IRS Rules & Best Practices for International & Enhanced Domestic Grant Making Ted Hart, ACFRE CEO, CAF America
Three Protocols 1. Expenditure Responsibility 2. Equivalency Determination 3. Enhanced Domestic Vetting (Due Diligence)
Donor Advised Fund (DAF) Pension Protection Act of 2006 for the first time defined donor advised funds and placed new rules on their use. Owned by a sponsoring public charity Separately tracked funds identified by reference to one or more specific donors Donors or their designees reasonably expect to have advisory privileges Can make distributions to multiple grantees
Donor Advised Fund (DAF) Corporation, Foundation or Individual gives to a recognized public charity that manages the Fund Those with tax obligations can receive immediate tax benefits for contribution The charity takes responsibility to ensure charitable use of funds Donor may advise or suggest but cannot direct, instruct, control, etc
Benefits of a DAF Donor can get a tax deduction now and give later Private foundations can make grants without exercising normal oversight Sponsoring charity handles due diligence process
Restrictions on DAFs Must exercise expenditure responsibility if grantee is not a certain kind of public charity or private operating foundation No distributions to individuals No distributions for non-charitable purposes 20% (of value of grant) tax on sponsoring charity for violations
Restrictions Donor Benefit 25% tax on donor for any grant, loan, compensation or similar payment to donor, advisor or related parties (repayment required). 125% tax on other substantial return benefit Tickets, tuition credit, member dues, etc. Recognition for gift OK Round-tripping?
Why Use a DAF? Direct Gift = No Tax Benefits Gift through a DAF = Tax-deductible contribution Thank you to Caplin & Drysdale, Washington DC
IRS Requirements No earmarking/ pledging : No agreement, oral or otherwise, that funds must go to predetermined recipient or to recipient of donor s choice. Must clearly inform donor that donor advised fund has ultimate discretion/control over funds donor does not! IRS looks to reality, not just form Do we inevitably follow donor s advice? Do we provide our own expertise? Are we serious about making sure grants further our charitable purposes? Thank you to Caplin & Drysdale, Washington DC
No Conduit The Preapproved Grant Relationship model of fiscal sponsorship is widely misunderstood and easily abused as a conduit when the fiscal grant maker fails to exercise the requisite discretion and control. The key element to avoid in grant making relationships is the creation of a pass-through or conduit arrangement. discretion and control The grant maker must exercise variance power or independent discretion and control over the grant funds for the relationship to pass IRS muster.
Charitable Purposes Relief of poverty, combating community deterioration Education, promotion of the arts Scientific research Combating prejudice, protecting human rights, helping disadvantaged Protecting the environment Lessening burdens of government Promotion of health (e.g., hospitals) Religious purposes
Charitable Benefit No substantial private benefit or commercial purpose benefit to private parties must be incidental: Organization improving a public lake is charitable even if neighboring property owners are benefitted Community hospitals can be funded Private practices cannot Watch for close relationships with a related commercial entity Make sure benefits are designed to serve a charitable class (not an individual or small group, not businesses) Watch for organizations acting like a for-profit business
No Political Activity No candidate endorsements, contributions, in-kind assistance Ban any non-neutral expression of favoritism (e.g., voter guides, voter registration or mobilization, etc.) No highlighting candidate positions that exclusively agree/disagree with organization Do not support activities that provide candidates unequal speaking opportunities Do not fund activities that ask candidates to sign onto the organization s pledge
Lobbying vs. Advocacy You must not fund activities that attempt to influence legislation at any level But you can seek to influence rules and regulations once laws are passed Do not fund communications with legislators, staff, or other officials, or encouraging the public to make such communications, for the purpose of influencing legislation You can fund advocacy for broad causes and issues Do not fund activities that directly advocate for/against legislation Thank you to Caplin & Drysdale, Washington DC
