The Heart of It: Allowing Donor Participation in the Scholarship Process

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1 The Heart of It: Allowing Donor Participation in the Scholarship Process Karen Leaffer National Scholarship Providers Association October 11, Leaffer Law Group 1

2 Overview: Why Does Donor Participation Matter? 2016 Leaffer Law Group 2

3 Our World View: Many Types of Scholarship Providers, One Common Goal Public Charities Private Foundations Community Foundations Scholarship Recipient Colleges and Universities Other Providers Corporate Programs 2016 Leaffer Law Group 3

4 IRS World View: Three Types of Scholarship Providers, Each Uniquely Regulated 501(c)(3) Public Charities Scholarship Recipient 501(c)(3) Private Foundations Others 2016 Leaffer Law Group 4

5 Public Charities v. Private Foundations 501(c)(3) Public Charities More public involvement = less IRS oversight 501(c)(3) limitations 501(c)(3) Private Foundations Less public involvement = greater IRS oversight 501(c)(3) limitations and private foundation rules 2016 Leaffer Law Group 5

example: Charities with scholarship focus Community foundations with

6 Public Charities: Types of Providers 501(c)(3) Public Charities More public involvement = less IRS oversight 501(c)(3) limitations For example: Charities with scholarship focus Community foundations with scholarship funds College/university foundations and alumni groups 2016 Leaffer Law Group 6

7 Public Charities: Donor Participation 501(c)(3) Public Charities Donate Establish Criteria Select Recipient Name Scholarship Advise 2016 Leaffer Law Group 7

8 Public Charities: Donor Participation! Warning: when a public charity allows donor participation in the scholarship process, take pause, because we re in sensitive territory! 2016 Leaffer Law Group 8

9 Public Charities: Donor Participation!» If donor participation becomes too great, fund/account may be considered a Donor Advised Fund (DAF)» Donor Advised Funds (DAFs) are prohibited from making scholarships, unless they satisfy stringent requirements for a Qualifying Scholarship Fund! 2016 Leaffer Law Group 9

Public Charities: Donor Participation» Complex rules can snag well-meaning scholarship providers and their donors» Penalties are severe: 20% of

10 Public Charities: Donor Participation» Complex rules can snag well-meaning scholarship providers and their donors» Penalties are severe: 20% of scholarship amount for sponsoring charity (plus correction ) 5% of scholarship amount for fund managers (for knowing violation) 2016 Leaffer Law Group 10

11 So, if There is Donor Participation, Ask Yourself Does the donor participation create a DAF? If yes, is the DAF a Qualifying Scholarship Fund? If no, scholarships are allowed If yes, scholarships allowed If no, scholarships are prohibited 2016 Leaffer Law Group 11

12 Does the Donor Participation Create a DAF? 2016 Leaffer Law Group 12

13 DAF Definition ` Is fund/account owned or controlled by a sponsoring organization? + Is fund/account separately identified by reference to contributions of donor(s)? + Does donor/advisor have or expect advisory privileges as to distributions or investments because of donor status? Donor Advised Fund 2016 Leaffer Law Group 13

14 DAF Definition: Sponsoring Organization 1 Is fund/account owned or controlled by a sponsoring organization? Covered: 501(c)(3) public charities War veteran organizations Fraternal organizations Not Covered: 501(c)(3) private foundations Non-501(c)(3) entities Governmental entities Custodial funds 2016 Leaffer Law Group 14

15 DAF Definition: Separately Identified 2 Is fund/account separately identified by reference to contributions of donor(s)? Covered: Fund bears name of donor/advisor Fund tracks contributions of specific donor(s) Not Covered: General fund* Field of interest fund* Other multiple donor funds* (more later) * Multiple donors, contributions pooled 2016 Leaffer Law Group 15

16 DAF Definition: Advisory Privileges 3 Does donor/advisor have or expect advisory privileges as to distributions or investments because of donor status? Covered: Advisory privileges as to distributions or investments (donor/advisor makes recommendations; sponsor considers them) Not Covered: Gift restrictions (e.g. donor restricts purpose of fund to scholarships; or establishes eligibility or section criteria) 2016 Leaffer Law Group 16

17 DAF Definition: Because of Donor Status 3 Does donor/advisor have or expect advisory privileges as to distributions or investments because of donor status? Covered: Donor/advisor participates in selection process because of donor s status as a donor Not Covered: Donor/advisor participates in selection process because he/she holds a certain position (e.g. officer, director, faculty) 2016 Leaffer Law Group 17

18 DAF Definition: Distributions/Investments 3 Does donor/advisor have or expect advisory privileges as to distributions or investments because of donor status? Covered: Recommendation of scholarship recipients Recommendation of investments Not Covered: Recommendation of selection committee, so long as based on objective criteria related to expertise (e.g. department heads, high school principal, etc.) 2016 Leaffer Law Group 18

19 DAF Definition: Have or Expect 3 Does donor/advisor have or expect advisory privileges as to distributions or investments because of donor status? Covered: Privilege arises under written agreement Privilege arises by course of conduct Privilege exists even if not exercised Privilege that arises later Not Covered: No mutual expectation of donor/advisor and sponsor 2016 Leaffer Law Group 19

20 DAF Definition ` Is fund/account owned or controlled by a sponsoring organization? + Is fund/account separately identified by reference to contributions of donor(s)? + Does donor/advisor have or expect advisory privileges as to distributions or investments because of donor status? Donor Advised Fund 2016 Leaffer Law Group 20

