A charitable organization must pursue one or more tax-exempt purposes constituting the basis of its tax exemption [Reg. Sec.1.501(c) (3)-1(c)(1)]. The Internal Revenue Code Sec. 501(c) specifies such purposes as religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals.

Charitable Organizations in General

A charitable organization must pursue one or more tax-exempt purposes constituting the basis of its tax exemption [Reg. Sec.1.501(c) (3)-1(c)(1)]. The Internal Revenue Code Sec. 501(c) specifies such purposes as religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals. The term “charitable” as used in IRC Sec. 501(c)(3) is understood in its generally accepted legal sense and should not be construed as limited by the separate enumeration in IRC Sec. 501(c)(3) of other tax-exempt purposes which may fall within the broad outlines of “charity” as developed by judicial decisions [Reg.1.501(c)(3)-1(d)(2)].

In its operational activities, the charity must meet the following tests:

1. The net earnings of the organization may not inure to the benefit of any person in a position to influence the activities of the organization.
2. The organization must operate to provide a public not a private benefit [Reg. Sec. 1.501(c)(3)-1(d)(1)(ii)].
3. The organization may not be operated primarily to conduct an unrelated trade or business [Reg. Sec. 1.501(c)(3)-1(e)(1)] .
4. The organization may not participate or intervene in any political campaign.

Charities “qualified” for estate and gift tax purposes under IRC Sec. 2522 and 2055 mirror the income tax list, with some minor refinements. For example, estate and gift tax regulations do not allow a deduction for a donation to a cemetery corporation. And, unlike the income tax, estate and gift tax rules do not require the qualified organization to be a domestic organization.

Qualified Charitable Organizations Under Federal Income, Estate, and Gift Tax Rules

Income Tax Charitable Deduction	Estate Tax Charitable Deduction	Gift Tax Charitable Deduction
The U.S., a state, the District of Columbia, or a political subdivision1	The U.S., a state, the District of Columbia, or a political subdivision1	The U.S., a state, the District of Columbia, or a political subdivision1
A domestic corporation, trust, community chest, fund, or foundation organized for purposes of: religion, charity, science, literature, education, fostering national or international sports competition,2 or to prevent cruelty to children or animals3	A corporation organized for purposes of: religion, charity, science, literature, education, art, fostering national or international amateur sports competition,2 or the prevention of cruelty to children or animals3	A corporation, trust, community chest, fund, or foundation organized for purposes of: religion, charity, science, literature, education, fostering national or international amateur sports competition,2 art, and the prevention of cruelty to children or animals3
A domestic fraternal organization operating under a lodge system if organized for purposes of: religion, charity, science, literature, education, or prevention of cruelty to children or animals5	A fraternal organization operated under a lodge system if organized for purposes of: religion, charity, science, literature, education, or prevention of cruelty to children or animals5	A fraternal organization operated under a lodge system if organized for the purposes of: religion, charity, science, literature, education, art or prevention of cruelty to children or animals5
A domestic war veterans’ organization or post4	A veterans’ organization incorporated by Congress4	A domestic war veterans’ organization or post4
A cemetery company operated exclusively for the benefit of its members4	A qualified stock ownership plan, if the transfer qualifies as a gratuitous transfer of qualified employer securities under IRC Sec. 664(g)

¹Contribution must be made exclusively for public purposes.
²No part of its activities involves provisions for athletic facilities or equipment.
³No part of the net earnings may inure to the benefit of private shareholders or individuals and the organization may not be disqualified from tax-exempt status by attempting to influence legislation or participating (or intervening) in a political campaign.
⁴No part of the net earnings may inure for the benefit of a private shareholder or individual.
⁵The organization may not be disqualified for tax exempt status because of attempting to influence legislation or participating (or intervening) in any political campaign on behalf of any candidate to public office.

Private Foundations

Definition

Private foundation is not explicitly defined under the Internal Revenue Code. Rather, private foundation is legally defined as what it is not under IRC Sec. 509(a). All 501(c)(3) organizations are private foundations except for four specified categories of organizations defined in IRC Sec. 509(a)(1)-(4).

