Strategic Source Online

July 2004

Alert: U.S. Senate Finance Committee Opens Inquiry into Non-Profit Abuses

The U.S. Senate Finance Committee has begun an inquiry into possible abuses in the non-profit industry, including public charities and foundations.  The Committee, under Senator Grassley (R-IA), will be examining governance issues and ways to improve regulatory oversight, focusing on internal accountability, transparency, self-governance, and best practices. They are paying particular attention to compensation and administration expenses. We should expect changes in the tax reporting forms 990 and 990-PF, closer federal and state information sharing; penalties for nonprofits participating in tax-shelters; and increased pressure for self-regulation, accreditation programs, and education about best practices.  Message here – foundations should be cautious and careful in their conduct, or much tighter regulation will follow.

Council on Foundations: Legislative Network Alert

Philanthropy Update: Contributions Up in 2003

Philanthropic contributions rose 0.6% in 2003, after inflation is taking into consideration, for a total of $240.7 billion. This news is encouraging and is another indicator of a strengthening economy. The contributions are derived from individuals (83.5%, of which 74.5% comes from living individuals and 9% from estates), 10.9% from foundations, and 5.6% from corporations. Individual giving went up by 0.2%, but foundation grants actually dropped 4.7%, reflecting the drop in the value of foundation assets in 2002. It’s expected that foundation grants will go up in 2004, as a result of strong investment performance reported by foundation’s in 2003. Reported in Giving USA, a publication of American Association of Fundraising Council (AAFRC) Trust for Philanthropy, June 2004.

AAFRC: Giving USA 2004

New Regulations: IRS Issues Notice 2004-35 & 36

The IRS is proposing new regulations that will provide that a private foundation’s net investment income for Internal Revenue Code Section 4940 purposes does not include distributions from trusts and estates. This means that a distribution from a decedent’s estate, or a charitable remainder or charitable lead trust will not be treated as income to the foundation, and thus won’t be subject to the 2% excise tax. There is currently different treatment of distributions from some trusts than for others. To eliminate this, the IRS issued Notice 2004-35 indicating that the new regulations will treat all distributions as additions to principal, rather than income. This will avoid the excise tax that might have been charged. A similar notice was issued that affects distributions from split interest trusts for purposes of Section 4942, Notice 2004-36. This follows a case in the Tax Court which held the current regulation was invalid. If a foundation has previously paid tax on these distributions, and the statute of limitations has not expired, it should promptly file for a refund.

Planned Giving Design Center: IRS Seeks Modification of Rules on Distributions to Private Foundations

Legislative Update: Assets of Foundations Must be Managed in Accordance with State Law

In most states, the law that applies to foundations organized as a corporation (rather than as a trust) is known as the Uniform Management of Institutional Funds Act or "UMIFA." First promulgated in 1972, UMIFA has been adopted in whole or in part by all states except Alaska, Pennsylvania and South Dakota. For several years, the National Commissioners on Uniform State Laws have been considering changes in UMIFA. The Commissioners have just announced their recommendations, which will now be submitted to state legislators for their action. Several of the changes in the proposed law apply primarily to public charities. But there are a few important changes that will apply to foundations. First, the new law would apply to foundations organized as trusts, as well as to corporations. Second, the standard of care that applies to the board and investment committees will change from a duty to manage with "ordinary business care and prudence" to "manage and invest the institutional fund in good faith, with the care that an ordinarily prudent person in a like position would exercise under similar circumstances."

This section adopts the prudence standard for investment decision making and directs directors, trustees or others responsible for managing and investing the funds of an institution to act as a prudent investor would, using a portfolio approach in making investments and considering the risk and return objectives of the fund. The section lists the factors that commonly bear on decisions in fiduciary investing and incorporates the duty to diversify investments absent a conclusion that special circumstances make a decision not to diversify reasonable. Thus, the section follows modern portfolio theory for investment decision making. Section 3 applies to all funds held by an institution, regardless of whether the institution obtained the funds by gift or otherwise and regardless of whether or not the funds are restricted.

While the change in language may seem more semantic than practical, it actually adopts a relatively modern view of fiduciary duty. Even though the proposed statute has not yet been enacted in any state, trustees and directors would be well advised to review the foundation’s current investment policy and begin to adapt to this new standard.

IFF Advisors: Contact us for more information on starting or running your foundation

Reminder: Self-Dealing

Distributions from your foundation to a charity in exchange for a table at the charity's black tie gala event is self-dealing. There are some exceptions, but be sure you have legal counsel advise you before attending.

California Tax Education Council (CTEC): Self-Dealing Policy

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