Northwest Planned Giving Roundtable Annual Conference

Sunrise View of Portland, Oregon from Pittock Mansion.

The 2016 Northwest Planned Giving Roundtable Annual Conference in Portland, Oregon on September 16 features several notable speakers including NEO Of Counsel Brigit Kavanagh, who will be co-presenting a session on Why Donor Advised Funds and Supporting Organizations are a Gift Planner’s Friend with Wendy Chou, senior philanthropic advisor with The Oregon Community Foundation.

Donor advised funds and supporting organizations are increasingly familiar features in philanthropic planning and represent an opportunity for gift planners to think creatively about ways these vehicles can be mutually beneficial to donors and charities alike. Too often, gift planners view these giving vehicles as competitors to the would-be recipient of a charitable gift. This does not have to be and is not usually the case. This session will give context to these two giving vehicles and familiarize gift planners with them, including why they may be compelling gift options for donors. Using a series of case studies, the presenters will demonstrate how donors are using donor advised funds and supporting organizations to achieve their philanthropic objectives, dispel some myths about these giving vehicles, and discuss ways that how gift planners can work with donors to secure gifts from donor advised funds and supporting organizations.

Development and governance consultant Alan Cantor, a frequent contributor to The Chronicle of Philanthropy, is delivering the opening keynote: Building Assets or Deferring Impact? How Our Infatuation with Charitable Endowments is Hurting the Very People and Causes We’re Trying to Help. Read Cantor’s article on The False Allure of Charitable Endowments here. Cantor’s strong opinions, including on donor-advised funds, should make for provocative discussion at the Conference!

 

Donor-Advised Funds: What You Should Know

woman listening to gossip

Introduction

A donor-advised fund (“DAF”) is a charitable vehicle housed within a 501(c)(3) public charity that allows a donor to make a gift, take an immediate charitable deduction, and recommend, typically with strong persuasive authority, future grants made from funds in the DAF. Unlike private foundations that require a minimum annual distribution, a DAF has no distribution requirements and can allow investment funds within the account to build up for years or even decades. This is one reason why DAFs have come under fire by philanthropists and academics like Lewis B. Cullman and Ray Madoff, who together wrote The Undermining of American Charity published by The New York Review of Books (“Donor-advised funds (or DAFs) give donors all of the tax benefits of charitable giving while imposing no obligation that the money be put to active charitable use.”).

Growth

DAFs are growing ever faster, according to The Nonprofit Quarterly. The 2015 Donor-Advised Fund Report released by the National Philanthropic Trust in November 2015 and cited by The Nonprofit Quarterly provides:

Grants from donor-advised fund accounts to charitable organizations reached a new high at $12.49 billon …. This is a 27.0 percent growth rate compared to a revised total for 2013 grants of $9.83 billion.

 

Contributions to donor-advised fund accounts in 2014 totaled $19.66 billion, also an all-time high. This number surpasses the revised 2013 value of $17.23 billion by $2.4 billion …, an increase of 14.1 percent.

 

Charitable assets under management in all donor-advised fund accounts totaled $70.70 billion in 2014, an all-time high …. The increase in total charitable assets can logically be attributed to the growth in the number of funds (an 8.8 percent increase) and contributions (a 14.1 percent increase).

 

The number of donor-advised fund accounts increased by 8.8 percent in 2014, to 238,293 ….

 

Grant payout rates from donor-advised fund accounts annually exceeded 20 percent for the eighth consecutive year.

 

The 2014 average donor-advised fund account size reached $296,701, which is also an all-time high ….

Definition

A donor-advised fund is defined in the Internal Revenue Code as a fund or account:

  1. which is separately identified by reference to contributions of a donor or donors,
  2. which is owned and controlled by a sponsoring organization, and
  3. with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reason of the donor’s status as a donor.

– IRC Sec. 4966(d)(2)(A)

The first prong of this definition may be met by (1) naming the fund after a donor, or (2) treating a fund on the books of the sponsoring organization as attributable to funds contributed by a specific donor or donors. Contrary to popular myth, giving a fund a generic name (e.g., “The Human Fund” (Seinfeld alert)) doesn’t result in a fund falling out of the DAF definition. The second prong requires ownership and control by a sponsoring organization, which generally includes most domestic public charities. The third prong may be met even if a donor doesn’t have advisory privileges codified in a written agreement so long as the donor has reasonable reason to expect to have advisory privileges with respect to distribution or investment of amounts held in the fund. For more information, see our earlier post What is a Donor Advised Fund?

