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@aspca.org (212) 876-7700 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. 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) Distinctions

10. 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:

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 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.

17. 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

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 PF’s

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 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

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 grantee’s 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 – 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

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 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

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 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.

44. 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.) Supporting the Sector

45. Thank you for coming! Any questions?