2011 leaffer law donor-advised scholarship funds: the rhythm and harmony of donor participation...

© 2011 Leaffer Law

Donor-Advised Scholarship Funds:

The Rhythm and Harmony ofDonor Participation

Karen LeafferBecky Farr Seidel

National Scholarship Providers AssociationOctober 19, 2011

© 2011 Leaffer Law

Agenda

1. Overview / Background

2. Donor-Advised Funds (DAFs) – Key Characteristics

3. Scholarship Fund Exception - How to Qualify

4. Real Life Application

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Overview

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Donor-Advised Scholarship Funds: Past

Donor(s) established separate fund or account with charity Donor(s) “advised” charity in selection process,

but gave ultimate decision-making authority to charity

Benefits to Donor(s): Current tax deduction Avoid cost and complexity of separate scholarship entity Participate in selection process Avoid private foundation rules

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Donor-Advised Scholarship Funds: Past

Typical examples included scholarship funds established by: Individual donors or families Companies and their employees University alumni and faculty Professional associations and their members Civic/service organizations and their members Members of faith based organizations

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Donor-Advised Scholarship Funds: Past

Abuse #1: de facto donor control over selection process

Abuse #2: convert personal gift to charitable donation

Abuse #3: impermissible private benefit

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Donor-Advised Scholarship Funds: Present

Pension Protection Act of 2006:

DAFs are no longer permitted to make scholarships,unless the scholarship fund exception applies!

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Donor-Advised Scholarship Funds: Present

Penalties: Sponsoring Charity – 20% Fund managers – 5% (for knowing violation) Donors – possible penalties for private benefit

or denial of deduction

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Donor-Advised Scholarship Funds: Present

Key Questions:

1. Is the scholarship fund a DAF?

2. If so, does the “scholarship fund exception” apply?

3. If not, what are the options?

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Is the Scholarship Fund a DAF?

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Donor-Advised Fund: Three Elements

1. Fund or account is owned or controlled by a sponsoring organization

2. Fund or account is separately identified by reference to contributions of donor(s)

3. Donor/advisor has or expects to have advisory privileges as to distribution or investment of fundsby reason of donor’s status as a donor

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Donor-Advised Fund: Three Elements

1. Fund or account is owned or controlled by a sponsoring organization

Covered: 501(c)(3) public charities Covered: war veteran organizations, fraternal organizations and

cemetery companies

Not covered: private foundations Not covered: non-501(c)(3) organizations Not covered: custodial funds

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Donor-Advised Fund: Three Elements

2. Fund or account is separately identified by reference to contributions of donor(s)

Covered: fund bearing name of donor (or related party)

Covered: separate fund on books and records which tracks contributions of specific donor(s) (or related parties)

Not covered: “general” fund from which scholarships are made(multiple donors, contributions pooled anonymously)

Not covered: “field of interest” fund dedicated for scholarships(multiple donors, contributions pooled and not separately tracked)

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Donor-Advised Fund: Three Elements

2. Fund or account is separately identified by reference to contributions of donor(s) … continued

Other “multiple donor” donor funds? (more on this later)

IRS will look at substance over form

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Donor-Advised Fund: Three Elements

3. Donor/advisor has or expects to have advisory privileges as to distribution or investment of fundsby reason of donor’s status as a donor

Covered: advisory privilege(donor has right to make recommendations and sponsor will consider them)

Not covered: gift restrictions (e.g., purpose of fund is for scholarships or selection criteria)

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Donor-Advised Fund: Three Elements

3. Donor/advisor has or expects to have advisory privileges as to distribution or investment of fundsby reason of donor’s status as a donor … continued

Covered: donor participates in selection process because he/she is a donor

Not covered: donor participates in selection process because he/she holds certain position (e.g., officers, director or fund manager of sponsor, president of university)

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Donor-Advised Fund: Three Elements

3. Donor/advisor has or expects to have advisory privileges as to distribution or investment of fundsby reason of donor’s status as a donor … continued

Covered: selection of scholarship recipients

Not covered: recommendation of selection committee, so long as based on objective criteria related to expertise(e.g., department heads, high school principal, etc.)