Exceptions: Even if a fund meets three prongs required of a DAF, it may still be excepted from the definition if:

  1. it make distributions only to a single identified organization or government entity; or
  2. the donor or donor advisor provides advice regarding grants to individuals for travel, study, or other similar purposes, provided that:
    1. the donor’s, or the donor advisor’s, advisory privileges are performed in his capacity as a member of a committee, all the members of which are appointed by the sponsoring organization;
    2. no combination of donors or donor advisors (or related persons) directly or indirectly control the committee; and
    3. all grants are awarded on an objective and nondiscriminatory basis pursuant to a procedure approved in advance by the board of directors of the sponsoring organization that meets the requirements of IRC 4945(g)(1), (2), or (3) (scholarship or fellowship grant to be used for study at a qualifying educational organization; prize or award to recipient selected from the general public; or grant with a purpose to achieve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific, teaching, or other similar capacity, skill, or talent of the grantee; respectively).

Restrictions

No Distributions to Natural Persons

A sponsoring organization and its fund managers (including directors, officers, trustees, and employees having authority or responsibility related to any act or failure to act resulting in the prohibited distribution) may be subject to excise taxes if they engage in “taxable distributions” with respect to the DAF’s grants. A taxable distribution includes any distribution from a DAF to any natural person.

A taxable distribution imposes an excise tax of 20% on the sponsoring organization and 5% (with a $10,000 cap) on any fund manager who knowingly agrees to the distribution.

Unfortunately, the meaning of a “distribution” within the context of this rule has not been clarified by the IRS. A conservative view would suggest that payments to any individuals, even if goods or services of equal value were provided in return, are prohibited as a form of distribution. Under this interpretation, DAFs could only make payments to business entities for goods or services and not to any individuals or sole proprietorships.

Conditional Distributions to Organizations

A taxable distribution also includes any distribution from a DAF to any entity if:

  • the distribution is not for a religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals purpose; or
  • the sponsoring organization does not exercise expenditure responsibility with respect to such distribution.

However, excepted from the definition of a taxable distribution are distributions from a DAF to:

  • any organization described in section 170(b)(1)(A) (which includes most public charities and private operating foundations) other than a disqualified supporting organization (e.g., non-functionally integrated Type III supporting organizations, other supporting organizations controlled directly or indirectly by the donor or any donor advisor),
  • the sponsoring organization of such DAF;
  • any other DAF.

Accordingly, distributions from a DAF to most public charities (other than disqualified supporting organizations and public safety organizations) and private operating foundations will not be taxable distributions.

As noted above, a taxable distribution imposes an excise tax of 20% on the sponsoring organization and 5% (with a $10,000 cap) on any fund manager who knowingly agrees to the distribution.

No Prohibited Benefits to Donors, Donor Advisor, or Related Persons

A donor, donor advisor, or related person* may be subject to a tax penalty if they advise a distribution, or receive, directly or indirectly, more than an “incidental benefit” resulting from a distribution. The penalty tax is 125% of the prohibited benefit, and any prohibited benefit must be returned to the DAF. As an example, a distribution from a DAF to a college for payment of a donor’s child tuition would be a prohibited benefit warranting a penalty tax.

* A related person includes a member of the donor or donor advisor’s family (spouse, ancestors, children, grandchildren, great grandchildren, and the spouses of children, grandchildren, and great grandchildren) and any 35-percent controlled entity (i.e., entity in which the donor and donor advisors own more than 35% of the total combined voting power of a corporation, the profits interest of a partnership, or the beneficial interest of a trust or estate).

Furthermore, any fund manager (e.g., director, officer, or employee having authority or responsibility with respect to the act in question) who knowingly agrees to make a distribution that confers a prohibited benefit faces a 10% tax amount of the benefit amount, not to exceed $10,000 per transaction. Note, though, that taxes for a prohibited benefit will not be imposed if the taxes for an excess benefit transaction are imposed instead on the same transaction.