Expenditure Responsibility IRS Requirements and Penalty Pre-grant inquiry: reasonable assurance that the expenditure is charitable Grant agreement restricts use of funds to specific charitable projects Financial & narrative reports at least annually & final cumulative report Reporting to IRS: Coming soon? 20% tax on amount of the grant if you get it wrong Thank you to Caplin & Drysdale, Washington DC
Beyond The Minimum CAF America s 100-step industry leading due diligence process is a combination of both Expenditure Responsibility and Equivalency Determination. Certifies that selected organizations meet the highest standards of our proprietary due diligence vetting process: Organization Identification and Contact Document Collection: Grant Eligibility Application (GEA) Financials Governing Documents Board and Executive Staff rosters Proof of Charitable status Country-specific relevant documentation Ongoing weekly watch list scanning Scan the nonprofit, key staff and board members against 450 + global databases. Three-tier CAFAmerica review
Pre-Grant Inquiry Requirements and Best Practices Complete enough to give a reasonable person assurance that the grantee will use the grant for proper purposes Identity and prior history and experience of grantee and its managers. Information about management and practices of grantee Prior successful completion of grants normally enough Rigor may depend on size of grant
Grant Agreement Requirements and Best Practices Must include certain terms & be signed by an officer: Specify use of funds, which must be charitable Prohibit lobbying, political campaign intervention, non-charitable activity Prohibit grants that would violate IRS section 4945 rules on individual travel/study/scholarship grants or ER requirements Require funds to be tracked in a separate account (does not require a separate bank account) Require access to files on request and written reports Thank you to Caplin & Drysdale, Washington DC
Reporting Requirements and Best Practices Annual Narrative and Financial Reports Reports collected at end of each accounting period of the grantee Final cumulative reports at the end of grant period Must report on use of grant funds, progress toward goals, and compliance with grant terms IMPORTANT: you must not make additional grants when reports are outstanding or if there are unresolved concerns raised over use of funds or compliance; IMPORTANT: you must make reasonable efforts to obtain reports
Verification & Reporting When a report indicates funds have been misspent: Grant maker must try to get funds restored / returned Must withhold further grants until special measures in place to avoid future misuses Normally, IRS requires a summary report on each ER grant indicating purpose of grant, name and address of grantee, dates of reports received, amounts expended by grantee (per report), and information about any diversions / verification efforts. This is not required yet on the Form 990, but IRS has indicated informally that orgs should maintain this information MISSPENT FUNDS Thank you to Caplin & Drysdale, Washington DC
Non-DAF Funded Grants Still can t be a conduit relationship in granting funds Still need to make sure funds are used for charitable purposes Specific penalties for failure to get ER right don t apply No prohibition on grants to individuals, if such payments and the charitable purpose served are documented Donors can receive benefits in return for gift if the grant maker properly indicates value of benefit received and reduces charitable deduction receipt accordingly Thank you to Caplin & Drysdale, Washington DC
Funding Capital Equipment If grantee uses funds to purchase capital equipment, arguably those funds are not spent until end of useful life of that equipment longer period of ER reports required. Normally, easiest to have grantee use our funds for something else. If recipient is a 501(c)(3) or equivalent, can stop reports after 3 years. [Equivalency Determination Rules Will Help Here]
Re-granting Rules Private foundation ER rules require grantee to agree not to make any grants that a grant maker couldn t make itself. If grantee will re-grant to organizations, you need to require the grantee to exercise expenditure responsibility as grant maker would. It is less clear how re-grants to individuals would work conservative view is that grantee s individual grant procedures would need to meet Private Foundation requirements, including IRS preapproval.
