JEWISH COMMUNITY FOUNDATION
PROFESSIONAL SEMINAR SERIES
FAMILY PRIVATE FOUNDATIONS,
SUPPORTING ORGANIZATIONS AND
DONOR ADVISED FUNDS
Thursday, November 6, 2003
12:00 – 2:00 p.m.
The Westin La Paloma
Philip T. Temple, Esq.
McCarthy, Fingar, Donovan, Drazen & Smith, LLP
White Plains, New York
I. There is a great American tradition of philanthropic giving. And charitable organizations greatly contribute to their communities and individuals over a broad variety of causes - - medical and scientific research, education, religion, the arts, the elderly, the needy.
II. Giving alternatives.
A. Outright gifts to qualified charities.
B. Split-interest trusts:
(1) Charitable remainder unitrusts.
(2) Charitable remainder annuity trusts.
(3) Charitable lead unitrusts.
(4) Charitable lead annuity trusts.
C. Other life income arrangements.
(1) Pooled income funds maintained by charity.
(2) Charitable gift annuities.
III. Types of charities.
A. Public charities. IRC §170(b)(1)(A)
(1) Traditional public charities such as churches, schools, hospitals, or organizations receiving a significant portion of their support from the public.
(2) Community foundations - - such as the New York Community Trust.
(3) Donor advised funds that are part of community foundations and other charities.
B. Private foundations.
(1) An organization exempt from taxation under IRC §501(c)(3) that is not a public charity or a supporting organization. IRC §509. Three general features:
(a) Single major source of funding.
(c) Pays expenses and makes grants from income.
(2) Operating foundation. Defined in IRC §4942(j)(3).
(a) An operating foundation uses its funds in its own operations; example, a small museum.
(b) Tests to qualify:
(i) Must distribute 85% or more of its adjusted net income each year for qualified charitable purposes.
(ii) Must meet one of three tests:
(A) 65% or more of its assets must be devoted to active conduct of exempt purpose;
(B) Makes qualifying distributions of at least two-thirds of its minimum investment return to be used directly for the active conduct of its exempt purpose; or
(C) Substantially all of its support, other than investment income, must come from five or more unrelated exempt organizations and not more than 25% of its support from one or more such organizations and not more than one-half of its support from gross investment income.
(2) Conduit foundation. IRC §170(h)(1)(E)(ii).
(a) Pays out all of its contributions within two and one-half months after the year in which received plus all of its income.
(b) Close monitoring required to assure that those strict distribution requirements are met.
(3) Advantage of classification as an operating foundation or a conduit foundation is that the more stringent deductibility ceilings for income tax purposes are not applicable.
(4) Non-Operating Foundation - - the classic type of grant-making foundation.
IV. Tax consequences to donor.
A. Income tax charitable contribution deduction.
(1) Gifts of cash or ordinary income property are deductible up to a ceiling of 50% of a donor’s contribution base (essentially adjusted gross income) which is the rule for gifts to public charities, operating foundations, conduit foundations and supporting organizations but only up to 30% of adjusted gross income for gifts to private foundations.
(2) Gifts of long-term capital gain property, while generally deductible up to 30% of adjusted gross income, are limited to 20% of adjusted gross income for gifts to private foundations.
(3) A further limitation: gifts of long-term capital gain property to a public charity are ordinarily deductible at fair market value. Gifts to a private foundation - - except for gifts of “qualified appreciated stock” (“stock for which market quotations are readily available on an established securities market) - - deductible only for the donor’s cost basis. See IRC §170 (e)(5).
(4) In all cases, contributions which may not be deductible are carried over for five additional years up to the appropriate ceiling until exhausted.
B. Gift tax and estate tax. No difference from the deduction allowed for gifts to public charities. Gifts to private foundations are also eligible for the unlimited charitable deduction.
V. The family private foundation.
A. Reasons and benefits for creating.
(1) Before establishing, individual should consider:
(a) Overall estate planning objectives
(b) Extent to which a charitable giving program fits those objectives and
(c) Consequences to the family.
(2) Help cure “affluenza.”
(a) Builds self-esteem.
(b) Reaching personal aspirations.
(c) Gives meaningful role in community.