No Excess Business Holdings

Generally, a DAF and its disqualified persons together may own no more than 20% of the voting stock, profits interest, capital interest, or beneficial interest in a business enterprise. For these purposes, a disqualified person includes the donor, donor advisor, and related persons. The penalty for a violation of the excess business holdings rule is a first-tier tax of 10% of the value of such excess business holdings and a second-tier tax of 200% if the foundation still has excess business holdings at the end of the taxable period. The amount of excess holdings is determined as of the day during the tax year when the foundation’s excess holdings were the greatest.

There are a few exceptions to this general rule, including:

  • Where the DAF (together with certain related DAFs) owns less than 2% of the voting stock and 2% of the value of all outstanding shares of all classes of stock.
  • Where the DAF and disqualified persons with respect to the DAF own up to 35% of the business enterprise but one or more persons who are not disqualified persons have effective control of the business enterprise.

No Excess Benefit Transactions

An excess benefit transaction is defined as any transaction in which an economic benefit is provided by the organization directly or indirectly to or for the use of any disqualified person, and the value of the economic benefit provided exceeds the value of consideration (including the performance of services) received for providing the benefit. For these purposes, a disqualified person is a person in a position to exercise substantial influence over the affairs of the organization at any time during the five-year look back period from the date of the excess benefit transaction, and, with respect to a DAF, includes the donor, donor advisor, and related persons (which also includes for these purposes, the donor’s and donor advisor’s brothers and sisters (whether by the whole or half blood) and their spouses).

If an excess benefit transaction has occurred, the IRS can levy taxes, commonly referred to as intermediate sanctions, on both the disqualified person who received the excess benefit and the organizational manager(s) who knowingly approved the excess benefit transaction:

  • 25% excise tax of the excess benefit on the disqualified person who received the excess benefit; and an additional 200% excise tax of the excess benefit if the violation is not corrected within the taxable period.
  • 10% excise tax of the excess benefit on the organizational manager who knowingly participated in the transaction (maximum of up to $10,000).

Resources

Donor-Advised Fund Guide Sheet Explanation (IRS)

Donor-Advised Funds (Council on Foundations)

Is the Fund a Donor-Advised Fund? (Council on Foundations)

What are the issues with donor-advised funds? (Urban Institute)

Discerning the True Policy Debate over Donor-Advised Funds (Urban Institute)

An Analysis of Charitable Giving and Donor Advised Funds (Congressional Research Service, 2012)

Regulations

Well, we’ve been waiting for regulations on DAFs for almost a decade since a DAF was first defined in the Pension Protection Act of 2006. DAF guidance has been on the IRS priority guidance list for years. The Treasury Department completed and released a study on DAFs in 2011, though it was criticized as “disappointing and non responsive” by Senator Chuck Grassley, Senate Finance chairman at the time of the 2006 legislation, and I can no longer access the report from the link on the IRS site.

You can read comments about prospective regulations from the American Bar Association’s Charitable Planning and Organizations Group of the Section of Real Property, Trust and Estate Law (“RPTE Section”) here and download comments from the RPTE Section in a letter to Treasury dated August 18, 2016 here. My personal view is not to expect proposed regulations before the Presidential election because of the growing controversy with DAFs, whether they should be treated more like private foundations with minimum annual distribution requirements, and how this all fits in with broader tax policies.

Benefits to Donors

  • An immediate income tax deduction
  • Avoidance of capital gains taxes if the gift is appreciated property
  • Reduction of the gross estate by the amount of the excluded asset

Advantages Over Setting Up a Private Foundation:

  • Donations to a donor-advised fund qualify for the more favorable charitable deduction treatment of a gift to a public charity than donations to a private foundation
  • Donor-advised funds are not subject to the self-dealing and payout rules applicable to private foundations
  • Sponsoring organization generally takes care of all the administrative work
  • Typically, low contribution minimums
  • Ease and relative low-cost in establishment
  • Privacy, if donor desires
  • Ability to receive donations from private foundations, charitable remainder trusts, charitable lead trusts

Disadvantages Over Setting Up a Private Foundation:

