Introduction to Private Foundations and Public Charities

Adam Liebling

American Society for the Prevention of Cruelty to Animals (ASPCA)

adam.liebling@aspca.org

(212) 876-7700 ext 4498

Agenda

Definitions Similarities & Distinctions Types of Foundations Determining Exempt Status Expenditure Responsibility Current Issues & Concerns Best Practices

The 501(c) Universe

501(C)(3)

501(c)(3) - Organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition, to promote the arts, or for the prevention of cruelty to children or animals.

Public Charity - Definition

“Public charity” is a generic term for all exempt organizations described in IRC Section 501(c)(3) that is not a private foundation

Characteristics:

1. Organized and operated exclusively for a charitable purpose

2. No part of its activities may involve political activities for or against political candidates

3. No substantial part of its activities may involve lobbying

4. Usually has a broad revenue base

Types of Charities

Categories under 501(c)(3):

509(a)(1): “Inherently charitable,” “The Institutions” : churches, educational institutions, hospitals, medical research organizations, some governmental units. And publicly supported organizations that receive substantial support from a governmental unit or from the general public.

509(a)(2): Exempt purpose activity-supported charities, that is, charities supported by “program service revenue,” e.g. museums, nonprofit magazines, etc.

509(a)(3) Supporting organizations: Orgs similar to private foundations that are connected to, and support, a specific (a)1 or (a)2 charity (i.e. university printing press)

Private Foundation - Definition

“Negative” definition – A private foundation is a charitable organization that is not a public charity as described under 509(a).

Characteristics:

1. Organized and operated exclusively for charitable purpose

2. Initially funded from one source

3. Its ongoing income is derived from investments

4. Typically makes grants to other organizations, rather than operate its own program

Similarities

Both must be organized and operated exclusively for a charitable purpose

Both are exempt under IRC Section 501(c)(3) No part of its activities can involve “political activity” (i.e.

electioneering/campaigning) Private inurement doctrine – cannot engage in activities

that result in private inurement or private benefit. Resources cannot be transferred to persons in a private capacity.

Both can make grants!

Distinctions

Foundations

Pays excise taxes (2% of net investment income)

Required to make a minimum distribution annually (5% of assets)

Prohibited from lobbying Must refrain from self-dealing Initially funded by one or few

sources; relies on investment earnings for ongoing support

Public Charities

Pays no excise taxes No minimum distribution – charity

can sit on money Can lobby in limited capacity Self-dealing acceptable in certain

cases; must be disclosed Must demonstrate that its income

is derived from a “broad base” (Public Support Test)

Taxes on Private Foundations Because PF’s are privately funded and

controlled, the IRS feels there is an increased likelihood of improper benefits to those controlling the PF. Therefore, more rules, restrictions, taxes, and penalties than on PC’s.

2% of net investment income – can be reduced to 1% if foundation increases its “qualifying distributions” by a certain amount

The IRC imposes a two-tier excise tax on “private foundations, foundation managers, or other disqualified persons that engage in certain prohibited acts. These are (1) the taxes on self-dealing between private foundations and their substantial contributors or other disqualified persons; (2) requirements that the foundation annually distribute income for charitable purposes; and (3) penalty excise taxes designed to discourage behavior detracting from a foundation's ability to further charitable purposes. Thus, the IRS may assess excise taxes on:

Taxes (continued)

Certain foundation holdings in private businesses;

Foundation investments that jeopardize the carrying out of exempt purposes;

Expenditures for certain activities not furthering exempt purposes.”

“Violation of these provisions give rise to taxes and penalties against the private foundation and, in some cases, its managers, its substantial contributors, and certain related persons. The first tier (initial) tax is automatically imposed if the foundation engages in a prohibited act. With the exception of self-dealing acts under section 4941, the initial taxes may be set aside if it is established that (1) a taxable event was due to reasonable cause and not to willful neglect, and (2) the event was corrected within the correction period.”