(3) The private foundation may help define charitable priorities and help target worthwhile organizations.
(4) Creating a private foundation transforms the donor from a “passive” supporter of charity to a force himself in a particular charitable field or fields. Often, charities interpret establishment of private foundation as a long-term commitment to the charitable community in a way that is difficult for an individual donor to create.
B. Potential downsides.
(1) Family tensions. While the private foundation involving members of the family can have a positive impact on teaching family members philanthropy and thereby increasing their involvement, sometimes family tensions and disputes can override those beneficial aspects.
(2) Expense of creating and of obtaining recognition of tax-exempt status.
(3) Maintaining good books of account and filing the annual information return (Form 990PF) which must also be open for public inspection.
(4) State registration and reporting requirements.
(a) Annual report to Charities Bureau, Attorney General’s Office in New York
(b) $250 annual fee.
(5) Private foundation excise taxes.
(a) Tax on net investment income - - IRC §4940.
(i) Generally 2%
(ii) Can reduce to 1% under certain circumstances
(iii) Must pay that tax on an estimated basis quarterly
(b) Tax on acts of self-dealing - - IRC §4941
(i) A variety of financial transactions between the foundation and disqualified persons are prohibited.
(ii) The prohibition is absolute and has nothing to do with fair market value or other elements of fairness.
(iii) However, exception for personal services.
(c) Tax on failure to make minimum distributions - - IRC §4942
(i) Foundation must distribute greater of 5% of its investment assets and its actual net investment income.
(ii) Under certain circumstances, Foundation can treat amounts set aside for a specified charitable project as having been distributed even though actual payment is not made until later year.
(iii) Advance IRS approval of the project is required.
(d) Tax on excess business holdings. Designed to restrict Foundation involvement in the ownership and operation of closely held businesses. IRC §4943
(i) Five year “safe harbor” period.
(ii) Stock redemptions.
(e) Tax on jeopardizing investments - - IRC §4944
(f) Tax on expenditures for non-charitable purposes - - IRC §4945
(g) Potential tax on termination of foundation - - although under existing rules, can often avoid that tax - - IRC §507
C. How much to give?
(1) Define your goals
(2) Define the cash needs to meet those goals.
D. The process
(1) Determine organizational structure
(a) Not-for-profit corporation
(c) Suggest creating corporation. Terms of trust instrument or state law may limit powers and ability to govern a not-for-profit organization. Because trust must be irrevocable, its terms cannot be modified except in rare circumstances.
(d) Using not-for-profit corporation provides greater flexibility because Certificate of Incorporation and by-laws may be easily amended as circumstances change.
(e) Additional flexibility may be built into corporate structure by use of multiple classes of members and directors (for example, voting and non-voting) and through using committees to which various functions can be delegated.
(f) Also can minimize the liability of the foundation managers.
E. Getting started.
(1) Selecting initial board members.
(2) Retain qualified counsel.
(3) Begin long range planning.
(4) In larger foundations, consider staffing.
F. Obtain recognition of tax exempt status from IRS. Form 1023.
G. Record keeping.
(1) Retain competent accountants.
(2) Establish accounting and record keeping system.
(3) Retain qualified investment counsel.
H. Strategic business plan.
(1) Prepare mission statement.
(2) Identify goals and objectives.
(3) Decide on initial annual budget of grant making.
I. Grant making policies and guidelines.
(1) Establish and adopt them. Pay particular attention to the foundation’s intended purposes - - adopt policies that will be consistent and will help foundation management in carrying out those purposes.
(2) Factors to consider:
(a) Determine whether to support specific project or furnish general support or a combination thereof.
(b) Decide whether there are minimum grants levels that the foundation should make.
(c) Determine whether to have a policy on matching grants.
(d) Set up system for evaluation of grants. Make certain there is sufficient help to properly do so.
(e) If the foundation makes grants to other private foundations or individual scholarships are contemplated, create policy regarding the monitoring of such grants so that the foundation properly exercises its obligation of “expenditure responsibility.”
(f) Determine whether to provide a form of application to be used by organizations seeking grants.
(g) Consider whether or not the foundation is to play an active, as opposed to a passive, role with the organizations that are being supported.