  • Lack of control over distributions (grant-making)
  • Lack of control over investments
  • Less visibility and prestige than family-named private foundation
  • Lack of flexibility (e.g., grant-making areas)
  • No ability to hire staff (such as the donor and his or her family members)
  • No distributions to individuals

Rules Affecting Donor Advised Funds

rulesAs stated in our earlier post What Is A Donor Advised Fund?, donor advised funds (DAFs) are subject to several private foundation-like rules that sponsoring organizations may not ordinarily be subject to as public charities. These rules are meant to curb abuses and create more transparency within the DAF community. Prohibited actions include providing personal economic benefits to donors and their families, making distributions to individuals, and making distributions for non-charitable purposes. Both donors and sponsoring organizations should be aware of such rules so as to avoid substantial tax penalties and possible revocation of the sponsoring organization’s 501(c)(3) tax exemption.

Excess Benefit Transactions (IRC §4958)

Transactions that produce an excessive economic benefit to “insiders” of a DAF may result in a tax penalty on both the insider and the organization’s managers (generally, directors and officers) who approved the transaction. An excess benefit occurs if the value of the economic benefit provided by the charity directly or indirectly to any disqualified person exceeds the value of the consideration (including the performance of services) received for providing the benefit. With respect to a DAF and its sponsoring organization, disqualified persons include:

  • Donors;
  • Donor advisors;
  • Investment advisors compensated by the sponsoring organization;
  • Family members of a donor, donor advisor, or investment advisor; and
  • 35% controlled entities by any of the described persons above.

If an excess benefit transaction occurs between a DAF and any disqualified person listed above, in addition to the required return of the excess portion, an initial excise tax of 25% of the excess portion may be imposed on the person who received the benefit.  If the excess benefit remains uncorrected within the taxable period, a second-tier tax equal to 200% of the excess benefit is imposed on the disqualified person. In other words, the person who received the benefit must self-correct the transaction sometime between the date of the transaction and the date on which the tax is assessed or a notice of deficiency with respect to the tax is mailed, whichever is earlier. The sponsoring organization’s managers may also be hit with a 10% tax for willfully approving an excess benefit transaction, up to $20,000.

Additionally, certain DAF transactions are treated as automatic excess benefit transactions for the purposes of the penalty. DAFs are prohibited from issuing grants, loans, compensation, or other similar payments to a donor, donor advisor, or related person. In such transactions, the entire payment, not just the excessive portion, is subject to the excise tax.

Prohibited Benefit Tax (IRC §4967)

A donor, donor advisor, or related person may be subject to a tax penalty if they advise a distribution, or receive, directly or indirectly, more than an “incidental benefit” resulting from a distribution. The penalty tax is 125% of the prohibited benefit, and any prohibited benefit must be returned to the DAF. As an example, a distribution from a DAF to a college for payment of a donor’s child tuition would be a prohibited benefit warranting a penalty tax.

Furthermore, any fund manager (e.g., director, officer, or employee having authority or responsibility with respect to the act in question) who knowingly agrees to make a distribution that confers a prohibited benefit faces a 10% tax amount of the benefit amount, not to exceed $10,000 per transaction. Note, though, that taxes for a prohibited benefit will not be imposed if the taxes for an excess benefit transaction are imposed instead on the same transaction.

Taxable Distributions (IRC §4966)

A sponsoring organization, and its fund manager, may be subject to excise taxes if they engage in “taxable distributions” with respect to the DAF’s grants.  A taxable distribution is any distribution from a DAF to:

  • Any natural person;
  • Any entity other than a public charity or certain government entities if the distribution is not for a charitable purpose; or
  • Any foreign organization, disqualified supporting organization (e.g., non-functionally integrated Type III supporting organizations, other supporting organizations controlled directly or indirectly by the donor or any donor-advisor), and most private grantmaking foundations, and foreign organizations without first exercising expenditure responsibility.

A taxable distribution imposes an excise tax of 20% on the sponsoring organization and 5% (with a $10,000 cap) on any fund manager who knowingly agrees to the distribution. Note that the meaning of a “distribution” within the context of this rule has not been clarified by the IRS. Conservatively, this would prohibit payments to any individuals even if goods or services of equal value were provided in return. Under this interpretation, DAFs could only make payments to business entities for goods or services and not to any individuals or sole proprietorships. It appears that the more popular understanding limits the interpretation of distributions to transactions in which value is not being exchanged, such as grants and scholarships.

