on investment income (section 4940).** A flat 1.39% of net investment income, since the 2019 amendment that replaced the former 2% rate. - **Jeopardizing investments (section 4944).** An investment made in a manner that jeopardises the foundation's exempt purposes triggers a 10% tax on the amount invested for each year. A program-related investment, whose primary purpose is charitable and of which no significant purpose is income or appreciation, is not a jeopardizing investment. - **Excess business holdings (section 4943).** Combined with its disqualified persons (such as the founder's family), a foundation may generally hold no more than 20% of a company's voting stock (35% if unrelated persons have effective control), with a 2% de minimis exception; excess holdings bear a 10% initial tax. A trade or business at least 95% of whose gross income comes from passive sources is not a business enterprise for this purpose (section 4943(d)(3)), so an interest in a fund that meets that test is not a business holding; a fund that holds operating businesses through partnerships may not meet it, and for partnerships the limits apply to the profits interest (section 4943(c)(3)). - **Unrelated business income.** Debt-financed income from leveraged funds is [UBTI](https://altss.com/glossary/ubti); foundations often invest through [blocker corporations](https://altss.com/glossary/blocker-corporation) or fund feeders structured to limit it. ## How foundations invest in private markets A perpetual foundation needs a long-run return at least equal to its payout, inflation and costs to keep its real value. That arithmetic, and a horizon with no benefit liabilities, is why many larger foundations hold private equity, venture capital and real assets alongside public markets. The payout floor is computed on average asset values, so it falls after a market decline, but capital calls do not. Foundations therefore pace commitments so that grants and calls can be met from liquid assets. Spend-down foundations, which plan to distribute everything by a set date, take less illiquidity as the date approaches. Smaller foundations often outsource to an [OCIO](https://altss.com/glossary/ocio) or consultant; family foundations are frequently administered by the family's [family office](https://altss.com/glossary/family-office) but remain separate legal entities. Some allocate to [impact investing](https://altss.com/glossary/impact-investing) strategies under the same prudence rules as other investments. ## Worked example ### Illustrative private foundation, one year ($ millions) Average non-charitable-use assets are $200m with no acquisition indebtedness, so the minimum investment return is 5% × 200 = **$10.0m**. Net investment income of $12m bears the section 4940 tax at 1.39% = $0.17m. The distributable amount is about 10.0 − 0.17 = **$9.83m**, and qualifying distributions of that amount must be made by the end of the following taxable year. If the foundation distributes only $8.0m by then, $1.83m is undistributed income and the initial tax is 30% of it, about **$0.55m**; an additional 100% tax applies if it is still not corrected. Examples are illustrative; figures are not market data. ## Not the same as - [Endowment](https://altss.com/glossary/endowment): An endowment funds an operating institution (a university, hospital) under a spending policy and is not subject to section 4942; a foundation is itself the grant-maker. - [Family Office](https://altss.com/glossary/family-office): A family office manages a family's own wealth; a family foundation is a separate charitable entity with its own tax rules, even when the office's staff administer it. ## How it is classified - Classify as a foundation when the entity's own purpose is charitable grant-making or programmes funded from its invested assets. - Record US tax status (private non-operating, private operating, public charity) from the entity's Internal Revenue Service (IRS) filings or determination, not from its name. - Keep a corporate or family foundation as its own allocator, related to the company or family office; never merge them, even when staff are shared. ## Common mistakes - Applying the 5% rule to every charity. Section 4942 applies to private non-operating foundations, not to university endowments or to community foundations that qualify as publicly supported organisations. - Computing the 5% on total assets. Assets used directly for exempt purposes are excluded, acquisition indebtedness is deducted, and values are averaged. - Treating a mission-related investment as a qualifying distribution. Among investments, only program-related investments are listed as qualifying distributions. - Quoting the section 4940 rate as 2% or as tiered. Since the 2019 amendment it is a flat 1.39%. - Assuming a perpetual foundation can ignore liquidity. Grants and capital calls continue when markets fall. - Merging a family foundation with the family office that administers it. ## Edge cases - A foundation endowed with a large block of the founder's company stock must manage excess business holdings; section 4943(g) gives a narrow exception for certain wholly owned