A 509(a)(1) organization is essentially a public charity as described in IRC Sec. 170(b)(1)(A)(i)-(vi). These charities are churches, educational organizations, hospitals and medical research organizations, certain organizations related to colleges and universities, and governmental units. These charities qualify as tax exempt because of the inherent public service they perform. Their status is not dependent on their sources of public support.

A 509(a)(2) organization is one that receives most of its revenue from “exempt function income”—earnings from the performance of its charitable functions such as fees for admission to a museum or theater. This organization does not receive most of its support from gifts or grants as does a public charity. However, a 509(a)(2) organization must meet public support requirements.

A 509(a)(3) organization is an organization that provides support to another 501(c)(3) organization that is not a private foundation. Supporting organizations are classified as public charities. It avoids the operating requirements and restrictions to which private foundations are subject. The Pension Protection Act of 2006 has added a new classification for supporting organizations and has denied and in other cases imposed restrictions on deductions from certain categories of charitable organizations to this new category of supporting organization. Further discussion on this will be covered later in this booklet.

A 509(c)(4) organization is one devoted to testing for public safety.

Deduction of Gifts Made to a Private Foundation

A private foundation appeals to donors who want to retain some control over charitable donations. However, the limits on deducting a charitable gift to a private foundation are more onerous than those limits for gifts to public charities:

• Donors may only deduct up to 30% of adjusted gross income for gifts of cash, and 20% of AGI for gifts of appreciated property as a charitable contribution.
• For gifts of long-term capital-gain property, the donor must reduce the contribution by any gain that would have been realized if the donor had sold the property (effectively limiting the amount to the cost basis).
• Any deduction to the 30% organization may be limited by current contributions made to 50% organizations. For example, a donor has an AGI of $100,000, and has made a cash gift of $15,000 to a public charity and a cash gift of $25,000 to a private foundation. The donor may only deduct $15,000 of the gift to the private foundation.There are exceptions to the general limits on deducting gifts to a private foundation.
• A 1998 law made gifts of “qualified appreciated stock” to private foundations more advantageous to donors. Contributions of qualified appreciated stock to private foundations are deductible to the full extent of the fair market value (subject to the percentage limits that cap the deduction). The definition of qualified appreciated stock is a stock of a corporation that is openly traded on an established securities market on the date the stock is contributed that is capital-gain property [IRC Sec.170(e)(5)(B)].

Example 1: A donor contributes qualified appreciated stock to a private foundation. He purchased the stock many years ago for $1,000, and on the date of the contribution (in 2007) the stock had a fair market value of $25,000. The donor may claim a $25,000 deduction for the contribution.

Example 2: A donor contributes closely held stock (not traded in an established securities market) to a private foundation. The donor purchased the stock many years ago for $1,000 and at the date of the contribution the fair market value of the property is $25,000. The donor would only be able to claim a deduction of $1,000.

An IRS Private Letter Ruling indicated that mutual fund shares can be qualified appreciated stock [Ltr. Rul. 199925029]. However, stock that was merely convertible into stock that could be sold in an established securities market for which price quotations were readily available was not qualified appreciated stock [Ltr. Rul. 199915053]. And American Depository Shares (a negotiable instrument issued by a U.S. depository bank that represents an interest in the underlying ordinary shares of a non-U.S. company) is also qualified appreciated stock [200322005].

• Three types of private foundations allow the donor to claim a 50%-of-AGI deduction. These foundations offer the benefits of privacy and control associated with private foundations, without the normal limitations on deductibility. However, the private foundation excise tax rules will still apply to these foundations. The foundations include:
• A private operating foundation is an organization that makes distributions each year for the active support (meaning the charity itself is conducting the activities and not solely making grants) of charitable purposes. The foundation must distribute the lesser of its adjusted net income and 5% of its net investment assets and meet the requirements of any one of the three following tests:
• Assets test– more than 65% of the foundation’s assets are put to use for the active conduct of the foundation’s exempt purposes.
• Endowment test– annual distributions are made for charitable purposes in an amount equal to at least 3.3% of its investment assets.
• Support test– the foundation must: (1) receive at least 85% of its support from five or more exempt organizations (not related to the private foundation or each other) and from the general public; (2) derive less than 25% of the foundation’s support from the exempt organizations; and (3) derive less than 50% of it’s support from gross investment income.
• A pass-through foundation requires distribution of 100% of the contributions to public charities or private operating foundations which are not controlled directly or indirectly by the private foundation. The distribution must occur no later than the 15th day of the third month after the close of the tax year in which the contribution was made. For example, if the contribution was received in 2006, the pass-through foundation must make a distribution by March 15, 2007. The contribution is valued as of the date the contribution is completed.