Excess Business Holdings (IRC §4943)

Lastly, donors and sponsoring organizations must also be aware of excess business holdings rules that are usually applied to private foundations. DAFs must divest any excess business holdings, generally more than 20% of stock of a company, or else be subjected to a 10% penalty, followed by an additional tax if not corrected.

____

Currently, Congress is considering a number of proposals that could affect these DAF excise taxes and potentially require certain distributions.

What Is A Donor Advised Fund?

wispering  business information
Donor advised funds are an increasingly popular mechanism for individuals with charitable objectives who want to make a deductible charitable contribution in one year but make charitable distributions (grants) over a period of years. They are often recommended to such individuals as a preferable alternative to starting a private foundation. In general, a donor advised fund (“DAF”) is an account hosted by a sponsoring 501(c)(3) organization, usually a community foundation or a nonprofit affiliate of a financial services company, that is funded by a donor’s contributions in the form of cash, stock, or other assets. While the donor relinquishes legal control over the donation at the time it’s made, the donor retains advisory privileges as to the distribution of the funds and is generally able to benefit from a tax deduction on the contribution in the year in which it is made. In practical terms, the advice is generally followed by the sponsoring organization so long as grants to the identified grantees would not violate applicable laws or be outside of the sponsoring organization’s exempt purpose or mission.

Definition

Under the Pension Protection Act of 2006, a DAF is defined as a fund or account:

(i) which is separately identified by reference to contributions of a donor or donors,

(ii) which is owned and controlled by a sponsoring organization, and

(iii) with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account

 IRC Section 4966(d)(2)(A).

All three-parts of the above definition must be met in order for the fund or account to be characterized as a DAF. While the IRS has yet to provide regulations interpreting these requirements, the IRS released a Donor-Advised Funds Guide Sheet Explanation in 2008 that is instructive in a determination of whether a certain fund meets the test:

  1. Separately Identified Fund: In order to be a distinct fund or account for the purposes of prong one, the fund or account must refer to contributions of a specific donor or donors. The Guide Sheet provides that a distinct fund or account of a sponsoring organization does not meet this prong of the definition unless the fund or account refers to contributions of a donor or donors, such as (1) by naming the fund after a donor, or (2) by treating a fund on the books of the sponsoring organization as attributable to funds contributed by a specific donor or donors. While we have no authoritative guidance on what would constitute specific donors in this context, we agree with attorney Greg Colvin’s analysis* based on the legislative history that the term refers to related donors (including any member of the donor’s or donor advisor’s family or a 35% controlled entity of the donor or member of the donor’s or donor advisor’s family). Accordingly, if a sponsoring organization has established a restricted fund or account that is funded exclusively by contributions from a single donor or a group of related donors, regardless of the name of the fund, this requirement may be met. If the restricted fund or account is funded by contributions from a group of unrelated donors (which is often a characteristic of a giving circle), this requirement may not be met. Note, however, that that the number of unrelated donors and the relative contribution amounts of the different donors may impact this analysis.
  2. Owned and Controlled by a Sponsoring Organization: To meet the second requirement, the sponsoring organization, which must be a public charity, generally must have legal ownership and control over the assets following the contribution, and the fund or account must not be owned or controlled by the donor or other such person.
  3. Donor Has Advisory Privileges: Lastly, the donor or donor advisor must have, or reasonably expect to have, advisory privileges over the distribution, which may be evidenced in a written document or through the conduct of the donor, donor advisor, and sponsoring organization. Advisory privileges refers to the right of a donor or donor advisor to provide “noncompulsory recommendations, suggestions, or consultative advice” with respect to how the fund is granted out, but should be understood to be distinct from a donor’s legal right to control the donation.

DAFs are subject to several private foundation-like rules that sponsoring organizations may not ordinarily be subject to as public charities. These rules will be addressed in a follow-up post. Additionally, though long overdue, the IRS is expected to issue regulations on DAFs sometime in the near future. Potential areas of uncertainty that could be addressed include whether the IRS will impose a mandatory payout of funds being held in a DAF, similar to the 5% payout requirement applicable to private foundations, and other such private foundation rules that could reasonably capture DAFs.

