Tax Benefits of Foundations: What's Behind the Tax-Saving Myth?

Foundations and taxes somehow go hand in hand. But instead of the actual tax benefits or state subsidies, which apply almost exclusively to charitable foundations, foundations often stand for a shady tax-saving model, which is used in particular by the super-rich. What is the truth behind the myth of the "foundation tax-saving model"? This blog article deals with the topic of taxes and tax burden as well as the question of to what extent different foundations are actually able to reduce them.

📚 Contents

1. Tax benefits for charitable foundations

2. Are there loopholes in non-profit law?

3. Tax benefits for private foundations

4. Tax avoidance through complex legal structures and foreign foundations

5. Does the foundation have a terminology problem?

6. Conclusion

Foundations and Tax Benefits

First, let's look at the definition of a foundation again, as it is of great importance in this context. A foundation is an asset (often monetary assets, but real estate and other valuables can also be meant) that the founder permanently and irrevocably dedicates to a specific purpose, giving it its own legal form. A distinction is made between family/private foundations, i.e. normally taxable foundations (which are often used to keep company shares together over generations of heirs), and charitable, i.e. tax-privileged foundations. The latter pursue one or more of the social purposes of the German Tax Code.

Tax benefits for charitable foundations

In principle, the state wants to encourage people to donate and offers tax incentives for private engagement - e.g. for charitable foundations or direct donations to NGOs.

Income tax

For donations to charitable organizations, up to 20 percent of total income can be deducted from tax each year. This means that you receive the corresponding amount back in your income tax return. For example, if you have a tax rate of 40 percent and donate 100 euros, you get 40 euros back. The state therefore subsidizes your donation in the amount of your tax rate.

Even if you donate more than 20 percent of your taxable income in one year, you can carry forward the excess amount to subsequent years and thus use the tax benefit over several years. In this context, it can make sense to set an annual donation goal in order to optimize the tax benefit and only decide later where the money should go. Learn more about donating and saving taxes.

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This applies to all charitable organizations in Germany, but also to organizations abroad that would be recognized as charitable under German law. Would you like to donate to an organization abroad and be one hundred percent sure that you will get your tax back? Then your best option is to donate via a foundation based in Germany, such as bcause. Learn more here: supporting organizations abroad.

Inheritance and gift tax

When transferring assets to a charitable foundation, reduced or even waived inheritance and gift tax rates may apply. In this way, assets can be transferred to charitable purposes without incurring heavy tax burdens.

In addition, there is an additional tax advantage for contributions to the so-called endowment capital of a foundation under civil law. This amounts to up to one million euros per person (up to two million euros for married couples) and is independent of income. This amount can also be transferred.

The deduction can be structured flexibly: In high-income years, a larger part of the amount can be used to significantly reduce taxable income and benefit from a lower tax rate.

However, this advantage must be weighed against the restriction of not being able to use up this capital or expose it to investment risk - for societal challenges of high urgency, this means that only a small fraction of the capital can be used each year.

Tax deferral for endowments

Endowments into an existing foundation are tax-privileged in the same way as placing assets into a new foundation. This can make it possible to bring assets into the foundation during one's lifetime or as part of estate planning. 

The question arises to what extent these tax advantages can be used for personal motives.

Can loopholes in non-profit law be exploited?

Of course, loopholes in existing tax or non-profit law are not infrequently sought after to exploit the non-profit status and the associated tax benefits for one's own advantage. But the rule here is: any attempts have been and will be penalized by the responsible authorities and courts. In a ruling from 2021, the attempt to obtain a personal benefit through a charitable foundation was classified as a hidden distribution of profits (vGA).

A vGA actually occurs when a company, or in rarer cases also foundations, grants benefits to its own shareholders that do not correspond to ordinary business transactions and are not openly distributed as profit. The ruling of the Federal Fiscal Court concerned a married couple who were shareholders of a GmbH and at the same time founders of a charitable foundation. The tax office and the fiscal court saw the contributions as hidden distributions of profits because the GmbH did not act selflessly, but rather supported the private art collection of the married couple.