A common fund foundation is treated as a public charity if two requirements are met:

(1) The foundation distributes all net income to a designated public charity(ies) by the 15th day of the third month following the tax year of the contribution; and (2) the foundation distributes all the principal to a designated public charity(ies) within one year of the donor’s death (or his or her spouse’s death if the surviving spouse has the right to designate the recipients of the principal).

Donors may form a common fund foundation to support virtually any public charity, i.e., an alma mater or a community foundation.

Excise Taxes on Private Foundations

A variety of excise taxes may be imposed on a private foundation if it engages in prohibited transactions or fails to maintain required levels of charitable expenditures. Many of these excise taxes were doubled from prior levels by virtue of the Pension Protection Act of 2006. Prohibited transactions include:

• Self-dealing between foundations and their contributors [IRC Sec. 4941]
  A private foundation and a disqualified person (creators, substantial contributors, trustees, directors, members of their families, controlled corporations and trusts) cannot engage in:
  • Sales, exchanges, or leases of property
  • Loans
  • Furnishing of goods, services, or facilities
  • Paying compensation
  • Transferring income or assets from the foundation to the donor
  • Payment to government officials

The penalties for self-dealing imposed on persons who willingly violate the rules are an initial excise tax of 10% of the proscribed amount on the self-dealer, and/or 5% excise tax on the foundation manager who permits the transaction.

• There are some exceptions to the self-dealing restrictions:
  • A loan to the foundation made without interest or other charges, if the funds are used for charitable purposes
  • The furnishing of goods, services, or facilities to the foundation without charge that are used for charitable purposes
  • Reasonable payment by a foundation to a disqualified person for personal services which are reasonable and necessary to carrying out the exempt purpose of the foundation
• Failure to distribute at least a minimum amount of the foundation’s income for exempt purposes [IRC Sec. 4942]Current law sets out minimum income distribution requirements that private foundations must meet. The law requires a foundation to distribute annually the greater of: (1) the foundation’s adjusted net income for the tax year; or (2) a minimum percentage of its investment assets (as valued for each tax year). With regard to a private, non-operating foundation, 5% of its net investment assets must be distributed annually (despite its adjusted net income).Failure to meet this minimum income distribution results in an excise tax of 30% on the undistributed amount.
• Holding business enterprises in excess of specified maximum ceilings [IRC Sec. 4943]A private foundation cannot hold/own:
  • More than 20% of the voting stock of any corporation (less the percentage owned by all disqualified persons)
  • Any non-voting stock if disqualified persons collectively own 20% or more of the voting stock in the same corporation
  • More than 35% of the voting stock of any corporation if an unrelated party has effective control of the corporation

The excise tax is 10% of the fair market value of the excess business holdings for each tax year.

• Investments that jeopardize tax-exempt status [IRC Sec. 4944]A private foundation is prohibited from investing either principal or income in a way that would jeopardize its exempt purposes. Although there is no specific list of investments that violate the rules, the Internal Revenue Service will pay close scrutiny to the following activities:
  • Trading securities on margins
  • Trading in commodity futures
  • Investment in working interests in oil and gas wells
  • Buying warrants
  • Selling short

The excise tax is 10% of the invested amount involved, both for the foundation and its manager.