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Donor-Advised Fund: Three Elements

3. Donor/advisor has or expects to have advisory privileges as to distribution or investment of fundsby reason of donor’s status as a donor … continued

Covered: privilege arises under written agreement Covered: privilege arises by course of conduct Covered: privilege exists even if not exercised Covered: privileges later

Not covered: no mutual expectation of donor/advisor and sponsor

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Donor-Advised Fund: Three Elements

1. Fund or account is owned or controlled by a sponsoring organization

2. Fund or account is separately identified by reference to contributions of donor(s)

3. Donor/advisor has or expects to have advisory privileges as to distribution or investment of fundsby reason of donor’s status as a donor

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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

Caution! Lack of guidance … but penalties still apply!

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Of Special Concern: Multiple Donor Funds

Key factors for your attorney to consider: How large is the donor group? How are the donors related? 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?

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Key Questions:

1. Is the scholarship fund a DAF?

2. If so, does the “scholarship fund exception” apply?

3. If not, what are the options?

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Does the Scholarship Fund Exception Apply?

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Scholarship Fund Exception: Five Requirements

1. Donor/advisor (or related party) has advisory privileges only as member of advisory committee

2. Entire advisory committee is appointed by sponsoring charity

3. Donor/advisor and related persons do not directly or indirectly control advisory committee

4. Scholarships are awarded pursuant to pre-approved plan of sponsoring charity’s governing board

5. Plan is designed to comply with private foundation rules for scholarship activity

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Scholarship Fund Exception: Five Requirements

1. Donor/advisor (or related party) has advisory privileges only as member of advisory committee

Okay: donor is a member of a 5-member advisory committee, does not control the committee, and gets to vote on candidates as part of this committee

Not okay: assume the facts above, but donor also gets to pre-select individuals who will be considered by the full committee

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Scholarship Fund Exception: Five Requirements

2. Entire advisory committee is appointed by sponsoring charity

Okay: donor and spouse serve on five-person advisory committee,all appointed by community foundation

Not okay: fund agreement designates donor and spouse as advisors

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Scholarship Fund Exception: Five Requirements

3. Donor/advisor and related personsdo 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

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Scholarship Fund Exception: Five Requirements

4. Scholarships are awarded pursuant to pre-approved plan of sponsoring charity’s governing board

Okay: board adopts “master” procedures applicable to all scholarship funds of the organization

Not okay: staff determine procedures for each fund

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Scholarship Fund Exception: Five Requirements

5. Plan is designed to comply with private foundation rules for scholarship activity 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

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Scholarship Fund Exception: Five Requirements

1. Donor/advisor (or related party) has advisory privileges only as member of advisory committee

2. Entire advisory committee is appointed by sponsoring charity

3. Donor/advisor and related persons do not directly or indirectly control advisory committee

4. Scholarships are awarded pursuant to pre-approved plan of sponsoring charity’s governing board

5. Plan is designed to comply with private foundation rules for scholarship activity

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Real Life Application

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Conclusion

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Remember . . .

Any scholarship fund with ongoing donor involvement should be reviewed to determine DAF status

If scholarship fund is a DAF and does not qualify for scholarship fund exception … consider your options!

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Options:

1. Eventually … request Treasury Department exemption

2. Modify fund terms to avoid DAF status

3. Modify fund terms to qualify for scholarship fund exception

4. Reorganize fund as supporting organization or private foundation

5. Don’t allow scholarship activity

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Karen Leaffer, Esq.303.781.6899karen.leaffer@leafferlaw.com

Becky Seidel, Esq.303.781.6899becky.seidel@leafferlaw.com

1899 Wynkoop Street | Suite 275 | Denver, CO 80202LeafferLaw.com