Charitable status in Germany is closely monitored by the tax office. An audit takes place every year, and every three years an organization (foundations, associations, or even companies) must reapply for charitable status. To maintain charitable status, the organization must present proper accounting and prove that all funds were used in accordance with the articles of association. Charitable status can also be revoked retroactively, which can lead to back taxes. No surpluses may be generated that have not been allocated to reserves in accordance with the articles of association.

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What charitable foundations can do, however, is distribute one third of their income to the founder and their close relatives without losing their status with the tax office.

A systematic abuse of charitable foundations to exploit tax benefits for individuals, families, or companies can therefore be virtually ruled out. What is more problematic are tax law aspects, such as when charitable foundations are integrated into structures with private foundations. Some lawyers have even specialized in developing solutions where assets are transferred to charitable foundations to avoid taxes, while control over the assets or voting rights of the company remains with a private foundation. This leads us to the next point.

Tax benefits of private foundations and foundation structures abroad

Private foundations, such as family or corporate foundations, are taxed normally unlike charitable foundations. 

They are generally subject to corporate and trade tax, and asset transfers can be subject to inheritance or gift tax. Nevertheless, they offer options for tax structuring, for example to secure assets within the family over the long term. Foundations can help optimize the tax burden across generations by binding assets and distributing the income to the family instead of inheriting them "directly".

The example of the family foundation

We spoke with Alexander Vielwerth, expert in association and non-profit law at Vielwerth-Junginger, about the case of the family foundation. Drawing on an article in the Handelsblatt, he explains how family foundations can be used in their structure and function to save tax liquidity.

Family foundations are often misunderstood, especially when it comes to the supposed benefit of tax savings. In fact, family foundations are not a suitable instrument for avoiding taxes. Taxes cannot be "saved" directly. Rather, it is about the concept of tax liquidity. This means that a family foundation allows assets to first be built up and retained within the foundation. Profits that arise, for example, from real estate or company shares brought in, remain in the foundation and can initially be reinvested. This makes more liquidity available, which in turn can be used for investments in various asset classes. This additional liquidity enables the foundation to generate further profits, which also remain in the foundation and do not have to be taxed immediately.

Crucially, however, as soon as the money is distributed from the foundation to the beneficiaries, regular taxation takes place. This is usually done at the flat-rate withholding tax of 25%, meaning the tax liability is not avoided, but only deferred. 

In its basic function, however, the foundation remains primarily an instrument for long-term asset protection and allocation, and not a tax-saving model.

But the truth also includes: Private foundations are not infrequently used to protect assets from the reach of the state or other parties through complex legal structures. Such designs often involve nested corporate networks, holding companies, or trust solutions that make it difficult to identify the actual owner of the assets. This can not only reduce inheritance or wealth taxes but also bypass disclosure requirements. These strategies are usually legal but morally controversial, as they aim to remove wealth from public scrutiny. It becomes particularly problematic when assets remain hidden in such foundations while influence and power of disposal indirectly remain with the actual owners. Courts in Germany and the EU have tried in various cases to take action against abusive foundation models when a clear tax avoidance purpose could be proven. The ruling of the Federal Fiscal Court (BFH) on hidden profit distribution shows that the state is trying to break through such structures if they only serve to avoid taxes.

Panama, Seychelles, and Switzerland: Foreign foundations and tax avoidance 

Especially when the legal structures described above also include foundations abroad, the principle is pushed to the extreme. In countries like Panama, the Seychelles, or Switzerland, which are known for their offshore services, so-called tax havens offer the opportunity to conceal assets and avoid tax and legal obligations. These countries lure with extremely low or even non-existent tax rates, a high degree of anonymity for the founders, and minimal regulatory requirements, making them ideal for individuals and companies wishing to hide assets from authorities. Complex networks of shell companies and trust models can be used to disguise the true owner of the assets. This makes it extremely difficult for tax authorities to keep track and enforce tax obligations.