Scholarships IRS tracks a long history of abuse. Donations in lieu of tuition payments Grants for junkets or no charitable activity at all Do not grant directly from a DAF scholarship awards (or any other awards) to individuals Equivalency Determination grants to charities for scholarships are OK, so long as grantee selects recipients completely independently No grantee rep or donor/advisor rep on selection committee No non-charitable constraints (e.g., requirement that only corporate executive children need apply)
Equivalency Determination Focused on Grantee as a Whole Grant maker must make reasonable judgment / good faith determination that grantee meets U.S. standards IRS Rev. Proc. 92-94 issued September 2012 http://www.irs.gov/pub/irs-tege/rp_1992-94.pdf New Guidance: Qualified Tax Practioners can provide opinions to third parties
Charitable Standards Nonprofit status Can t distribute earnings or assets to shareholders, members, or similar private owners. Nonprofits Could include charities, unions, trade associations, political organizations, etc. No private ownership interest in organization. No private inurement dealings with insiders must be at fair market value. For-profits, individuals Thank you to Caplin & Drysdale, Washington DC
Charitable Standards Charitable status Nonprofit Organized and operated exclusively for charitable purposes. Private benefit must be incidental No substantial lobbying No campaign intervention Permanently dedicated to charitable purposes (dissolution clause) Nonprofits Charities 501(c)(3) For-profits, individuals Thank you to Caplin & Drysdale, Washington DC
Charitable Standards Public Charities Churches, schools, hospitals Medical research organizations Orgs supported by gov t, public, or other publicly supported charities Orgs supported by combination of donations & revenue from charitable activity from public Private Nonprofits Charities 501(c)(3) Public Charities 509(a)(1), (2), (3) Supporting organizations Private Supported by investments or a few donors Operating or non-operating For-profits, individuals Thank you to Caplin & Drysdale, Washington DC
Charitable Standards Public Charities Churches, schools, hospitals Medical research organizations Orgs supported by gov t, public, or other publicly supported charities Orgs supported by combination of donations & revenue from charitable activity from public Supporting organizations Private Supported by investments or a few donors Operating or non-operating Operating 4942(j)(3) Nonprofits Charities (501(c)(3)) Non-Operating Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) For-profits, individuals 509(a)(1) Thank you to Caplin & Drysdale, Washington DC
Charitable Standards Organizational Test Organizing document must limit purposes to be exclusively charitable. Cannot expressly empower lobbying, electioneering, inurement, or other non-charitable activities. Assets must be permanently dedicated to charitable purposes. Dissolution clause. Law (e.g., cy pres) Operating 4942(j)(3) Nonprofits Charities (501(c)(3)) Non-Operating Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) Post-2006 DAF Grant making 509(a)(1) Thank you to Caplin & Drysdale, Washington DC
ED Step 1: 501c3 Status Operational test Activities must be exclusively charitable (no substantial exceptions). No substantial lobbying, no electioneering at all. Assets must be permanently dedicated to charitable purposes. Dissolution clause. Law (e.g., cy pres) No private inurement, no substantial private benefit. Operating 4942(j)(3) Nonprofits Charities (501(c)(3)) Non-Operating Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) Post-2006 DAF Grant making 509(a)(1) Thank you to Caplin & Drysdale, Washington DC
ED Step 1: 501c3 Status No Substantial Lobbying Contacting government officials for the purpose of influencing legislation. Urging the public to do so. Advocating the adoption or rejection of legislation. Exceptions for discussions of broad social issues, nonpartisan analysis & research, technical advice, selfdefense. Nonprofits Charities (501(c)(3)) Non-Operating Operating 4942(j)(3) Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) 5% rule of thumb. Post-2006 DAF Grant making 509(a)(1) Thank you to Caplin & Drysdale, Washington DC
ED Step 1: 501c3 Status No Electioneering Candidate forums, voter registration, voter education OK if absolutely nonpartisan. Can t focus charitable activities on one candidate or party. Educating the public on candidates position on single issue on which organization has a clear position is not OK. Even insubstantial electioneering is forbidden. Operating 4942(j)(3) Nonprofits Charities (501(c)(3)) Non-Operating Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) Post-2006 DAF Grant making 509(a)(1) Thank you to Caplin & Drysdale, Washington DC
ED Step 2: Public Charity Per Se Public Charities Educational Institutions Churches Hospitals Honorary public charities: Government entities Certain international organizations Nonprofits Charities (501(c)(3)) Non-Operating Operating 4942(j)(3) Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) 509(a)(1) Post-2006 DAF Grant making Thank you to Caplin & Drysdale, Washington DC
