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Strategic
Source Online
Q1 (January - March) 2006
In this Issue
Legislative Update
Senator Grassley and the Senate Finance Committee are continuing their efforts to curb perceived tax abuses in the charitable field. The most recent statement by the Chairman indicates that he will be introducing legislation that will include:
- Restricting the use of donor-advised funds. There are several features of this proposal.
- The first feature would eliminate any tax deduction for a contribution to a DAF intended to benefit a supporting organization. The theory here is that the donor is keeping too much control over the DAF and then the supporting organization to merit a charitable deduction.
- The second feature provides that if, at the end of the taxable year, the donor advised fund (“DAF”) holds illiquid assets that equal more than 10% of the total value of the assets in the account, the DAF must distribute at least 5% of the value of the DAF assets within 12 months. Further, if the DAF invests in illiquid assets (like a closely held business), such assets will be valued at the sum of the purchase price and an assumed annual rate of return of 5%. This reflects a concern about a charity accepting illiquid gifts that produce little or no return.
- The third feature would prohibit distributions from a DAF to individuals and certain organizations, including supporting organizations. This will be a serious problem to university and hospital foundations, which are structured as supporting organizations for their operating entities. This is intended to eliminate the problems related to distributions that provided personal benefits to the donors, but it would also eliminate the ability for a DAF to fund scholarships to unrelated parties.
- Improved accountability of supporting organizations. There are several features of this proposal as well.
- The first would prohibit all supporting organizations from making grants, loans, or compensation to a substantial contributor of the supporting organization.
- The second would require more reporting and disclosure to the IRS of the activities of the supporting organization. The organization will have to certify that a majority of its board consists of individuals with special knowledge or expertise in the field in which the supporting organization is operating, or represents the supported charity, and who have no family, personal, or business relationship with the donor or other disqualified parties.
- The third would apply the excess business holdings rule to a supporting organization (limiting ownership to under 20% in any business entity which is also owned by the donor or disqualified party, after aggregating all the interests of those parties). This is obviously intended to avoid the ability of donors to control their businesses through the foundation, without the risk of a takeover by others or tax on sale.
- Finally, the proposal would prohibit Type III supporting organizations from being used to support non-U.S. charities or making contributions from a donor advised fund. Though we doubt this was intended, such a restriction would affect foreign universities (such as Cambridge University) and other major non-U.S. charities from creating a “Friends of Cambridge”, in order to raise money in the U.S.
- Increased excise taxes on private foundations
- Under this proposal, the excise tax imposed for self-dealing, including payment of excess compensation to a foundation officer, would be increased from 5% to 25%, though some may be subject to abatement if the foundation can demonstrate good cause.
- The amount of the tax would also be increased for failure to distribute the required income, excess business holdings, jeopardizing investments, and taxable expenditures. In other words, mistakes will cost a lot more.
- Expand the base of the tax on a private foundation’s net investment income
- The excise tax is imposed on the foundation’s net investment income. The definition of net investment income would be expanded to include other types of transactions that are not currently included. The federal courts have imposed limits on the IRS in this area that the proposal seeks to reverse.
In addition, the Chairman proposes changes in the following areas:
- Charitable deduction for non-itemizers
- Public disclosure of information regarding unrelated business income
- Involvement of charitable organizations in tax-shelter transactions
We’ll continue to keep you posted on developments.
Planning Idea
What should a foundation consider in evaluating a prospective grantee?
As foundations begin to focus their grant making to achieve the maximum impact with the resources available, it becomes clear that there are many more opportunities to give than there are funds with which to make such gifts. How does a foundation differentiate amongst the alternatives? What are the factors that will help you identify the potential good grant from a bad one, or between a good organization and a much better organization? There are many such factors, but we like to break them into three major categories – the project, the organization’s financial condition, and its governance and leadership. We believe these are the critical components that will best define your alternatives.
- Breakdown of the budgeted expenses. Is there too much overhead? Are the expenses relevant to the project goals? Second, the ratio of funds not pledged to the overall budget. Too much un-pledged funds may jeopardize the success of the project if the total funding is below the required minimum.
- Organization’s financial picture. What is the overhead versus total revenues? What are the program related expenses versus the organization’s total expenses? These help determine the cost efficiency of the organization and can be compared to industry benchmarks. We look also at funding costs versus related revenues to determine the efficiency with which funds are raised. This, too, can be compared industry benchmarks.