A well-known example of this practice is the Panama Papers leak in 2016, which revealed how politicians, celebrities, and wealthy individuals used offshore structures to avoid taxes or even launder illicit funds. In this context, the names Panama, Seychelles, or even Switzerland keep appearing because these countries make it possible to park assets in opaque foundations while the actual control over the assets remains with the founder.

By exploiting double taxation treaties or loopholes in international tax law, foundations in these countries can be used to shift assets across borders without being noticed by the tax authorities of the home country. This not only makes it harder to track the use of funds but also contributes to global tax injustice.

In recent years, international courts and organizations such as the OECD or the European Court of Justice (ECJ) have increasingly dedicated themselves to the important task of fighting tax evasion and offshore structures. It is encouraging that some countries have already signed agreements on information exchange. However, for many states, the possibility still exists to hide their assets from the grasp of tax authorities. These structures are often legal or operate in a legal gray area. They thus differ from foundations that are aligned with the common good.

In summary, the reason why foundations and taxes are often mentioned in the same breath is that there are different types of foundations, especially charitable and non-charitable foundations, some of which are subject to different rules abroad. Non-charitable foundations are subject to tax in Germany and primarily serve to protect family or corporate assets. These private foundations are often used in complex structures to conceal monetary and physical assets or protect them from access, especially when they are established abroad. This practice is usually legal, but should not be confused with donations to German charitable foundations.

Does the foundation have a terminology problem?

Looking at the different models, it becomes clear that a distinction between private and charitable foundations would be desirable to create more clarity. In English, a clear differentiation is made between trusts (private foundations) and foundations (charitable foundations). In German, however, this unification can certainly cause confusion. Many people initially think of taxes or tax avoidance when they hear the term "Stiftung" (foundation). However, this is only the case for private foundations. Charitable foundations also have a connection to the topic of taxes, which can create the impression that they also use tax loopholes and legal structures to benefit personally.

In Germany, over 90% of foundations are tax-privileged and pursue charitable purposes, such as promoting education, culture, or environmental protection. It is of crucial importance to distinguish between charitable and private foundations. While private foundations distribute profits and can also use their funds for the private benefit of the founders, charitable foundations serve society and are not allowed to distribute profits. Equating them with private foundations, which often aim for asset protection and tax optimization, leads to a distorted image of the foundation landscape in Germany.

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Summary and Conclusion

Yes, there is a close connection between foundations and taxes. However, it is a common misunderstanding that foundations are an instrument or proven model for tax savings. 

Rather, the fundamental ability to receive assets and tie them to a specific purpose is often exploited to conceal the ownership of financial assets and real estate and protect them from external, especially state, access. However, this applies almost exclusively to private foundations. It should be noted that in Germany, over 90% of foundations are tax-privileged and dedicated to charitable purposes such as education and environmental protection. These charitable foundations are subject to strict regulations and controls, meaning that virtually no profits may be distributed for private purposes.

The tax benefits for charitable foundations aim to encourage people to donate and set up foundations. They can deduct up to 20% of their taxable income from tax. In addition, they can benefit from reduced inheritance and gift tax rates when transferring assets to foundations. Abuse of charitable status is rather rare, as it is strictly monitored - also retroactively - by tax authorities. This is shown in a ruling of the Federal Fiscal Court, which penalized hidden profit distributions in a foundation.

In summary, the perception of foundations as tax-saving models is often based on confusion between the different types of foundations, leading to a certain blurring in public perception. Charitable foundations pursue clear, altruistic goals and are subject to strict legal requirements. Even private foundations are not designed for tax avoidance in their basic function, but in practice are sometimes integrated into complex legal structures to hide assets from state access.