So, To Sum Up…

Public Charities Have an Advantage!No excise tax, no minimum distribution requirement, more flexibility

with lobbying

And Also:

Fewer reporting requirements Higher allowances for donors to contribute (they can deduct up to

50% of adjusted gross income vs. 30% to foundations). Therefore, easier to fundraise.

Easier for public charities to receive $ from private foundations; difficult for private foundations to receive $ from other private foundations

More flexibility in their giving and charitable activities

Life Cycles for PFs and PCs

Must be organized for charitable purpose Must be incorporated under state or regulatory law

Protects board from being held personally liable in case of lawsuit Charter/Articles of Incorporation – primary statements regarding purpose/mission

and location of a corporation; must be filed with state or regulatory agency Certificate of Incorporation – issued by state or regulatory agency By-Laws – further details on how the corporation will be run (powers and voting

rights of the board; meetings; quorums; etc.). Can be revised. Apply to IRS for Employer Identification Number (EIN)

For PCs, register with state agencies where you plan to do fundraising Apply for “Recognition of Exemption” with IRS, receive IRS

Determination Letter (aka Exemption Letter) Apply for other state tax exemptions (sales tax, property tax, etc.) File annual information returns (Forms 990 & 990-PF) Alert IRS to material changes or termination

A Note on Political Activity

"Under the Internal Revenue Code, all section 501(c)(3) organizations are absolutely prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for elective public office. Contributions to political campaign funds or public statements of position (verbal or written) made on behalf of the organization in favor of or in opposition to any candidate for public office clearly violate the prohibition against political campaign activity. Violating this prohibition may result in denial or revocation of tax-exempt status and the imposition of certain excise taxes.”

Organizational leaders at 501(c)(3)s should not make partisan comments in writing or at official or public functions.

Other Types of Foundations/PCs

Private Corporate Foundations Family Foundations Operating Foundations

Public Community Foundations Public Foundations Donor-Advised Funds

Corporate Foundations

Private foundation that derives its funds from a for-profit company

Focus and grantmaking usually related to the company’s interests

Can benefit from other company support, such as shared staff & departments

Can be affected by downturns at corporation, layoffs, mergers, etc.

Different from corporate-giving programs. Corporate foundations are separate legal entities whereas corporate-giving programs are administered within the corporation.

Family Foundations

Private foundation in which the donor or donor’s relatives play a significant governing role.

Assets endowed by family wealth

Generations of family members are stewards of the philanthropy and family legacy

Many private independent foundations began as family foundations

Operating Foundations

Foundation/charity hybrid.

Like private foundations, does not generally raise funds from the public

Like public charities, uses resources for own charitable programs and services

Rarely makes grants to other organizations

Different minimum distribution requirements and excise taxes than from PF’s

Community Foundations

An organization that pools assets within a community to service that community

Provides a number of consultancy, administrative, and investment services for donors and local organizations looking to be philanthropic in their community

Endowments, scholarships, grant programs, etc., created with donor intent (but CF retains discretion and control)

Often operated as a public foundation or a donor-advised fund (DAF).

Public Foundations

Simply, a public charity that focuses more on grantmaking than on providing direct charitable services

Follows normal IRS rules for public charities, but many adopt foundation best practices for grantmaking

ASPCA can be considered a public foundation

Donor-Advised Funds

A public charity that manages charitable donations on behalf of another organization, individual, or family.

Allows donors to be grantmakers without having to set up a private foundation

DAFs provide all due diligence and administrative functions, but retain “control and discretion” of funds – donors can provide “recommendations” but DAFs have final say

First DAF was in 1931 (New York Community Trust), but DAFs were first legally defined by the Pension Protection Act of 2006

Determining Exempt Status

IRS Determination Letter Includes a lot of important info (next slide)

Guidestar.org Notes whether org is 501(c)(3) and Public Charity or Private Foundation

and in good standing Some grants management systems connect to Guidestar New tools include better monitoring and alerts Seal of approval by the IRS

IRS Publication 78 Huge publication (also on IRS.gov as searchable database). Includes most

deductible orgs and their deductible codes IRS.gov includes revocations, suspensions, additions and deletions

IRS Determination Letter

Date of letter

Federal Tax ID/Employer Identification Number (EIN)

Legal name

Verifies not a PF and specifies type of charity under 509(a)

Advance ruling (No longer required as of 2008)

Expenditure Responsibility

Who can foundations and public charities give grants to?