• Expenditures for lobbying [IRC Sec. 4945]A private foundation may not engage in the following “taxable expenditures”, including:
  • Influencing legislation
  • Influencing the outcome of a public election
  • Making grants for non-charitable or IRC 170(c) purposes
  • Making grants to non-public charitable organizations (unless the foundation exercises “expenditure responsibility”)
  • Making grants to any individual for study or travel (unless the Internal Revenue Service approves in advance the grant-making procedures)

The excise tax on the foundation is 20% per improper expenditure, and 5% for the manager.

Definition of Investment Income

While the 2% tax on investment income (reduced to 1% if certain distribution requirements are met) seems low, the definition of what is considered investment income has been expanded. Prior to the enactment of the Pension Protection Act of 2006, investment income was defined under IRC Sec. 4940 as interest, dividends, rents, payments with respect to securities, loans, and royalties. Excluded from this definition of investment income was the gain or loss from the sale of property used for exempt purposes.

Under the new law, investment income now includes income items such as annuities, income from notional principal contracts, and other similar income from ordinary and routine investments. Plus, capital gains and losses from the sale or other disposition of assets used to further an exempt purpose are included. For instance, the sale of a building used by the charity to carry out its exempt purposes would be considered investment income.

Supporting Organizations

Definition

A supporting organization provides support to another 501(c)(3) organization that is not a private foundation. In order to qualify as a supporting organization it must meet three tests:

1. It must be organized and at all times operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more “publicly supported organizations” [IRC Sec. 509(a)(3)(A)].
2. It must be operated, supervised or controlled by or in connection with one or more publicly supported organizations [IRC Sec. 509(a)(3)(B)].
3. It must not be controlled directly or indirectly by one or more disqualified persons (as defined in IRC Sec. 4946) other than foundation managers and other than one or more publicly supported organizations [IRC Sec. 509(a)(3)(B)].

Types of Supporting Organizations

In order to satisfy the relationship test, the supporting organization must fall within one of three types of categories:

1. Type I organizations are operated, supervised, or controlled by a publicly supported organization. The supported organization must have a substantial degree of control over the policies, programs, and activities of the supporting organization. This can be reflected by the fact that a majority of the officers, directors, or trustees of the supporting organization are appointed by the publicly supported organization [Reg. Sec.1.509(a)-4(g)(1)(i)]. The relationship is comparable to that of a parent and subsidiary.
2. Type II organizations are operated, supervised, or controlled by or in connection with one or more publicly supported organizations. The relationship is one comparable to that of a brother-sister. There must be common supervision or control by the persons supervising or controlling both the supporting organization and the publicly supported organizations. Control of the supporting organization must be vested in the same persons that control or manage the publicly supported organization [Reg. Sec. 1.509(a)-4(h)(1)].
3. Type III supporting organizations are “operated in connection with” one or more publicly supported organizations. This relationship requires the least connection with the supported organization or organizations. In order to satisfy the “operated in connection” test, an organization must meet both of two subtests, the “responsiveness” and the “integral part” test.
   • The responsiveness test is met one of two ways: One way is that at least one officer, director, or trustee of the supporting organization is elected by the supported organization. Or, at least one member of the governing body of the supported organization is also an officer, director, or trustee of the supporting organization. Or the organizations have maintained a close and continuous working relationship; and consequently, the supported organization has a significant voice in the investment and grant-making policy and in otherwise directing the use of the income or assets of the supporting organization [Reg. Sec. 1.509(a)-4(i)(2)(ii)].The second way is to show that the supporting organization is a charitable trust under state law, each publicly supported organization is a named beneficiary in the trust’s governing instrument, and the beneficiary organization has the power to enforce the trust and compel an accounting under state law [Reg. Sec. 1.509(a)-4(i)(2)(ii)].
   • The integral part testis satisfied if the supporting organization is significantly involved in the operations of one or more publicly supported organizations and these organizations are dependent on the supporting organization for the support it provides [Reg. Sec. 1.509(a)-4(i)(3)(i)]. In order to meet this test the supporting organization must either:
     • Perform functions for or on behalf of the designated public charities that would normally be engaged in by the public charities themselves [Reg. Sec. 1.509(a)-4(i)(3)(ii)], or
     • Pay substantially all of its income for the use of the designated public charities in an amount large enough in part to ensure the attentiveness of the supported organization, and a substantial amount of the total support provided by the supporting organization goes to that supported organization [Reg. Sec. 1.509(a)-4(i)(3)(iii)(a)].

