by Betsy Buchalter Adler
The donor-advised fund is a familiar concept in philanthropy today. Many charities accept gifts and extend to the donors the privilege of suggesting possible recipients of the income or principal of the donated funds. Questions arise, however, when donors appear to control the charity's subsequent distribution of funds. When an advised fund makes grants to foreign charities suggested by the original donor of the fund, the level of concern rises because of the historical position of the IRS regarding a U.S. organization's exercise of discretion of control over grants to foreign charities. In fact, because of the interplay between the Financial Accounting Standards Board (FASB) rules applicable to donor-advised funds and the added measure of IRS attention to foreign grantmaking, a properly structured and administered advised fund in the international arena may be especially able to satisfy the concerns of the IRS and the philanthropic community regarding advised funds.
Questions of donor control are of particular importance when the ultimate recipient is a foreign charity. This is because the donor will be treated as having made the gift directly to the foreign charity unless the collaborating domestic charity genuinely controls the donated assets. For individual donors, the issue is one of eligibility for the income tax charitable deduction, which is not generally available for direct gifts to foreign charities. For private foundation grantors, a grant to a foreign charity requires either the exercise of expenditure responsibility or the determination that the foreign charity is the equivalent of a domestic public charity. If the gift or grant is genuinely made to a domestic public charity, however, these issues do not arise. How, then, can one determine whether a collaborating public charity owns and controls the assets in an advised fund? A recently promulgated FASB accounting standard provides strict rules under which auditors may treat advised funds as the property of the public charity to which they are given:
A recipient organization [i.e., the public charity] that is directed by a resource provider [i.e., the donor or grantmaker] to distribute the transferred assets, income from those assets, or both to a specified third-party beneficiary [i.e., a recommended grantee from the advised fund] acts as a donee and a donor, rather than an agent, trustee, or intermediary, if the resource provider explicitly grants the recipient organization the unilateral power to redirect the use of the transferred assets to another beneficiary. In that situation, explicitly grants means that the recipient organization’s unilateral power to redirect the use of the assets is referred to in the instrument transferring the assets, and unilateral power means that the recipient organization can override the resource provider’s instructions without approval from the resource provider, specified third-party beneficiary, or any other interested party.
In plain language, the FASB standard validates a practice that many public charities with advised funds adopted long ago: the inclusion, in the instrument creating the fund, of an explicit grant to the public charity of the unilateral power to select the ultimate beneficiary. In the community foundation context, this is known as a variance power—the power to substitute the charity's judgment for the judgment of the donor. The FASB standard does not have the force of law; technically, it is only relevant to charities that seek to have their financial statements audited. Nonetheless, the FASB standard effectively increases the likelihood that charities with advised funds will, in fact, operate with donor advice rather than donor control.
The FASB standard does not discriminate on the basis of geography. It applies to advised funds with international beneficiaries as well as advised funds whose scope is limited to domestic charities. In the context of international philanthropy, however, the FASB standard must be integrated with another set of rules: those of the IRS.
When an American grantmaker distributes charitable funds to a foreign charity, it is obligated by Federal tax law to exercise discretion and control over those funds to ensure that they are spent in a manner consistent with the grantmaker’s charitable purposes. Rev. Rul. 63-252,1963-2 C.B.101, modified by Rev. Rul. 66-79, 1966-1 C.B. 48. This requirement of discretion and control, combined with the FASB standard, has prompted public charities with advised funds to take a much more active role in vetting recommended foreign grantees than may be the custom with recommended domestic grantees.
Much of the discretion exercised by the collaborating public charity takes place in the screening and selection process. The public charity should have a screening procedure that enables it to make the threshold determination of whether a recommended advised-fund grantee is a charity, as that term is understood under American law and practice, and whether the potential grant can be structured so that its use is restricted to purposes that are charitable under American law. The public charity should have a selection procedure that allows it to assess whether the recommended grant, once past the screening stage, is consistent with its own charitable purposes as well as with the purposes of the advised fund, which will often be more narrowly focused.
The public charity can exercise control through grant agreements that limit the grantee’s use of the funds to purposes and activities that are effectively within the scope of Section 501(c)(3). The grant agreement should also impose a reporting obligation on the grantee, although the nature of the report will vary with the circumstances. Depending on the needs of the situation, the public charity may follow up through site visits, either through its own staff or contractors, or through collaborations with other charities with the necessary expertise.
The responsible administration of international advised funds by public charities, consistent with the FASB standards and federal tax law, expands the opportunities available to American philanthropists to assist foreign charities.
About the Author
Betsy Buchalter Adler is a senior partner in the San Francisco law firm of Silk, Adler & Colvin, which specializes in representing tax-exempt organizations and their supporters throughout the U.S. and abroad. Ms. Adler also teaches the law of tax-exempt organizations at Boalt Hall School of Law, University of California at Berkeley, and lectures frequently on topics of interest to the nonprofit sector.
For copies of this
article with citations to legal authority, please contact Ms. Adler at 415/421-7555. "Legal Dimensions" articles are edited by an editorial board in which the following firms are represented: International Center for Not-for-Profit Law; Silk, Adler & Colvin; Day, Berry & Howard; and Caplin & Drysdale.