- Governance and leadership. It’s as true in the non-profit world as it is in the for-profit world. Good management means good stewardship of the resources. We look at the composition of the Board. How many directors are there? What is their background and experience? How much time do they spend on governance? Do they contribute financially to the organization? Who are the senior officers and staff and what is their background and experience? How are they compensated? Evaluated? What is the turnover and what causes the turnover? Many of these and other features can be compared to industry averages and norms and used to rate the organizations against their peers.
There are, of course, other factors to be considered and you should consult the few independent rating organizations to see if the prospective grantee has been formally reviewed by them.
Next quarter, we will look at the flip side of these questions. Just how does your foundation look to the grantee? How does your foundation compare to its peers? Is your foundation exercising best practices? Is it minimizing its overhead and maximizing its charitable resources? We’ll take a look at how you might assess your own or your client’s foundation’s activities and operations.
 American Institute of Philanthropy: Charity Watchdog
BBB Wise Giving Alliance: Give.org
Charity Navigator: Charity Search
GuideStar.org: Charity Check
Internal Revenue Service: Search for Charities
Litigation Update
Family Of Donor Sues Charity For Violating The Intent Of The Gift
What do you do if you feel the charity has failed to live up to its obligations and commitments? The family of the late Charles and Marie Robertson, who established the Robertson Foundation in 1961, as a supporting organization to Princeton University, decided to sue the University, alleging that it had not spent the distributions from the foundation for the purposes intended by the donors. The Roberstons funded the foundation with $35 million. Over the years, the corpus had grown to more than $650 million. The foundation was created as a supporting organization to provide Princeton with income to prepare graduate students at the Woodrow Wilson School of Public and International Affairs for government careers in diplomacy. A supporting organization is typically structured with a majority of the board appointed by the supported charity, and a minority representing the donors. The donors apparently created this arrangement because they feared that an outright gift to the University might be diverted for other purposes.
The family argues that very few of the graduates are pursuing a career in government and the distributions are not being applied as intended. The University maintains that, while the primary purpose was to support graduates who were seeking a career in government, it was not exclusively for such a purpose and the distributions from the foundation could be used for other, but presumably related, purposes. The family has asked the court to remove Princeton from participating in the governance of the foundation.
This problem – a perceived or actual disconnect between the intent of the donor and the use to which the charity puts the funds – is a serious dilemma for both donors (including foundations) and charities. Sometimes the problem comes from lack of clarity by the donor; sometimes its due to the failure by the charity to really understand the underlying objectives of the donor; and sometimes it’s the result of changes in circumstances that make it impossible to meet the original goals.
According to a recent survey by the Zogby International polling firm, 97% of Americans believe that charities using contributions for unauthorized purposes would be a “serious” problem. Approximately 60% of those polled indicated that they believed a charity should return the contribution if the organization intentionally failed to spend the funds as intended by the donor. We’ve discussed this problem before (see The Barnes Foundation, Strategic Source Online, April 2005).
The 4th Circuit Court of Appeals in California has just ruled (L.B. Research and Education Foundation vs. UCLA Foundation, 130 Cal.App.4th 171 (June 14, 2005) that private individuals, not just the Attorney General, have standing to enforce the intent of the donor. This reverses a long standing assumption that only the AG has the power to sue a charity for breaching the donor’s intent. This will certainly increase the pressure on charity’s and likely the level of litigation.
There are some clear steps to take to minimize the risks of unintended or intended misuse of contributions.
- Direct gifts and grants to a charity should be accompanied by a written agreement that specifies the purpose of the gift and how the funds may or shall be applied;
- There should be provisions for how the funds are to be used if the original intent of the donor is impractical or impossible to fulfill (such as the inability to attract the type of student or faculty who were to receive the benefit from the gift, or the closure of the particular department or school or program);
- Who has the authority to make the decision to change the use of the funds;
- What responsibility the charity has to report to the donor or foundation on the annual use of the funds and any proposed changes in such use; and
- How disagreements are to be resolved without resort to litigation.
Donors have the right to expect their contributions to be used as they intended, but charities must be able to respond to changes in circumstances, whether unforeseen or not. By anticipating these possibilities, donors and charities can structure their relationship that will endure through the generations.
 Contact us for more information.
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