September 4, 2008 | Read Time: 2 minutes
Foundations have been living under stricter tax rules than charities since 1969, when the tax code was changed to crack down on perceived abuses by grant makers.
The Senate Finance Committee now wants to explore whether the different tax treatment still makes sense — and will probably hold a hearing on the issue in 2009, says an aide to Sen. Charles Grassley, the senior-ranking Republican on the committee.
Some tax experts say they would welcome a review of the rules, noting that charities have also been accused of questionable activities like offering excessive executive compensation to family members, hoarding endowments, and flirting too much with commercial activities.
“We’ve been living with the system of private foundations in the bad class and public charities in the good class,” says Roger Colinvaux, associate law professor at Catholic University and a former top aide to the Congressional Joint Committee on Taxation. “I think the time is right to at least look at whether there’s a different way to structure our tax-exempt organizations.”
Distributing Assets
Private foundations, which generally receive contributions from only a few sources and rely on investment earnings to keep operating, are subject to a host of rules that do not apply to charities, which generally raise money from the public or from activities that support their missions.
For example, foundations must spend at least 5 percent of their assets on charity annually, pay excise taxes on their net investment income, and limit their stakes in for-profit businesses.
Foundations also face tougher restrictions on “self-dealing,” or financial transactions that benefit board members, family members, or other people close to the organization.
Congress has tried to align the rules covering the two groups — for example, in 1996 agreeing to apply “intermediate sanctions,” or excise taxes, to nonprofit groups that provided “excess benefits” like high compensation or below-market loans to insiders.
“There’s creeping overlap between the two bodies of law, but it’s incremental and only partial,” says Bruce R. Hopkins, a nonprofit lawyer in Kansas City, Mo., and author of the Nonprofit Law Dictionary.
He says having two sets of rules is overly complicated, but applying the foundation rules across the board to charitable groups would cause a huge disruption.
Many nonprofit hospitals, for example, own for-profit health-related businesses, he says. The 5-percent spending rule would not be an easy fit for charities with endowments, because unlike foundations they are generally not making grants with that money .
“If you’re going to meld the rules, it’s probably better to take the private-charity rules and apply them to public foundations,” he says.