 

Further Reading:

IRS: Donor-Advised Funds

* Adler & Colvin: Is a Fiscal Sponsorship Maintained for a Project by a Public Charity also a “Donor Advised Fund?”

NEO Law Group’s Video on Tips for Starting a Nonprofit – Alternatives to Forming a Nonprofit

 

Today, NEO Law Group released a new 3 minute video in its series of videos on tips for nonprofits, available on YouTube.  While incorporating a nonprofit and applying for tax exemption may be the right choice in some instances,  there may often be a better way to achieve your charitable goals.  This video focuses on some possible alternatives to formation, including partnering with an existing nonprofit, fiscal sponsorship, and donor-advised funds.  We hope that you enjoy it and please stay tuned for additional videos from NEO Law Group on tips related to nonprofits.

2010 Western Conference on Tax Exempt Organizations

Last Thursday and Friday, I attended one of my favorite annual events, the Western Conference on Tax Exempt Organizations (WCTEO), co-sponsored by Loyola Law School and the Internal Revenue Service.  As always, the event was attended by many prominent attorneys, accountants, and executives who practice in the nonprofit and tax-exempt organizations area.

After brief introductions, the program began with speakers from the IRS and Treasury Department.  Among the items they discussed:

  • Patient Protection and Affordable Care Act signed by President Obama in March 2010 enacts new Section 501(r) of the Internal Revenue Code, which impacts tax-exempt hospitals.  See Notice 2010-39.
  • The IRS 2011 Priority Guidance Plan (to be published soon) will include additional regulations for supporting organizations, proposed regulations for donor advised funds, and guidance on IRC Section 501(r), changes to Form 990, and international activities.  The donor advised fund report due in 2007 under the Pension Protection Act has yet to be completed in part because a "donor advised fund" was statutorily defined only in 2006.
  • CyberAssistant for preparing and filing Form 1023 (exemption application) will not be released soon due to technical and other issues.  Don't hold your breath on this for 2011.
  • The agency-wide study on employment tax issues will continue (nonprofits need to make sure they are in compliance).

 

Loyola Irs-logo

William Choi, Ruth Madrigal, and LaVerne Woods discussed supporting organizations and donor advised funds (DAFs).  It was very helpful for more experienced practitioners because the presenters focused on practical issues involving these vehicles and not on the basics.  Woods discussed the Polm Family Foundation case in which an applicant sought recognition as a Type II supporting organization but was determined to be a private foundation.  Choi discussed two cases (Styles v. Friends of Fiji and In re:  National Heritage Foundation, Inc. that illustrate how important it is for donors to carefully choose sponsoring organizations of donor advised funds because of the lack of remedies if such sponsoring organizations use the funds without regard to the donor's advice (including in bankruptcy).  Choi also discussed a number of issues left open with DAFs, including:

  • How many unrelated donors do you need to qualify as a "multiple" donor fund (not a DAF)?
  • Does the prohibition on distributions to individuals apply to individual vendors or contractors who provide goods or services in connection with the DAF?
  • If a donor advises a distribution of $1,000 to a charity (the amount of the charity event ticket) and attends the charity event without paying the $200 non-deductible portion, is the amount of the prohibited benefit subject to tax just the non-deductible portion ($200) or the entire distribution ($1,000)?
  • If instead the donor advises a distribution of $800 and pays the remaining $200 out-of-pocket, is there a prohibited benefit received by the donor?  In the private foundation context, this strategy would not avoid self-dealing.  PLR 9021066
  • How do you distinguish between prohibited benefits (IRC 4967) and excess benefits (IRC 4958)?

We received two presentations on Form 990 – one from the IRS's Stephen Clarke (government perspective) and the other (on Friday) from Jody Blazek (practitioner's perspective).  Clarke focused on changes on the 2010 Form.  Blazek covered a number of ongoing issues for practitioners and offered some helpful tips:

  • Prepare Schedule R first (if it applies) because it will drive other parts of Form 990.
  • It is vital that organizations with modest public support ratios monitor them before year's end to try to avoid the unexpected circumstance of tipping into private foundation status (see Schedule A).
  • Adopt an annual combined relationship-conflict of interest disclosure form, including questions about family and business relationships among officers, directors, trustees, and key employees (and not just with the organization).