What is expenditure responsibility (X-REP/ER)?

What do foundations have to do to exercise X-REP?

Alternatives to X-REP

X-REP: Why?

IRC Section 4945: Grants to organizations that are not public charities as described in 509(a)(1), (2), or (3) are considered taxable expenditures and subjected to excise taxes, unless Expenditure Responsibility is maintained.

Non-Public Charities that PF’s might make grants to: foreign charities, for-profits, other private foundations, and public charities that have lost, or not yet received, their status

X-REP: The Rules

Under the Internal Revenue Code, if a section 501(c)(3) private foundation makes a grant to an organization that is not a section 501(c)(3) public charity described in sections 509(a)(1), (2), or (3) (or, in the case of a foreign organization, treated as such), the private foundation must exercise “expenditure responsibility” over the grant. To exercise expenditure responsibility over a grant, a foundation must “exert all reasonable efforts” and establish adequate procedures:

To see that the grant is spent solely for the purpose for which it is made; To obtain full and complete records from the grantee detailing how the grant

funds are spent; and To make full and detailed reports with respect to such expenditures to the

IRS.

X-REP: Other IRS Requirements

In addition, the exercise of expenditure responsibility should include the following:

A pre-grant inquiry A written grant agreement, signed by an officer, director or trustee of the

grantee, containing the grantee’s agreement to:

1. To repay any amount not used for the purposes of the grant,

2. To submit full and complete annual reports to the grantor foundation on the manner in which the funds are spent and the progress made in accomplishing the purposes of the grant,

3. To keep records of receipts and expenditures and to make its books and records available to the grantor at reasonable times, and

4. Not to use any of the funds to influence legislation, to influence the outcome of elections, to carry on voter registration drives, to make grants to individuals or other organizations, or to undertake any nonexempt activity, when such use of the funds would be a taxable expenditure if made directly by the foundation.

Alternatives to X-REP

Using intermediaries/fiscal agentsMust be very careful because of earmarking rules.

Equivalency DeterminationLegal opinion based on affidavits and detailed grantee information that

grantee can be treated as equivalent to a US public charity. Can be burdensome and expensive, but there can be advantages.

Note: If grantee is a for-profit, equivalency determination not an option

Fiscal Agency/Pass-Through Grantmaking

Traditionally used to avoid taking X-REP

Foundation makes grant to an intermediary (usually a nonprofit with exempt status), who then grants to a non-exempt organization

The intermediary MUST retain “discretion and control” over money. Otherwise, it is considered “earmarking.”

Earmarked grants are as if foundation made grant directly to final recipient

No longer considered a viable alternative to X-REP, needlessly complicates grantmaking

Current Issues & Concerns

Sarbanes-Oxley Patriot Act Pension Protection Act of 2006 (HR4) Other Congressional Activities Recent IRS Activity Local Activity Media Scrutiny Public Confidence Greening Other Trends Best Practices

Sarbanes-Oxley

Enacted in 2002 in response to corporate scandals

Additional financial disclosure, enhanced accountability and corporate responsibility, auditor independence, significantly harsher penalties for violations

Does not apply to nonprofits – only publicly-held organizations

Many foundations and charities implemented some Sarbanes-Oxley provisions

Patriot Act & Related

Patriot Act – Stiff fines/prison terms for those that willingly fund terrorism

Executive Order 13224 – Gov’t can freeze assets of any terrorist or individual or organization that supports terrorism. Very vague and broad with no requirement that support include knowledge or intent.

Embargoes and Sanctions – Foundations cannot violate them except for very narrowly defined activities.