philanthropic businesses. - Private operating foundations are outside the section 4942 tax but are still private foundations for other purposes. - A spend-down foundation's private-markets programme must end with fund interests realised or sold, often through the secondary market. ## Questions ### What is the 5% rule for private foundations? IRC section 4942 requires a US private non-operating foundation to make qualifying distributions at least equal to its distributable amount, based on 5% of the average value of its non-charitable-use assets, by the end of the following year, or pay a 30% tax on the shortfall. ### Can a private foundation invest in private equity funds? Yes. The rules require that investments not jeopardise the foundation's purposes, that combined business holdings stay within section 4943 limits, and that unrelated business income from leveraged funds be managed or taxed. ## Sources 1. [26 U.S.C. 509 - Private foundation defined](https://www.law.cornell.edu/uscode/text/26/509). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). IRC sec. 509(a)(1), (a)(2)(A)-(B), (a)(3), (a)(4) — supports: Private foundation definition and the public-charity exclusions 2. [26 U.S.C. 4942 - Taxes on failure to distribute income (private foundation minimum distribution)](https://www.law.cornell.edu/uscode/text/26/4942). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). IRC sec. 4942(a), (b), (c), (d), (e)(1), (g)(1), (j)(3) — supports: Minimum investment return, distributable amount, 30% and 100% taxes, timing, qualifying distributions, operating foundation exception 3. [26 U.S.C. 4940 - Excise tax based on investment income (private foundations)](https://www.law.cornell.edu/uscode/text/26/4940). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). IRC sec. 4940(a) — supports: 1.39% excise tax on net investment income 4. [26 U.S.C. 4944 - Taxes on investments which jeopardize charitable purpose (incl. program-related investments)](https://www.law.cornell.edu/uscode/text/26/4944). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). IRC sec. 4944(a)(1), (c) — supports: Jeopardizing investment tax and program-related investment exception 5. [26 U.S.C. 4943 - Taxes on excess business holdings (private foundations)](https://www.law.cornell.edu/uscode/text/26/4943). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). IRC sec. 4943(a)(1), (c)(2)(A)-(C), (c)(3), (d)(3), (g)(1)-(2) — supports: Excess business holdings limits, partnership profits-interest rule, de minimis, passive-income exclusion, philanthropic business exception (100% voting stock, not acquired by purchase) 6. [26 U.S.C. 512 - Unrelated business taxable income](https://www.law.cornell.edu/uscode/text/26/512). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). IRC sec. 512 — supports: UBTI 7. [26 U.S.C. 514 - Unrelated debt-financed income](https://www.law.cornell.edu/uscode/text/26/514). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). IRC sec. 514(a)-(b) — supports: Debt-financed income included in UBTI 8. [26 CFR 53.4942(a)-3 - Qualifying distributions defined](https://www.law.cornell.edu/cfr/text/26/53.4942(a)-3). U.S. Department of the Treasury / IRS (CFR text via LII mirror), Current CFR text as published by LII (accessed 2026-10-02). Status: in force (checked 2026-10-02). 26 CFR 53.4942(a)-3(a)(2)(i)-(iii) — supports: Qualifying distributions include program-related investments 9. [26 U.S.C. 170 - Charitable, etc., contributions and gifts (incl. 170(b)(1)(A) organization types)](https://www.law.cornell.edu/uscode/text/26/170). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-02). Status: in force (checked 2026-10-02). IRC sec. 170(b)(1)(A)(vi) — supports: Publicly supported organisations (excluded from private-foundation status by 509(a)(1)) 10. [26 U.S.C. 511 - Imposition of tax on unrelated business income of charitable, etc., organizations](https://www.law.cornell.edu/uscode/text/26/511). U.S. Congress (Internal Revenue Code; LII mirror), Current US Code text as published by LII (accessed 2026-10-02). Status: in force (checked 2026-10-02). IRC sec. 511(a)(1)-(2)(A) — supports: UBTI tax applies to exempt organisations, including private foundations ## Related terms 7 terms - [Endowment](https://altss.com/glossary/endowment) - [Impact Investing](https://altss.com/glossary/impact-investing) - [Unrelated Business Taxable Income (UBTI)](https://altss.com/glossary/ubti) - [Blocker Corporation](https://altss.com/glossary/blocker-corporation) - [Family Office](https://altss.com/glossary/family-office) - [Outsourced Chief Investment Officer (OCIO)](https://altss.com/glossary/ocio) - [Institutional Investor](https://altss.com/glossary/institutional-investors) ## Concept record Concept ID ALTSS-ALLOC-011 Classification Allocator type Topics Institutional investors Jurisdiction US Version 2.0.0 Last reviewed 2026-10-02 Structured data [JSON](https://altss.com/reference/concepts/foundation.json) Source check Tax statements checked against the cited primary sources on 2026-10-02 ([how](https://altss.com/methodology)). General information, not advice. ## Canonical URL https://altss.com/glossary/foundation