The Internal Revenue Service has held that “substantially all” means at least 85% of the organization’s income. [Rev. Rul. 76-208, 1976-1 C. B.161].

New Prohibitions and Requirements for All Supporting Organizations

The Pension Protection Act of 2006 has new provisions dealing with automatic excess benefit transactions. These provisions deal with all supporting organizations (Type I, Type II, or Type III). If a supporting organization makes a grant, loan, payment of compensation, or other similar payment to a substantial contributor (or person related to the substantial contributor) of the supporting organization, for purposes of the excess benefit transaction rules [IRC Sec. 4958], the substantial contributor is treated as a disqualified person and the entire amount of the payment is treated as the excess benefit.

There is an initial tax of 25% of the amount of the payment and the organization manager that participated in the making of the payment is subject to a tax of 10% if he knew it was a grant, loan, payment of compensation, or other payment. This is a stricter application than the previous law because the entire payment is subject to the tax.

In addition, loans by any supporting organization (Type I, Type II, or Type III) to a disqualified person are treated as an excess benefit and the entire amount of the loan will be treated as an excess benefit.

New Prohibitions and Requirements for Type III Non-functionally Integrated Supporting Organizations

The Pension Protection Act of 2006 codifies the definition of supporting organizations into Type I, Type II, and Type III as discussed above. However, a major change in the new law concerns a Type III functionally integrated supporting organization. Before, a supporting organization could hold a family business interest in a way that would have been prohibited if held in a private family foundation. Now, the IRC Sec. 4943 prohibitions against excess business holdings apply to Type III non-functionally integrated supporting organizations.

The Pension Protection Act of 2006 provides that the Treasury Secretary shall promulgate new regulations on required minimum payments by Type III non-functionally integrated supporting organizations. Such regulations shall require these organizations to make distributions of a percentage either of income or assets to the public charities they support in order to ensure that a significant amount is paid to such supported organizations.

Donor Advised Funds

Introduction

Charitable organizations, most commonly community foundations, establish accounts to which donors may contribute and thereafter provide nonbinding advice or recommendations regarding which charities are to receive distributions from the fund or how assets in the fund are to be invested. Such accounts are referred to as “donor advised funds.” The charitable organization or community foundation, unlike the private foundation, is not subject to the control of an individual family, business corporation, or other private group. It is governed by a board representing the public interest and, in the case of community foundations, those most knowledgeable about community needs. Sponsoring charities generally must have legal ownership and control of such assets following the donor’s contribution. Most recently, financial institutions have formed charitable corporations for the primary purpose of offering donor advised funds, referred to as commercial donor advised funds. Due to the attributes of these charities and community funds, these funds are treated as public charities (not private foundations) and are allowed to claim the same tax deduction benefits as contributions to public charities. They are not subject to the restrictions, limitations, and excise taxes to which private foundations are subject.

The donor advised fund has become a very popular vehicle for many donors. While donors do not have the control that they would have with a private foundation, most of the time the charitable organization will follow their advice. Since the donor advised fund is treated as a public charity, the donor was given the favorable charitable tax deduction for a contribution to a public charity, was not subject to the excise taxes of a private foundation, and was relieved of the record keeping of a private foundation.

In order to make sure that the donor advised fund was operated differently than a private foundation, the Internal Revenue Service wanted to make sure the community foundation or charitable organization operated independently from the donor and that the donor did not reserve any rights with regard to those funds contributed to the fund. Accordingly, the service issued regulations setting out those circumstances which would indicate that such a right existed and circumstances in which they did not. Thus, if the charitable organization based its determination on independent investigation or if the advice followed guidelines specifying charitable needs consistent with those of the community foundation, then the organization was acting independently of the donor.

