Introduction to Private Foundations and Public Charities

1
Introduction to Private Foundations and Public
Charities

• Adam Liebling
• American Society for the Prevention of Cruelty to
  Animals (ASPCA)
• adam.liebling_at_aspca.org
• [phone] ext 4498

2
Agenda

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

3
The 501(c) Universe
4
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.

5
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
• Organized and operated exclusively for a
  charitable purpose
• No part of its activities may involve political
  activities for or against political candidates
• No substantial part of its activities may involve
  lobbying
• Usually has a broad revenue base

6
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)

7
Private Foundation - Definition

• Negative definition A private foundation is a
  charitable organization that is not a public
  charity as described under 509(a).
• Characteristics
• Organized and operated exclusively for charitable
  purpose
• Initially funded from one source
• Its ongoing income is derived from investments
• Typically makes grants to other organizations,
  rather than operate its own program

8
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!

9
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)

10
Taxes on Private Foundations

• Because PFs 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 PCs.
• 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

11
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.

12
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

13
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

14
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.

15
Other Types of Foundations/PCs

• Private
• Corporate Foundations
• Family Foundations
• Operating Foundations
• Public
• Community Foundations
• Public Foundations
• Donor-Advised Funds

16
Corporate Foundations

• Private foundation that derives its funds from a
  for-profit company
• Focus and grantmaking usually related to the
  companys 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.

17
Family Foundations

• Private foundation in which the donor or donors
  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

18
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 PFs

19
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).

20
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

21
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

22
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

23
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)

24
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

25
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 PFs might make grants
  to foreign charities, for-profits, other private
  foundations, and public charities that have lost,
  or not yet received, their status

26
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.

27
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 grantees agreement to
• To repay any amount not used for the purposes of
  the grant,
• 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,
• To keep records of receipts and expenditures and
  to make its books and records available to the
  grantor at reasonable times, and
• 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.

28
Alternatives to X-REP

• Using intermediaries/fiscal agents
• Must be very careful because of earmarking rules.
  
• Equivalency Determination
• Legal 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

29
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

30
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

31
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

32
Patriot Act Related

• Patriot Act Stiff fines/prison terms for those
  that willingly fund terrorism
• Executive Order 13224 Govt 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
  Depts Office of Foreign Assets Control (OFAC)
  guidelines for nonprofits on complying with these
  issues

33
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.

34
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

35
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

36
Local Activity

• Greenlining Institutes 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
• Michigans AG had considered enforcing
  MI-incorporated foundations to make 50
  distributions within MI

37
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

38
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

39
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

40
Change
41
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

42
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

43
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 organizations 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.

44
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.)

45
Thank you for coming!

• Any questions?