So-called “Voluntary Best Practices” – Treasury Dept’s Office of Foreign Assets Control (OFAC) guidelines for nonprofits on complying with these issues

Pension Protection Act of 2006

Largest charitable reforms since the Tax Reform Act of 1969

Affects mainly donor-advised funds and supporting organizations

However, burden is on foundations now to ensure they take proper actions when funding a 509(a)(3) Type III supporting organization.

Other Congressional Activities

Lobbying and ethics scandals The Legislative and Accountability Act: new rules for covering expenses of members of Congress

Frequent talk about raising the minimum distribution percentage

Frequent talk about executive compensation

Lower charitable deduction being considered for wealthy donors

Estate Tax frequently debated

Independent Sector promotes self-regulation - Panel on the Nonprofit Sector recommended actions to strengthen governance, ethical conduct of nonprofits

Recent IRS Activity

Stronger enforcement & scrutiny of exempt organizations engaging in political activity

Substantial changes to the 990 in 2008 – charities have to now report more about their governance and structure

Beginning 2007, ALL nonprofits have to file the 990 or 990-EZ (or 990-N “postcard” for orgs with annual revenue under $25,000)

Grace period just ended – tens of thousands of nonprofits lost their exempt status

Soon all nonprofits will have to file electronically

Local Activity

Greenlining Institute’s push for a “Foundation Diversity and Transparency Act” – would have made charities and foundations gather data and report on the ethnic makeup of their boards and their grantees’ boards

NY recently considered exemption of nonprofits from property taxes; tax on richest philanthropists

Kansas reconsidering exemption from sales tax Hawaii considering a 1% income tax Churches may still be exempt

Michigan’s AG had considered enforcing MI-incorporated foundations to make 50% distributions within MI

Media Scrutiny

Much coverage of large charities in the wake of 9/11 and Hurricane Katrina, focusing on ineffectiveness and inappropriate handling of funds

Higher coverage of, and public exposure to, the nonprofit sector for reasons positive (Gates/Buffett) and negative (scandals)

Blogs/online opinion pieces that cover the nonprofit sector are proliferating, but not always accurate

Public Confidence

Trust in “institutions” very low Church scandals University scandals Eroding confidence of charities Historically low approval of Congress High suspicion of government programs

Greening

Greening: The active process by which organizations critically analyze their procedures, policies and practices in order to reduce their impact on the environment.

Recycle, Reduce, Reuse Promoting energy efficiency Going paperless and telecommuting to reduce carbon imprint Encouraging public transportation Addressing food & product safety and sustainability Leadership in Energy and Environmental Design (LEED) Certification

Many organizations are now (at least) going for the “low-hanging fruit”

Change

Other Trends

Online Grantmaking Common Applications Uniform Coding Digital Archiving Data Gathering Emphasis on Outcomes/Metrics/Impact Social Media Endowments/Donations Down, Volunteerism Up Economic downturn

Best Practices for Nonprofits

For PFs, no self-dealing and avoid appearance of self-dealing. Okay for public charities in some cases.

No political activity Conflict of interest, whistleblower policies Consistent and formalized record keeping and file retention Transparency – internally & externally Establish an audit committee, if appropriate Environment-conscious/greening policies

The Era of Grants Management

Grants Managers are more important than ever!

Grants managers are on the forefront of:

Streamlining, doing more with less; creating new policies, processes, procedures, and technical solutions

Greening; paperless grantmaking Developing metrics for outcomes, evaluation, and impact Communicating the organization’s grantmaking successes Proper due diligence and compliance – having the right amount of

expertise in finance, law, audit, and IT. Keeping an eye on changes to the law.

Supporting the Sector

Groups Council of Foundations Foundation Center Independent Sector

Also: Center for Effective Philanthropy Chronicle on Philanthropy Grantmakers for Effective

Organizations Philanthropy Roundtable Regional Associations of

Grantmakers (Philanthropy New York)

Emerging Practitioners in Philanthropy

Health Research Alliance Grants Managers Network

Activities Testifying before Congress “Self-defense lobbying” Independent studies and

recommendations Op-Eds Conferences Education & dissemination (news

alerts, publications, etc.)

Thank you for coming!

Any questions?