Factors indicating that the donor retained control over his contributions would be:

• If the advice of all donors was consistently followed
• If solicitations from the community foundation state or imply a pattern of conduct on the part of the community foundation that creates an expectation that the donor’s advice will be automatically followed [Reg. Sec. 1.507-2(a)(8)(iv)(A)(2)(i)-(v) and (3)(i)-(iv)].

New Treasury Study on Donor Advised Funds

Section 1226 of the Pension Protection Act of 2006 provides that the Treasury Secretary shall conduct a study on donor advised funds and determine:

• Whether the deductions allowed for income, gift, or estate taxes for charitable contributions to sponsoring organizations are appropriate in consideration of A) the use of contributed assets including the type, extent, and timing of such use, or B) the use of the assets of such organizations for the benefit of the person making the charitable contributions (or a person related to such person).
• Whether donor advised funds should be required to distribute for charitable purposes a specified amount (whether based on the income or assets of the fund) in order to ensure that the sponsoring organization with respect to such donor advised fund is operating consistent with the purposes or functions constituting the basis for its exemption under IRC Sec. 501, or its status as an organization described in IRC Sec. 509(a).
• Whether the retention by donors to organizations described in paragraph (1) of rights or privileges with respect to amounts transferred to such organizations (including advisory rights or privileges with respect to the making of grants or the investment of assets) is consistent with the treatment of such transfers as completed gifts that qualify for a deduction for income, gift, or estate taxes .
• Whether the issues raised in the analysis of donor advised funds are also applicable to other forms of charities or charitable donations.

IRC Sec. 4966 Now Defines Both the Donor Advised Fund and Sponsoring Organizations

While donor advised funds were commonly understood to be accounts formed by charitable organizations (including community foundations) to which donors may make contributions and thereafter provide nonbinding advice or recommendations with regard to distributions from the fund or investment of assets in the fund, there has never been a formal definition of these funds until the enactment of the Pension Protection Act of 2006.

A donor advised fund is defined as a fund or account (1) which is separately identified by reference to contributions of a donor or donors, (2) which is owned and controlled by a sponsoring organization, and (3) with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reason of the donor’s status as a donor.

1. The Joint Committee on Taxation published explanation of the Pension Protection Act of 2006 notes that a donor advised fund does not meet the requirement of separate identification by reference to contributions of a donor or donors unless the fund or account refers to contributions of a donor or donors, such as naming the fund after a donor or by treating a fund on the books of the sponsoring organization as attributable to funds contributed by a specific donor or donors.
2. The fund must be owned and controlled by the sponsoring organization. If the donor retains control over those funds, it is not a donor advised fund and there may not be a completed gift for the charitable deduction.
3. The donor or donor advisor reasonably expects to have advisory privileges with respect to the distribution or investment of amounts held in the fund or account by reason of a donor’s status as a donor. There cannot be any enforceable rights. The presence of an advisory privilege may be shown through a written document that describes the arrangement between the donor or donor advisor and the sponsoring organization stating that advice may be provided to the sponsoring organization about the investment or distribution of amounts held by the sponsoring organization, even if such privileges are not exercised.

A donor advised fund is not a fund or account that makes distributions only to a single identified organization or governmental entity.

A donor advised fund does not include a fund or account with respect to which a donor or donor advisor provides advice as to which individuals receive grants for travel, study, or other similar purposes, provided:

• The donor or donor’s advisory privileges are performed in their capacity as a member of a committee whose members are appointed by the sponsoring organization.
• No combination of a donor or donor advisor or persons related to such persons, control, directly or indirectly, such committee.
• All grants from such fund or account are awarded on an objective and nondiscriminatory basis approved in advance by the board of directors of the sponsoring organization.

A sponsoring organization is an organization:

1. Described in IRC Sec. 170(c) (though not a governmental entity)
2. Not a private foundation as defined in IRC Sec. 509(a)
3. That maintains one or more donor advised funds.

Under the Pension Protection Act of 2006, each sponsoring organization of donor advised funds is now subject to new reporting requirements. The organization must disclose on its information return:

• The total number of donor advised funds it owns.
• The aggregate value of assets held in those funds at the end of the organization’s taxable year.
• The aggregate contributions to and grants made from those funds during the year.

