Agency Endowment Basics
What is an agency endowment?
An agency endowment is a type of designated fund established by a charity at a community foundation for the charity’s own benefit or the benefit of a related entity. That is, the donor or resource provider and the beneficiary or recipient organization is the same entity. For example, an art museum transfers funds to a community foundation to establish a fund that will provide annual distributions to the art museum for its own use. The instrument of transfer used in to establish an agency endowment references the variance power and transfers legal ownership over the assets to the community foundation.
What types of organization can establish an agency endowment at a community foundation?
A public charity under Section 509(a)(1), 509(a)(2), or 509(a)(3) may establish an agency endowment at a community foundation. This may include an endowment created by a government unit.
A community foundation should not establish an agency endowment for a private foundation or non-charity. Contributions to an agency endowment fund established for a private operating or non-operating foundation would likely be viewed as contributions subject to a material restriction, due to the private foundation status of the agency. In addition, such a fund would raise the question of whether the community foundation’s public charity status was being used by a private foundation to circumvent the private foundation minimum distribution requirements.
An agency endowment fund established by a non-charity would be problematic because distributions from an agency endowment are generally provided for the general support of the designated charity. In the case of a non-charity, the community foundation would need to establish significant processes to ensure that grants from the fund were only used for charitable purposes rather than for general support of the non-charity. For this reason, such a fund would likely be classified not as an agency endowment but as a field of interest fund.
When a public charity establishes an agency endowment at a community foundation, which organization owns the contributed funds?
The community foundation has legal ownership of funds contributed to an agency endowment. As such, the community foundation’s board has fiduciary responsibility over the funds. The legal ownership of the funds is a frequent a source of confusion between agencies and community foundations. Therefore, the ownership should be clarified in the fund agreement at the start of the relationship. The confusion arises, in part, because FAS 136 requires that an agency recognize a beneficial interest in assets held by a community foundation as an asset on the agency’s books. This leads some agencies and their advisors to believe they maintain legal ownership over the funds. However, FAS 136 only affects the accounting treatment of the funds, not the legal ownership.
Since the agency is releasing legal ownership of the transferred assets, how can the agency’s board agree to the transfer of assets to establish an agency endowment without violating its fiduciary duties?
The agency’s board must make the decision regarding whether transferring legal ownership of the funds to establish an agency endowment is consistent with its fiduciary duties. An agency’s board may decide that such a transfer is prudent and consistent with its fiduciary responsibility to the organization because of the benefits provided as a result of the relationship with the community foundation. For example, the agency may benefit from the expertise of the community foundation in long-term management of assets, the flexibility the community foundation may provide by accepting types of non-cash contributions not accepted by the agency, or the protection that the transfer will provide by establishing an endowment at a separate organization.
Can a community foundation accept a non-endowed fund from an agency?
If established properly, a community foundation may accept a non-endowed fund from an agency. The key is that the agency may not reserve the right to unilaterally withdraw the fund from the community foundation. Instead, grants to the agency must be subject to the community foundation’s approval. When establishing such a fund, it is important that the agreement clearly states that distributions are always subject to the approval of the community foundation. Such a fund could be called an “agency fund” to distinguish it from endowed funds.
Should fund agreements for agency endowments include the variance power?
Yes. Because an agency endowment comes with the legal restriction that distributions from the fund would benefit the named agency, the fund agreement should include the variance power. In addition, the National Standards for U.S. Community Foundations require that the variance power appear in the fund agreement. The variance power is the power held by the governing body of the community foundation to modify any restriction or condition on the distribution of funds for any specified charitable purpose or to any specified organization if, in the sole judgment of the governing body, such restriction or condition becomes, in effect, unnecessary, incapable of fulfillment, or inconsistent with the charitable needs of the community or area served.
If the fund is endowed, can the fund agreement still permit an agency to access principal?
A fund agreement may permit an agency to request or recommend a distribution of principal. The fund agreement may contain a general provision permitting a request for distributions of principal or the agreement could outline specific reasons for which a distribution of principal may be requested (e.g., capital projects). In either case, the agreement should be carefully drafted to ensure that any such agency request or recommendation is solely advisory. The community foundation must maintain final authority and control over whether such a distribution of principal will be permitted.
Can a nonprofit reserve the right to force a distribution of the fund (or a part of the fund) back to itself?
No. A contribution to a community foundation is subject to the legal control of the community foundation. Allowing the nonprofit to reserve the right to force a distribution would be contrary to the foundation’s legal ownership of the fund. For this reason, the reservation of the power to unilaterally withdraw the fund in full or in part creates several potential results which are often undesirable. First, reservation of such power raises the question of whether a completed gift has been made by the agency to the community foundation. If the gift is not completed, it may not be included in the calculation of the community foundation’s public support test as a contribution. Second, an incomplete gift may lead to the conclusion that the community foundation is managing somebody else’s fund. Third, reservation of the right to unilaterally withdraw the funds may be considered a material restriction calling into question whether the fund is a component fund. Finally, a contribution to the community foundation is subject to the legal control of the community foundation. Allowing the nonprofit to reserve the right to force a distribution would be contrary to the foundation’s legal ownership of the fund.
Can the community foundation maintain a hybrid fund (i.e., contributions from the agency and contributions from third parties in one fund) or should the community foundation create two separate funds?
As a legal matter, one agreement could govern a fund that accepts contributions from third parties and contributions from the agency. However, because contributions from the agency and contributions from third parties may be treated distinctly for accounting purposes, a community foundation may find it more practical to establish two separate funds. In this situation the community foundation should review FAS 136 and the materials available from FAOG on the subject to determine how the fund should be handled to ensure proper accounting.
Where can I find a sample agency endowment agreement?
Members of the Council on Foundations may access a sample agreement. The sample agreement is also available in the book Community Foundations and Agency Endowments (available from the Council’s online store).
Form 990 Reporting
Should a community foundation include contributions to agency endowments as contributions to the community foundation on its Form 990?
Yes. The application of FAS 136 does not affect the legal treatment of contributions to and grants from agency endowments. Regardless of the treatment of such contributions under the accounting rules, a contribution to the community foundation for an agency endowment is treated as a contribution to the community foundation for the purposes of Form 990. This treatment allows contributions to be included in calculating the community foundation’s public support test and is consistent with the principle that the contributions are contributions to the community foundation and subject to the community foundation’s legal control. Grants from agency endowments to an agency should also be recorded as grants from the community foundation to the agency for the purpose of Form 990.
The Council’s comments on the new Form 990 draft instructions requested that the IRS clarify this issue in the instructions for the new form.
The question of whether a third-party donor was aware that the contribution for the benefit of an agency was a contribution to the community foundation and subject to the foundation’s variance power is a key to determining the accounting treatment for a contribution. What should a foundation do if variance power is not easily determined?
Some examples of determining variance power may be found in the FAS 136 Implementation Guide for Community Foundations. If the treatment is not clear, consult local counsel for a specific legal opinion so you can establish the proper accounting for the endowment.
Where can I find additional resources on the accounting treatment of agency endowments for the community foundation and beneficiary agency?
See Agency Endowments Frequently Asked Questions (developed by the Accounting Practices Committee of FAOG)
This information is not a substitute for expert legal, tax or other professional advice and we strongly encourage grantmakers and donors to work with their counsel to determine the application of the law to their particular situations. This information may not be relied upon for the purposes of avoiding any penalties that may be imposed under the Internal Revenue Code.