assets donors commit to charita- donors' philanthropic vision and - PDF document

Vehicles that escape the excise tax rules on private foundations may involve different sorts of problems. ROBERT A. BOISTURE and LLOYD H. MAYER assets donors commit to charita- donors' philanthropic vision and D oDors with substantial as- ble purposes will continue to have the greatest flexibility pos- sets to contribute to char- sible to adjust its mission and ac- ity have two basic options. serve those purposes for the long term. A private foundation is a tivities as the world changes. They can make current contribu- Foundations with sufficient fi- tions to established charities or cre- charitable endowment, organized ate a fund from which to make as either a corporation or trust, de- nancial resources have the option scribed in Section 501 (c)(3 )-or- of hiring and training a profes- contributions, either directly or in ganized and operated exclusively sional staff to further pursue the the future. Those choosing to act for charitable, educational, or donor's vision. This staff can so- through a fund have several pos- other purposes described in that licit and review grant applications, sible vehicles for doing so-private section. The assets of the foun- work with potential grantees, or foundations, supporting organi- dation are invested, and the re- help design activities that the zations, community foundations, sulting income (and sometimes the foundation will engage in di- and commercially administered corpus) is then used to promote the rectly. It can also do research donor-advised funds. foundation's exempt purposes. and prepare reports for the trustees Most of these entities have been The trustees or board of directors or the board of directors of the available for years, but changes in of the foundation are initially se- foundation, and provide training the legal landscape have shifted the lected by the donor, after which for new trustees or directors. trade-offs that have to be analyzed the posts are usually filled ac- As discussed in greater detail in choosing between them. Advi- cording to procedures spelled out below, the price for this flexibil- sors therefore need to assist donors in the governing documents. ity is the restrictions placed on the in carefully considering which al- The donor may provide as few operations of private foundations ternative best matches their needs or as many restrictions as desired by the Code-primarily Chapter and desires. in the foundation's governing 42-that do not apply to Section documents, limited only by state SOl(c)(3) organizations qualifying law and the requirements of Sec- as public charities. These restric- PRIVATE FOUNOATIONS tion 501(c)(3). For example, the tions prohibit most financial trans- Private foundations are the most founder of a family foundation can actions with officers, directors, and flexible means for ensuring that the include a provision requiring that substantial contributors; limit the at least 60% of the directors or types of charitable activities foun- trustees be his or her direct lineal dations can fund; and impose ROBERT R. L YONS and MICHAEL R. MI- descendants. Donors can thus various restrictions on foundation CHOLAS are members of the CPA firm of craft a private foundation in a way investments. The deductibility of Watkins, Meegan, Drury & Company, L.L.C. that will best be able to pursue the contributions to foundations is in the Bethesda, MD, office. CHOICES IN GIVING 257

tions, the Type 3 alternative al- zations, only the general class of also subject to lower limits than contributions to public charities. lows the donor to select the organizations to be supported need be identified (e,g" "institu- Foundations that conduct most members of the organization's of their charitable activities di- board, and a majority of the tions of higher education located in the District of Columbia " ),8 rectly, instead of through grants, directors may be persons en- may qualify as "operating foun- tirely independent of the sup- Disqualified persons, including substantial contributors, may not dations" under Section 4942(j)(3 ). ported organization. Rather control any type of supporting or- The Code affords this class of than demonstrating control by ganization, This generally means foundations more favorable treat- the supported organization, that disqualified persons cannot ment than non-operating foun- the Type 3 supporting organi- make up (or have the ability to ap- dations in several respects.l zation must show that it is re- point or elect) 5 0% or more of the sponsive to and an integral supporting organization's board, part of the supported organi- The regulations, though, state SUPPORTING ORGANIZATIONS zation.4 that all facts and circumstances Supporting organizations, defined The responsiveness demanded of will be considered in determining under Section SO9(a)(3 ), are a: com- a Type 3 organization can be whether control exists.9 monly used public charity alter- demonstrated in one of two ways. Supporting organizations are native to private foundations. A There can be a small amount of free from the restrictions that en- supporting organization is orga- board or officer overlap (a single cumber private foundations, but nized and operated to support one person is sufficient) and a close that freedom comes at a price, or more public charities or publicly working relationship between the First, the supporting organiza- supported Section SOl(c)(4), (c)(S), boards of the supporting and the tion is tied to a specific group or or (c)(6) organizations. There are supported organization, giving the class of organizations and its ac- three types of supporting organi- supported organization "a signif- tivities are limited to supporting zations. icant voice" in the supporting or- those organizations. Second, the ganization's activities. Alternatively, 1. Operated, supervised, or the supporting organization can be controlled by. Under this established as a charitable trust 1 See Sections 4940(d) (exempting some alternative, the supported under state law for the benefit of organization ( or organi- operating foundations from the investment income tax), 4942(g)(3) (exempting op- the supported organization, with zations) controls the sup- erating foundations from certain restric- the supported organization having porting organization, tions when grants are received from private the right to enforce the trust.s To generally by appointing or foundations), and 4942(j)(3) (requiring a meet the integral part test, the electing a majority of its di- lower minimum payment rate for operat- ing foundations). Contributions to oper- rectors.2 This type of sup- supporting organization must (1) ating foundations are also subject to more pay most of its net income to the porting organization is most favorable deductibility limits that apply to supported organization, (2) allow likely to be used when a contributions to public charities. See sec- its assets to be used by the sup- number of organizations de- tions 170(b)(1)(A)(vii), (E)(i). 2 Reg. 1.509(a)-4(g). ported organization, or ( 3) perform cide to join forces to create a shared fundraising entity. activities that the supported or- 3 Reg. 1.509(a)-4(h). 2. Supervised or controlled in ganization would otherwise per- 4 Reg. 1.509(a)-4(i). See Shoemaker and connection with. This type form.6 Brockner, "Public Charity Status on the The specific organization ( or or- Razor's Edge," Continuing Professional of supporting organization Education, Exempt Organizations-Tech- has a common board of di- ganizations) to be supported must nical Instruction Program for FY 1997 rectors with the supported be explicitly named in the gov- (1996). For another interesting perspec- organization(s).3 This struc- erning documents of a Type 3 sup- tive on Type 3 supporting organizations, ture is most commonly used porting organization unless there see "Gimme Shelter: The SO Trend: How to Succeed in Charity Without Really when a public charity wants, has been an historic and contin- Giving," Wall St. J., 5129198, page A1. for organizational reasons, uing relationship between the 5 Reg. 1.509(a)-4(i)(2). to set up a separate fundrais- supporting and the supported or- 6 Reg. 1.509(a)-4(i)(3). ganizations through which they ing organization. 7 Reg. 1.509(a)-4(d)(2)(iv), (4). 3. Operated in connection with. have developed a substantial iden- tity of interests. 7 By contrast, for 8 Regs. 1.509(a)-4(d)(2), (3). In contrast to the Type 1 and 9 Reg. 1.509(a)-4(j)(1). Type 2 supporting organiza- Type 1 and 2 supporting organi- May I June 2000 Vol111 No 6 258 JOURNAL OF TAXATION OF EXEMPT ORGANIZATIONS