In seeking recognition of tax exempt status, sponsoring organizations must disclose whether they intend to maintain donor advised funds. The operation of those funds requires disclosure of (1) how they intend to communicate to donors and donor advisors that the assets held in donor advised funds are the property of the sponsoring organization; and (2) ensure that distributions from donor advised funds do not result in more than incidental benefits to any person.

New Rules Relating to Deductibility of Contributions to Donor Advised Funds

Section 1234 of the Pension Protection Act of 2006 provides that the following types of contributions to a sponsoring organization of a donor advised fund are no longer deductible:

• A veterans’ organization described in IRC Sec. 170(c)(3).
• A fraternal society described in IRC Sec. 170(c )(4).
• A cemetery company described in IRC Sec. 170(c)(5).

Furthermore, contributions to a sponsoring organization that is a Type III non-integrated sponsoring organization are not eligible for a charitable deduction for income, gift, or estate tax purposes.

A donor must obtain with each charitable contribution to a sponsoring organization a contemporaneous written acknowledgement from the sponsoring organization providing that the sponsoring organization has exclusive legal control over the assets contributed.

New Rules Extend Excise Taxes Associated with Private Foundations to Donor Advised Funds – Excess Business Holdings and Excess Benefit Transactions

The excess business holding rules under IRC Sec. 4943 now apply to donor advised funds. A disqualified person under the new rules means a donor, donor advisor, a member of the family of a donor or donor advisor, or a 35% controlled entity of any such person.

An excess benefit transaction is one in which a disqualified person receives a benefit in excess of the value of the service or product provided to the charitable organization. The new rules greatly expand the application of the excess benefit rules to donor advised funds. Under the new provision, any grant, loan, compensation, or other similar payment from a donor advised fund to a person that with respect to such fund is a donor, donor advisor, or a person related to a donor advisor is automatically treated as an excess benefit under IRC Sec. 4958 and the penalty applies to the entire amount. IRC Section 4967 imposes a tax equal to 125% of the benefit. The tax imposed shall be paid by the person who advised the distribution and the recipient of the benefit.

Under the provision there is more than an incidental benefit if, as a result of a distribution from a donor advised fund, a donor, donor advisor, or related person with respect to such fund receives a benefit that would have reduced or eliminated a charitable contribution.

Distributions After the Pension Protection Act of 2006: Treatment of Amounts Paid by Private Foundations and Donor Advised Funds to Supporting Organizations

Prior to the Pension Protection Act of 2006, a distribution by a non-operating private foundation to a supporting organization was a qualified distribution under IRC Sec. 4942(g). The distribution counted toward the 5% of the fair market value of the foundation’s assets for purposes of meeting its annual distribution requirement.

Supporting organizations (Types I, II, and III) were treated as public charities. However, Section 1244 of the Pension Protection Act of 2006 amended IRC 4942(g) to provide that distributions by a private non-operating foundation to a Type III organization that is not functionally integrated will not count as a qualifying distribution. Thus, a distribution to a non-integrated Type III supporting organization will no longer count toward the annual distribution requirement.

IRC Section 4945(d)(4) has been amended to provide that such a distribution to a Type III non-functionally integrated supporting organization constitutes a taxable expenditure unless the private foundation exercises “expenditure responsibility.”

Distributions to all supporting organizations (Type I, II, or III) will be deemed a non-qualifying distribution if the public charity supported by the organization is controlled by one or more of the private foundation’s disqualified persons unless the foundation exercises expenditure responsibility.

Distributions from a donor advised fund to a Type III supporting organization that is not functionally integrated will be treated as a taxable distribution. Distributions to a supporting organization (Type I, II, or III) that is directly or indirectly controlled by the donor, a person designated by the donor as advisor to the fund or any persons related to the donor (or advisor) will also be treated as a taxable distribution unless expenditure responsibility is exercised by the sponsoring organization.

In all cases it is imperative under the new law for the donor to determine whether their contribution is to a supporting organization and the type of supporting organization it is.