21 Of Special Concern: Multiple Donor Funds For example scholarship funds established by:» Faculty and alumni groups» Service and social clubs» Company employees» Friends in memory of loved one» Giving circles Lack of IRS guidance, so proceed with caution» Separately identified by reference to contributions of donors if named for group? What about relationship between donors? 2016 Leaffer Law Group 21

22 Of Special Concern: Multiple Donor Funds Key factors for your attorney to consider:» How large is the donor group?» How are the donors related? Is fund named after identifiable group?» Does anyone dominate or control the group?» How is the selection committee comprised and selected?» What is the nature of its advisory privilege?» Is there a scholarship plan that meets the private foundation rules?» To what extent does the sponsor oversee the scholarship activity?» How close does the fund come to meeting the scholarship fund exception? 2016 Leaffer Law Group 22

23 If There is Donor Participation, Ask Yourself Does the donor participation create a DAF? If yes, is the DAF a qualifying scholarship fund? If no, scholarships are allowed If yes, scholarships allowed If no, scholarships are prohibited 2016 Leaffer Law Group 23

24 Is the DAF a Qualifying Scholarship Fund? 2016 Leaffer Law Group 24

25 Qualifying Scholarship Fund: Five Requirements Donor/advisor (and related persons) have advisory privileges only as members of advisory committee Entire advisory committee is appointed by sponsoring charity Donor/advisor (and related persons) do not directly or indirectly control advisory committee Scholarships are awarded pursuant to plan pre-approved by sponsoring charity s governing board Plan is designed to comply with private foundation rules 2016 Leaffer Law Group 25

26 Qualifying Scholarship Fund: Five Requirements 1 Donor/advisor (and related persons) have advisory privileges only as advisory committee members Okay: Donor is member of 5-member advisory committee, does not control committee, and votes on candidates as part of committee Not Okay: Same facts, except donor pre-selects individuals who will be considered by full committee 2016 Leaffer Law Group 26

27 Qualifying Scholarship Fund: Five Requirements 2 Entire advisory committee is appointed by sponsoring charity Okay: Sponsoring charity appoints all members of 5-member advisory committee Not Okay: Gift instrument designates donor and spouse as members of advisory committee; sponsoring charity appoints remainder 2016 Leaffer Law Group 27

28 Qualifying Scholarship Fund: Five Requirements 3 Donor/advisor (and related persons) do not directly or indirectly control advisory committee Okay: Advisory committee consists of donor, spouse and three retired college presidents Not Okay: Advisory committee consists of donor, spouse, their accountant and two retired college presidents 2016 Leaffer Law Group 28

29 Qualifying Scholarship Fund: Five Requirements 4 Scholarships are awarded pursuant to plan pre-approved by sponsoring charity s governing board Okay: Board adopts master procedures applicable to all scholarship funds of sponsoring charity Not Okay: Staff determines procedure for each fund 2016 Leaffer Law Group 29

30 Qualifying Scholarship Fund: Five Requirements 5 Plan is designed to comply with private foundation rules Nondiscriminatory criteria and publicity Objective selection process Adequate records as to recipients Reasonable renewal criteria Monitoring of recipients performance, reports from recipients Investigate known diversion of funds Special rules for employee scholarships 2016 Leaffer Law Group 30

31 Qualifying Scholarship Fund: Five Requirements Donor/advisor (and related persons) have advisory privileges only as members of advisory committee Entire advisory committee is appointed by sponsoring charity Donor/advisor (and related persons) do not directly or indirectly control advisory committee Scholarships are awarded pursuant to plan preapproved by sponsoring charity s governing board Plan is designed to comply with private foundation rules 2016 Leaffer Law Group 31

32 Conclusion 2016 Leaffer Law Group 32

33 Recap:! Warning: any scholarship fund/account administered by a public charity, which permits donor participation, should be reviewed to determine DAF status 2016 Leaffer Law Group 33

34 What if? Does the donor participation create a DAF? If yes, is the DAF a qualifying scholarship fund? If no, scholarships are allowed If yes, scholarships allowed If no, scholarships are prohibited 2016 Leaffer Law Group 34

35 Options:» Modify donor participation to avoid DAF status» Modify fund terms to satisfy criteria for Qualifying Scholarship Fund» Reorganize fund as supporting organization or private foundation» Eventually request Treasury Department exemption» Consider alternative to scholarship activity 2016 Leaffer Law Group 35

We re Done! Visit our blog at http://leafferlaw.

36 We re Done! Visit our blog at Leaffer Law Group 36

advance and guide the work of nonprofit organizations and charitable foundations, so they can focus

37 Thank you. Karen Leaffer Leaffer Law Group Leaffer Law Group has one focus: providing legal counsel to support, advance and guide the work of nonprofit organizations and charitable foundations, so they can focus on their essential work DENVER: 1899 Wynkoop St. Suite 275, Denver, CO BOULDER: 1033 Walnut St., Boulder, CO leafferlaw.com 2016 Leaffer Law Group 37

The Perils of Donor Participation in Scholarship Funds

The Perils of Donor Participation in Scholarship Funds Karen Leaffer National Scholarship Providers Association October 15, 2013 Overview 2 Types of Scholarship Providers Scholarship Providers Tax-Exempt,