(h) Decide whether to search for grant seeking organizations or simply to just wait for applications.
J. Getting help. The Association of Small Foundations (Website: www.smallfoundations.org) is oriented to help small foundations and has a wealth of information to assist the novice.
VI. Supporting organizations - - one alternative to private foundation.
A. A separate legal entity that can be established as either a corporation or trust and is deemed a public charity under IRC 509(a)(3).
B. Usually an organization funded or endowed by an individual or family.
C. Advantages of a supporting organization.
(1) Contributions can be deducted to maximum ceilings - -unlike private foundation contributions.
(2) Supporting organizations are not subject to the above described private foundation excise taxes.
(3) Gifts of appreciated long-term capital gain property are deductible at fair market value.
D. Types of supporting organizations. To qualify as a supporting organization, one of three types of relationships must exist. IRC §509(a)(3)
(1) The supporting organization is “operated, supervised, or controlled by” the publicly supported organization. Akin to a parent-subsidiary relationship.
(a) The supported organization’s board members must elect or appoint a majority of the supporting organization’s board.
(b) Not an attractive alternative for a donor family that wants to control the supporting organization.
(2) The supporting organization is “supervised or controlled in connection with” the supported organization.
(a) This has sometimes been described as the supporting organization having a “brother-sister” relationship with the supported organization.
(b) The supported organization’s board members would serve on the board of the supporting organization.
(c) Again, not the most attractive type of organization for a family that wants to control its own supporting organization.
(3) The supporting organization would be “operated in connection with” the supported organization.
(a) For example, the supporting organization’s board could have five members which could consist of the founder, the founder’s spouse and three independent individuals who must be in a position of control over the supporting organization.
(b) This can be attractive because the family can at least select the independent individual board members. Therefore, there is somewhat more autonomy.
(4) In all three types, the following four tests be made:
(a) The control test - - the supporting organization cannot be controlled, directly or indirectly by one or more disqualified persons. Okay as long as disqualified persons have less than 50% of voting power of board.
(b) The relationship test that applies to the third type of supporting organization. Two relationship tests must be met:
(i) The responsiveness test.
(ii) An attentiveness test also known as an integral part test.
(c) The organizational test.
(i) The supporting organization governing instrument must limit the organization’s purposes to one or more purposes set forth in IRC §509(a)(3).
(ii) The instrument must not expressly empower the organization to engage in activities not in the furtherance of those charitable purposes.
(iii) The instrument must designate “specified” supported public charity or charities.
(iv) The instrument must not allow the organization to operate and support or benefit organizations other than the specifically supported charity or charities.
(d) Operational test. The supporting organization must demonstrate that it actually supports or benefits the supported organization or a member of a charitable class benefited by the supported organization. The organization must carry out permissible activities, including
(i) Making payments to, or providing services or facilities for, individuals or are members of the charitable class benefited by the supported organization.
(ii) Supporting or benefiting another public charity that is operated, supervised or controlled directly by or in connection with the supported organization.
(iii) Using its income to conduct independent activities or programs that benefit the supported organization.
(iv) Engage in fundraising or the solicitation activities on behalf of the supported organization.
E. When all else is said, a supporting organization still doesn’t give the donor and the family the same control as a private foundation does.
VII. The Donor Advised Fund - - another alternative.
A. A fund established by a public charity where advice or recommendations regarding distributions are made by the donor contributing to the fund or members of the donor’s family.
(1) Gifts to such funds qualify for maximum deductibility.
(2) The private foundation excise taxes do not apply.
B. The fund must be operated as a “component fund” of the public charity. See Reg. §1.170A-9(e)(11)(ii)(B) regarding Community Trusts.
(a) Regulations contain guidelines for determining whether a donor advised fund is a “component part” of the public charity.
(b) While the donor and/or others the donor designates may make recommendations regarding distributions, the public charity must have ultimate control over those decisions.
C. The commercial donor advised funds - - Fidelity, Vanguard, etc.
(1) Areas of concern:
(a) Lack of guidance - - what are the permissible bounds
for donor involvement
(b) Lack of IRS enforcement due to limited resources
(c) IRS perception that there are wide-spread abuses.
(2) The Vanguard Principles.
(3) Where are we heading?