ED Step 2: Public Charity 509(a)(1) Public Support Test Determine percentage of all support over preceding 5 years that is public support. Revenues from charitable activities are ignored. Contributions from government entities and other publicly supported (US) charities counted as public support. Other donations counted as public support but only up to 2% per donor. Above one-third passes, above 10% = case-by-case qualitative evaluation. Operating 4942(j)(3) Nonprofits Charities (501(c)(3)) Non-Operating Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) Post-2006 DAF Grant making 509(a)(1) Thank you to Caplin & Drysdale, Washington DC
ED Step 2: Public Charity Private Operating Foundation Tests Designed to distinguish foundations that are conducting charitable activity from those that just make grants or that just stockpile endowment. Most currently funded organizations will qualify. Generally must spend 85% of income (not including contributions/grants) on direct charitable activities & related admin. Direct charitable spending must be over 3.33% of investment assets & other no n-charitable assets. (But there are other alternative tests.) Current and previous 3 years 3 out of 4 or cumulative. Operating 4942(j)(3) Nonprofits Charities (501(c)(3)) Non-Operating Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) Post-2006 DAF Grant making 509(a)(1) Thank you to Caplin & Drysdale, Washington DC
ED : Treaty Agreements Generally, foreign charity classification is helpful but not a guarantee. BUT Canadian registered charities are automatically classified as 501(c)(3). Mexican Article 70-B organizations (now renumbered to Article 97) are automatically classified as 509(a)(1). Nonprofits Charities (501(c)(3)) Non-Operating Operating 4942(j)(3) Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) 509(a)(1) Post-2006 DAF Grant making Thank you to Caplin & Drysdale, Washington DC
ED Cautions Need to avoid being a conduit (need to exercise discretion and control, have a specific purpose for the funds). Grant Agreement provisions can vary, but some agreement / reporting still advisable. Specific restrictions on re-granting don t apply, but needs to be for a defined purpose. Nonprofits Charities (501(c)(3)) Non-Operating Operating 4942(j)(3) Schools, hospitals, churches, MROs Publicly supported (donations) 509(a)(2) 509(a)(3) 509(a)(1) Post-2006 DAF Grant making Thank you to Caplin & Drysdale, Washington DC
ED: Is It Charitable? Public Charities Expenditure Responsibility Churches, schools, hospitals Focused on specific funds Medical research organizations Orgs supported by gov t, public, or Pre-grant Inquiry other publicly supported charities Restrictive agreements Orgs supported by combination of donations & revenue from charitable Detailed activity from reporting public (to CAFA and to IRS) until all spent. Supporting organizations Private Awkward for capital equipment, regranting Supported by investments or a few donors Operating or non-operating Equivalency Nonprofits Focused on the nature of the Charities (501(c)(3)) grantee. Grantee Non-Operating churches, MROs must meet same legal requirements as US public Publicly supported charity/operating foundation. General support OK, less reporting Operating 509(a)(2) required. 4942(j)(3) Schools, hospitals, (donations) 509(a)(1) Depends on governing 509(a)(3) documents & detailed formulas applied to finances. Post-2006 DAF Grant making Thank you to Caplin & Drysdale, Washington DC
Enhanced Domestic A unique enhanced domestic nonprofit vetting process goes far beyond the standard practice of only verifying IRS charitable status for USA based Charities. We dig deep to ensure our donors are making safe and secure grants; providing confidence regarding governance structure and the application of funds through: Online grant eligibility application Ongoing weekly watch list scanning Verification of current nonprofit business address and banking information. Identification of nonprofits whose exemption status has been revoked due to IRS BMF exclusion, Pub 78 exclusion, OFAC inclusion and compliance with the Pension Protection Act. These additional screenings provide peace of mind regarding the governance, leadership and administration of the organization.
Office of Foreign Assets Control (OFAC) Specially Designated Nations (SDN) List: Grant maker may not engage in transactions with listed persons (or others it knows to be terrorists or terrorism supporters). www.treasury.gov/sdn Voluntary guidelines. Treasury recommends routine screening of grantees, their officers, directors, and key employees, especially in high-risk areas. Controversy over material support. Example of Palestine. Sanctioned countries. Transactions in certain countries or with their nationals are forbidden: Cuba, Iran, North Korea, Sudan (with some exceptions). Other countries have more limited restrictions.
1441 Withholding 1441 withholding of tax on nonresident aliens Foreign organizations owe 30% tax on U.S. source income. Safe interpretation: Grant maker must withhold 30% of portion of grants to foreign organizations spent on U.S. activities. Exceptions. Grant maker can obtain documentation making such withholding unnecessary. W-8BEN if a treaty applies W-8EXP & opinion of counsel otherwise Standard GEA prohibits these activities for simplicity.
Thank you Serving Corporations,, Families and Individuals Ted Hart Chief Executive Officer T: +1 (703) 549-8931 F: +1 (703) 549-8934 tedhart@cafamerica.org CAFAmerica 1800 Diagonal Road, Suite 150 Alexandria, VA 22314 www.cafamerica.org