Greenberg Traurig Alert
Donor-Advised Funds Under Attack;
IRS Business Plan Unveiled
By Harry J. Friedman and Robert J. Robes, Greenberg Traurig, Miami Office
View or download the PDF version of this Alert here.
A donor-advised fund is a fund typically held by a public charity consisting of money
contributed by an individual or entity. The donor or its designee retains the privilege of
making non-binding recommendations to the governing body of the public charity as to the
recipients of grants from the fund. The public charity is the owner of the principal
amount of the gift along with any income generated by the gift. It can decline to follow
or only partially follow the donors suggestions without any obligation to the donor.
The donor sacrifices control of the contributions because the donors recommendations
are advisory only; further the right to advise is often limited by the life span of the
donor. A donor-advised fund program is attractive to many donors who want advice and
administrative services. They are willing to sacrifice ultimate control over their funds
in exchange for these services.
Because the donor is making a gift to a public charity, the donor is entitled to the
most favorable rules on deductibility with respect to a gift to a donor-advised fund. This
is true so long as the gift is a complete gift and is not subject to material restriction.
Moreover, depending on the public charity, the donor may be permitted to let the fund
build tax-free over a period of years before making any recommendations. In contrast, if a
donor formed a private foundation, the foundation would be required to distribute annually
an amount equal to 5% of its assets.
Donor-advised funds formed by some mutual fund organizations have been heavily
advertised. For the donor, it permits a current charitable deduction for contributions,
not withstanding that the final recipient of the contribution has not been chosen. For the
mutual fund operator, it provides additional funds under management.
The increasing use of donor-advised funds has resulted in the 2001 Budget Proposal
including proposed legislation to provide rules for donor-advised funds that address the
potential for misuse of donor advised funds to benefit donors and advisors. The proposed
legislation would provide that a charitable organization which maintains more than 50%
percent of its assets in the operation of one or more donor-advised funds may qualify as a
public charity only if: (1) there is no "material restriction" or condition that
prevents the organization from freely and effectively employing the assets in such donor
advised funds, or the income therefrom, in furtherance of its exempt purposes; (2)
distributions are made from such donor-advised funds only as contributions to public
charities (or private operating foundations) or governmental entities; and (3) annual
distributions from donor advised funds equal at least five percent of the net fair market
value of the organizations aggregate assets held in donor advised funds (with a
carry forward of excess distributions for up to five years). Failure to comply with these
requirements with respect to any donor advised fund would result in the organization being
classified as a private foundation.
The proposed legislation also provides that a charitable organization that does not
maintain more than 50% of its assets in the operation of donor advised funds, but does in
fact operate one or more donor-advised funds, must comply with the above three
requirements with respect to the donor-advised funds. If the organizations
donor-advised funds do not comply, the organizations public charity status is
unaffected; however, all assets maintained by the organization in donor advised funds
would be subject to the private foundation rules and excise taxes.
The proposed legislation also changes the application of Intermediate Sanctions and the
prohibition on self-dealing. In the case of a donor-advised fund, this definition of
"disqualified person" is applied on a fund basis rather than looking to the
persons relationship to the organization.
Exempt Organization Items on IRS Business Plan
On March 21, 2000 the IRS and Treasury released this years business plan for
tax-exempt organizations. Annually, the IRS publishes a business plan outlining the
regulation projects and guidance it is intending to release during the year. The list puts
taxpayers and their advisors on notice of what to expect for the year from the Treasury
and IRS. More importantly, the list offers some guidance as to what issues are high on the
IRSs radar screen.
Most of the exempt organization items reflect matters on the previous years
business plans that were not released in 1999. An important item on the list is the
promulgation of Final Regulations under Section 4958 of the Internal Revenue Code,
commonly referred to as Intermediate Sanctions. Proposed Regulations were issued in July,
1998. (See, GT Alert, August, 1998, for a discussion of the Proposed Regulations.)
Final Regulations were anticipated last year, but were not issued. In a recently published
interview, Marcus Owens, IRS Exempt Organizations outgoing Division Director, stated that
the chances of the regulations being finalized in 2000 are less than 50/50. Current IRS
officials have been less pessimistic.
Reportedly, there are several key issues that IRS and Treasury Officials are trying to
work out. Presumably, an important one is the impact of the decision of the 7th Circuit
Court of Appeals in the United Cancer Council case. (See below for an update on that
case.) Proposed Regulations did not contain a "first bite rule", i.e., a rule
that would presume that an initial contract with the organization would not support a
conclusion that the party was a disqualified person under the Intermediate Sanction rules.
The UCC case used a first bite rule to find that a party was not an "insider".
IRS and Treasury also indicate in the business plan that they will continue to work on
a notice requesting comments on applying the rules of unrelated business taxable income,
lobbying expenditures and political intervention to exempt organizations internet
activities. In the August, 1999 GT Alert we described some of the issues
presented by the internet activities of tax-exempt organizations. Websites have commonly
become the method for organizations to communicate with their members. In order to take
advantage of this, businesses who make payments for endorsements and sponsorships
frequently request that the website contain a link to the business web site. Members
of the organization who visit the organizations website then have the opportunity to
quickly move to the websites of businesses which are supporting the organization. IRS
officials have suggested that these links may constitute advertisements for the business.
