Don't Overlook This Alternative to Private Foundations
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Article reprinted with permission from the Cleveland Metropolitan Bar Journal
By: Matthew A. Kaliff
Individuals who want to establish a personal or family charitable enterprise often think first of setting up a private foundation. A distinct identity, close family control, and name recognition make private foundations very appealing and the right solution for some donors. However, being your own philanthropist comes with at a price: administration, tax consequences, minimum distribution requirements and reporting obligations, to name a few. For their clients whose goals include a philanthropic presence, legacy and family engagement, practitioners should remember to consider the supporting organization option. It has the features of a separate charitable grantmaking entity with the tax and administrative efficiencies of a public charity.
Supporting Organizations Generally
A supporting organization is a separately incorporated entity that is defined in Internal Revenue Code Section 509(a)(3) as a Section 501(c)(3) organization that qualifies as a public charity through its close connection to one or more 501(c)(3) public charities. The supporting organization’s “public charity” status results from the close relationship to the supported charity. Some public charities refer to their affiliated supporting organizations as “supporting foundations.” As discussed below, it is this public charity status that can leverage significant efficiencies over private foundations.
A supporting organization must meet the following three elements: 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 other specified public charities described in IRC Section 509(a)(1) or (2) (qualified public charities); 2. It must be operated, supervised, or controlled by or in connection with one or more qualified public charities; and 3. It must not be controlled, directly or indirectly, by one or more “disqualified persons” (see IR Code Section 4946; i.e., substantial contributors and related persons) other than persons who are solely foundation managers.
Section 509(a)(3) classifies a supporting organization as Type I, Type II or Type III based on the extent of control of the supported public charity. Type I supporting organizations are analogous to a parent-subsidiary relationship as the supporting organization is “operated, supervised or controlled” by the public charity. Public charities such as community foundations will typically use the Type I model for their supporting organization programs. Type II and Type III have lesser degrees of control and supervision from the supported public charity. They are subject to greater scrutiny and are generally not relevant options for individual donors.
A supporting organization may be established as either a nonprofit corporation or as a trust under state law. The governing documents will provide that the supported public charity elects a majority of the supporting organization’s board of directors or trustees. The donor or his or her representatives (usually family members) elects the balance of the board. The minority status of the donor trustees is necessary because the supporting organization’s classification as a “public charity” rather than a “private foundation” is based upon the fact that substantial contributors and persons related to them do not “control” the supporting organization.
Despite their minority status, the donor-elected trustees have their place at the table and may actively participate in the affairs of the supporting organization. They may be elected as officers. They may recommend and vote on charitable grants. They may participate in crafting mission statements and setting investment and spending policies. Like a private foundation, the supporting organization provides a platform for multiple generations of the donor’s family to engage in the family’s charitable mission and long-term legacy plan. However, demonstrated adherence to the formalities of control by the supported charity in all aspects of a supporting organization’s operation and governance is essential to maintaining public charity status and avoiding potential penalties.
A supporting organization may have broad latitude in charitable grantmaking. Because a supporting organization must “operate for the benefit of, perform the functions of, or carry out the purposes of” its supported public charity, the extent of the charity’s purposes marks the outer limit of the supporting organization’s grant purposes. However, grants are subject to the general tax law limitations applicable to charitable grantmaking entities. Grants must be made on an objective basis for charitable, educational or religious purposes and they cannot be made to discharge a personal obligation of a donor, disqualified persons, or any other private individuals. Unlike private foundations, supporting organization grants may not reimburse donors or related parties for personal expenses incurred on supporting organization business (e.g., travel expenses). Payment of compensation to disqualified persons is similarly prohibited.
Contribution, Tax and Administrative Efficiencies
Donors can contribute a full range of property to supporting organizations through current or planned gifts. The public charity status of a supporting organization presents significant advantage in the treatment of contributions as compared to a private foundation, especially with regard to assets such as real estate and closely held business interests: • Cash gifts to a supporting organization are deductible up to 60% of AGI; private foundations are limited to 30% of AGI. • Gifts of long-term capital gain property are deductible at fair market value up to 30% of AGI; private foundations are limited to cost basis for all property gifts, except fair market value for publicly traded stock, subject to 20% of AGI, aggregate contributions limited to 10% of outstanding stock of corporation. • Supporting organizations have no minimum annual distribution requirement; private foundations must grant 5% of investment assets. • Supporting organizations pay no tax on investment income; private foundations have up to 2% excise tax on investment income.
The supported public charity handles the grant payment process for the supporting organization, maintains records, invests assets and prepares and files the supporting organization’s annual IRS Form 990 and state filings. Supporting organizations at community foundations often have dedicated professional staff who can serve as consultants on grantmaking and philanthropy. The supported public charity may charge fees to cover back office and professional services, but these will be significantly lower than the cost to a private foundation to accomplish the same tasks through paid staff or outside professionals. The potential tax and cost efficiencies of a supporting organization leave more assets available for charitable grantmaking.
A supporting organization may make sense for donors who wish to retain influence over a separate charitable entity, but are willing to surrender legal control in exchange for the efficiencies that come with public charity status. Others may prefer the independence of the private foundation. The ultimate decision is unique to each donor’s situation and priorities. Legal and professional advisors of course should carefully consider the full range of vehicles, run the numbers, and recommend a path that best aligns with the client’s goals and expectations.
Matthew A. Kaliff, JD is assistant managing director, Endowment Development at the Jewish Federation of Cleveland. His responsibilities include planned giving, endowment vehicles, and the management of family supporting foundations of the Federation. A graduate of Georgetown University Law Center, Matt practiced in the private sector before joining the Federation. He has been a CMBA members since 2017.
For more information, Matt can be reached at 216-593-2831 or email@example.com.