Should Schools Set Up a Separate Foundation to Manage Their Endowment?

by: Andrew Hedrich
Verified by: CPA

July 26, 2023

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Endowments play an important role in the future of many independent schools. They provide long-term financial sustainability, funding capital improvement projects, scholarships, and other investments in real property that expand the purview of the school. 

As a school’s endowment grows larger and more complex, managing it becomes increasingly challenging. This is especially true when certain funds inside the school’s endowment are restricted in some sense: whether that’s temporarily or in perpetuity. 

To avoid the possibility of commingling operational and endowment funds, many schools consider establishing a separate foundation to manage their endowment. These foundations, which are classed as supporting organizations, allow for appropriate segregation of duties and improved supervision of endowment assets, helping ensure the long-term viability of the school. 

In this overview, we walk through the considerations that independent schools should bear in mind when weighing the decision to set up a separate foundation to manage their endowment. We will also share an overview of the process of establishing an independent foundation and outline the ongoing compliance requirements for board members to be aware of. 

Why Consider a Separate Foundation to Manage Your School’s Endowment?

A school’s endowment is typically held in various investment portfolios managed by wealth management professionals at the school’s banking partner. Generally, endowment funds are held in separate accounts from the school’s operating accounts to minimize the possibility of these funds becoming commingled. 

Setting up a separate foundation enables schools to create an additional layer of segregation while also providing for improved oversight of the endowment itself. A foundation is a separate legal entity that both supports the school and is supported by the school. The school maintains a direct line of supervision and responsibility over the foundation. There is often significant overlap between the boards of the foundation and that of the school. 

This approach enables schools to appoint board members to the foundation who are well-qualified to manage the assets of the endowment. The board of the school manages operational, administrative, and educational matters, while the board of the foundation focuses solely on managing the endowment. 

Key personnel, such as the head of the school, typically sit on both boards. There is often a 50% overlap between the two boards. This ensures the board of the foundation acts consistently with the goals of the school but also enjoys the bandwidth and expertise to more actively manage the school’s endowment. 

Potential Drawbacks of Setting Up a Separate Foundation to Manage Your School’s Endowment

With the right approach, many of the potential downsides of establishing a separate foundation to manage a school’s endowment can be avoided. Schools should partner with qualified legal counsel and accounting professionals to ensure the foundation is set up as a supporting organization, not as a controlled organization. If the foundation were to be considered a controlled organization by the IRS, there may be tax implications when distributions are made from the endowment.

Securing the services of qualified advisors also fosters the creation of an infrastructure that ensures sufficient alignment between the board of the foundation and the board of the school. The two boards must maintain a close relationship and work together to ensure the endowment is used to support the strategic aims of the school. Regular communication ensures funds are always available when the school requires access to them. 

Establishing a foundation to manage a school’s endowment does incur some additional compliance costs, which we’ll detail in the next section. For schools with small endowments of a few million dollars or less, setting up a separate foundation is rarely recommended. 

How to Set Up a Separate Foundation to Manage Your School’s Endowment

To structure the foundation appropriately, schools should work with experienced attorneys and nonprofit tax professionals. An attorney will help craft the Articles of Association and bylaws of this new entity and advise on the optimal structure of the organization. 

To secure tax-exempt status, the foundation must file Form 1023. If the school is transferring a considerable amount of assets into the new foundation, this can be a relatively complex filing and should not be completed without the support of experienced accounting professionals. The foundation will be designated as a Section 509(a) Supporting Organization

Once the foundation has been established, ongoing compliance requirements are relatively straightforward. From a Generally Accepted Accounting Principles (GAAP) perspective, the financial performance of the school and the foundation are reported together. The school’s audited financial statements will not materially change, save for a clearer bifurcation of school activities and foundation activities. 

Foundations do have an annual tax filing requirement, although this is a relatively simple filing. Foundations typically do not have much activity to report outside of investment earnings and distributions made to the school. A nonprofit tax firm can assist organizations with these filings. 

Smith + Howard: Trusted Advisors to Independent Schools

The decision to set up a foundation to manage a school’s endowment can be one that allows schools to operate far more effectively. A foundation provides legal protection for the school’s assets while also enabling the boards of both the school and the foundation to focus on their primary objectives. 

At Smith + Howard, we’re proud to have a long track record of advising independent schools throughout the nation. Our dedicated professionals are available to provide strategic guidance on the best approach for your school and are equipped to manage all setup and annual compliance requirements for foundations.

With connections to a range of respected attorneys in this field, our professionals have the network to help school leaders access comprehensive solutions that help them work toward securing a better future for their students. 

To learn more about Smith + Howard’s services for independent schools, contact an advisor today

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