I particularly enjoyed the Governance Update provided by Michael Peregrine and James Schwartz.  Peregrine, who has an excellent PowerPoint on nonprofit corporate law trends and developments available here, started the presentation by predicting the downfall of one or two big time executives this year because of expense account issues.  Here are some of the trends identified by the presenters:

  • The sustained focus on corporate governance from the IRS demands serious attention of boards and executive leadership.
  • The business judgment rule may not protect directors who consciously disregard compliance and liability issues.
  • "Best practices" for nonprofit organization governance continue to emerge with unavoidable force and considerable detail.  Will best practices be treated as industry standards, resulting in greater exposure to directors who do not observe best practices?
  • There will be no respite from close regulatory attention to executive compensation matters.
  • Boards will increasingly be expected to become more involved in confirming the effectiveness of the organization's system of legal controls, including but not limited to corporate compliance.
  • Boards will be under increased pressure to address and resolve issues related to director independence and conflicts of interest management.  It may be prudent to go beyond minimum requirements.
  • Increasingly, we are seeing a "where was the Board?" mentality – at least from the media.

Michael Sanders and Margaret Anadu discussed the New Markets Tax Credit (NMTC).  Fascinating but complex.  There is a brief overview of the NMTC on the Treasury's Community Development Financial Institutions Fund webpage here.  And you can learn more from Sanders' article on How Nonprofit Organizations Can Use the New Markets Tax Credits.

Bruce Hopkins started Friday's presentation with his always entertaining and informative recap of the past year.  Here are just a few of the many interesting private letter rulings, technical advice memoranda, and other tidbits identified by Hopkins:

  • Denial of exemption because of applicant's provision of ambulances and wheelchair vans to health care organizations that provide transportation services to elderly and handicapped, principally because it charges fees.  PLR 201041045
  • Denial of exemption because applicant's principal purpose in conducting workshops was to attract business for the benefit of its founders.  PLR 201039046
  • Public charity intervened in political campaigns when it absorbed the website pages of its controlled social welfare organization (which included candidate questionnaires and endorsements).  TAM 200908050
  • Sen. Baucus's letter to IRS Commissioner Shulman dated September 28, 2010 asking for an investigation of tax-exempt organizations engaged in politics.
  • IRS website to enable public comment on government tax forms, starting with Form 1023, which the IRS says is "extremely burdensome and difficult,'' and requires 96 hours to prepare.
  • Distribution by private foundation to disregarded LLC to accomplish charitable purposes, where sole member of LLC is public charity that is not controlled by foundation is qualifying distribution.  INFO 2010-0052 (but left answered is the question of whether a charitable contribution to the LLC would be deductible)
  • One-time sale of intellectual property rights to interactive website software ruled to be activity not regularly carried on, so sales proceeds not unrelated business taxable income.  PLR 201024069
  • Joint Committee on Taxation, on January 11, 2010, issued estimates of tax expenditures for fiscal years 2009-2013 (JCS-1-10); charitable contribution deduction is seventh largest tax expenditure ($237.6 billion).

There were three breakout sessions covering private foundations, intermediate sanctions, and charitable giving.  I attended the private foundation session presented by Michael Berry and Jeffrey Haskell.  There was brief discussion of the so-called hybrid organizations (L3Cs and benefit corporations) and the ABA Tax Section's comments on additional examples of program-related investments, which updated the Section's 2002 comments with 17 proposed examples of PRIs.

The conference ended with a 90-minute Q&A session with a knowledgeable panel of experts:  Blazek, Hopkins, Douglas Mancino, and Woods.

On a personal note, I really appreciate the efforts of my San Francisco colleagues Cherie Evans and Barbara Rosen (Evans & Rosen LLP), who lead the State Bar's Nonprofit & Unincorporated Organizations and Tax-Exempt Organizations Committees, respectively; Loyola's Ellen Aprill and the other WCTEO program committee members; and Bill Choi (Rodriguez, Horii, Choi & Cafferata LLP), a highly respected and experienced exempt organizations attorney and speaker who was kind enough to introduce himself to me.  And outside of the conference, it was great to catch up with my childhood best friend and well-known L.A. entertainment attorney Larry Zerner and several of my volleyball-playing friends.  I'll be back next year!