Some commentators have suggested that the link should be treated as merely an
acknowledgment of the sponsor and not advertising. Recent legislation provides that
acknowledgments of sponsorship activities does not constitute advertising for an exempt
Many commentators have indicated that the need for guidance in this area is critical.
So far, most of the IRS statements in connection with internet activities do not offer any
firm direction as to how the rules are to be applied.
Another item on this years agenda is charitable split-dollar insurance reporting
requirements. As has been widely publicized in the media, IRS officials are concerned
about these arrangements. Typically, they involve a wealthy taxpayer who makes a donation
to a charity. The understanding between the taxpayer and the charity is that the charity
will buy a split-dollar life insurance policy on the donors life. The donor then
claims a charitable deduction for the contribution, notwithstanding the fact that a
substantial portion of the proceeds of the split-dollar policy will be paid to the
donors family. The charity gets a cut of the life insurance proceeds. IRS notices
have indicated that such arrangement may constitute private inurement or more than
incidental private benefit.
In the benefits area, guidance on reporting and withholding for Section 457(b) plans is
on the project list.
UCC Closing Agreement Released
The United Cancer Council has released the closing agreement it reached with the IRS
that has been the subject of substantial litigation. UCC was a national organization whose
members were local cancer agencies. UCC was in poor financial condition when it hired
Watson and Hughey Company ("W&H") to act as a fundraiser. Under the contract
with W&H, a contributor list developed for the fundraising campaign on behalf of UCC
became the joint property of UCC and W&H. W&H was able to use list for marketing
itself to other charities. W&H provided UCC with the initial capital to conduct a
fundraising campaign and also provided operating funds to UCC. Contributions received were
placed in an escrow account controlled by W&H. Of $29 million received in
contributions, only approximately $2 million actually made its way to UCC.
The IRS revoked UCCs exemption arguing that UCC was operated for the private
benefit of W&H and that UCCs net earnings had inured to the benefit of a private
person, W&H. In 1997 the Tax Court upheld the private inurement argument and the IRS
revocation of UCCs exempt status. As noted in the Court of Appeals decision, the IRS
did not contend that any member of UCCs board of directors received any of
UCCs earnings nor that any member of the board was related to any of W&Hs
owners or employees. It was conceded that the contract was negotiated on an arms-length
basis. The Tax Court found that W&H was an "insider" and had improperly
received a portion of UCCs net earnings, thereby supporting revocation of exemption.
The terms of the contract, according to the Tax Court, provided W&H with influence
over UCC to the extent that it became an insider.
The 7th Circuit disagreed with the Tax Courts conclusions on private
Private inurement, according to the 7th Circuit, is designed to prevent "the
siphoning of charitable receipts to insiders of the charity, not to empower the IRS to
monitor the terms of arms-length contracts made by charitable
organizations. . . ." The Court observed that "insiders"
were persons who are the equivalent of owners or managers. An "insider" could be
a nominal outsider such as a physician with hospital privileges.
The Court concluded that a service provider was not an insider simply because it
entered into an arms length contract. The private inurement prohibition was, according to
the Court, not intended to provide the IRS with power to monitor service contracts of
charities. An arms-length contract even if badly negotiated and one-side in the IRS
eyes, does not constitute a violation of law that would lead to revocation of exemption.
Although the UCC was successful on the private inurement issue at the 7th Circuit, the
case was remanded to the Tax Court to address private benefit. Instead of returning to the
Tax Court on the private benefit issues, the parties agreed to settle. The settlement
agreement provides that the UCCs exempt status is revoked effective January 1, 1986.
The IRS agreed to accept a fixed settlement amount and did not require UCC to file an
income tax return for the period January 1, 1986 through December 31, 1989. At the
conclusion of the bankruptcy proceeding, UCC agrees to distribute its assets solely for
the payment of expenses of direct care of cancer patients. Its noteworthy that amounts are
only permitted to be distributed to exempt organizations that have never been associated
with W&H, the cause of the proceedings. The IRS agreed not to disallow the
deductibility of any charitable contributions made to UCC prior to 1989. This will benefit
its contributors who will not need to be concerned about disallowance of charitable
contribution deductions, although as a practical matter, it will remain unlikely that any
year remain open with respect to that period.
In addition, the IRS approved a new application for exempt status effective January 1,
1990. In the application, UCC states that it will limit its activities to accepting
charitable bequests and will transmit the bequest to local cancer councils for use solely
to provide direct care. It will not engage in other fundraising from the general public.
© 2000 Greenberg Traurig
This GT ALERT is issued for informational purposes only and is not intended
to be construed or used as general legal advice. Greenberg Traurig attorneys provide
practical, result-oriented strategies and solutions tailored to meet our clients’
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