Donor Advised Funds – An Uncertain Future

Donor advised funds enable people to claim a charitable tax deduction on donated cash, stock, and other assets to these special accounts offered primarily by financial companies and community foundations while also allowing them to recommend how, when, and to which charities their money should be distributed. Donor advised funds have been growing faster than other forms of charitable giving but with the struggling economy and potential change in Congressional regulations, new concerns may weaken this philanthropy.

Given the uncertainty about the magnitude or duration of the current economic slump, the future of donor advised funds is also similarly unclear. Both large and small gift funds are noticing a drop in donations. This may not directly affect the distribution of donations by donor advised funds to charities considering that during the economic recession in 2002, giving by donor advised funds had actually increased by 5 percent. In one respect, people may be less willing to donate more assets but will still direct the money already donated out because they know the charities are struggling. However, although people may still desire charitable tax deductions available through future donations, many of their decisions to donate, distribute, and the like may be delayed until later in the year. While the state of donor advised fund assets can be more accurately described as stagnant rather than suffering at this point, this may not always be the case. The assets of donor advised funds dropped by 2 percent after the 2001 terrorist attacks and they may be on the brink of facing a similar fate, affecting the assets that will be available in the future.

Officials of donor advised funds are also waiting for the lawmakers’ reaction once the Treasury Department submits its report on donor advised funds to Congress. One concern is that if lawmakers impose new regulations that require donor-funds to spend 5 percent of the donor fund each year, similar to the private foundations annual payout requirement, people may be discouraged from starting funds in the first place given the current decrease in donations.

– Emily Chan

IRS Releases New Guidelines for Form 1023

On July 31, 2008, the Internal Revenue Service (IRS) released a memorandum to explain the new guidelines for processing Form 1023 applications for exemption under IRC Section 501(c)(3) submitted by sponsoring organizations that maintain donor advised funds. These organizations must now refer to the Donor Advised Funds Guide Sheet and Donor Advised Funds Guide Sheet Explanation.

The guide sheet accounts for the changes made by the Pension Protection Act of 1996 and asks for more information on past, present, and planned activities. Prior to the Pension Protection Act, there was no definition for “donor advised funds” in the Code of Regulations. The Act intended to improve the accountability of donor-advised funds by enacting several provisions and defining terms such as donor-advised funds and sponsoring organization. The relevant provisions and defined terms of the Act as well as explanations to the guide sheet questions are listed in the Donor Advised Funds Guide Sheet Explanation.

These guidelines will be incorporated into the yet to be released IRM 7.20.8, Exempt Organizations Determination Letter Processing, Special Determination Issues.

– Emily Chan

Study of Donor Advised Funds and Supporting Organizations

In Notice 2007-21, Treasury and the IRS requested comments on issues relating to the organization and operation of donor advised funds and supporting organizations as part of a study required by the Pension Protection Act. 

The Notice identified the following issues for public comment:

  1. Whether charitable contribution deductions are appropriate in light of the use of assets contributed to these organizations
  2. Whether donor-advised funds should be required to distribute a specified amount for charitable purposes
  3. Whether retaining certain rights with respect to transferred assets (including advisory rights with respect to making grants or investing assets) is consistent with treating the transfers as completed gifts
  4. Whether issues identified in paragraphs 1-3 are also issues for other forms of charities or charitable donations.
  5. The advantages and disadvantages of these organizations, compared to other charitable giving arrangements
  6. How to determine the amount of a charitable contribution deduction for transfers to these organizations if the transferor retains certain rights, receives certain benefits, or the property is not readily convertible to cash
  7. The effects of new legislative provisions (including applying excess benefit transaction taxes) on the practices of these organizations and their donors
  8. Appropriate payout requirements for these organizations
  9. Advantages and disadvantages of perpetual existence for these organizations
  10. Whether issues identified in paragraphs 5-9 are also issues for other types of charitable giving arrangements.

View the comments of the Council on Foundations here (April 9, 2007).

View the comments of Independent Sector to the exempt organizations provisions of the Pension Protection Act here (August 8, 2007).