Officials of Funds That Invite Donors’ Advice Brace for Federal Scrutiny

Community foundations and similar organizations are bracing for Congressional scrutiny of their operations — and are working hard to head off new restrictions that they say would throw cold water on what has become a very hot giving technique.

Key Congressional staff members have been holding informal talks with community-foundation leaders and others on possible changes to the rules that govern so-called donor-advised funds.

Those funds enable donors to turn over cash and appreciated assets to a community foundation or similar charity, claim a charitable deduction, and then recommend how, when, and to which charities to distribute the money. While all giving decisions are approved by the board of the community foundation or other organization that oversees the advised funds, in most cases the donors’ wishes are followed.

Donor-advised funds are popular because they allow donors to avoid many of the taxes, regulations, and administrative headaches associated with starting and running a private foundation.

But Congressional aides are beginning to question whether such funds are so similar to private foundations that they should be required to follow many of the same rules that Congress put in place 30 years ago to curb private-foundation abuses.

The Internal Revenue Service has also raised concerns about whether donor-advised funds are subject to sufficient oversight. Marc Owens, director of the I.R.S.’s Exempt Organizations Division, says the service has seen cases where the funds have been used to pay for non-charitable activities, such as college tuition costs for a donor’s child.

Another big reason for the current federal scrutiny is the very successful entry of commercial players, such as Fidelity Investments and the Vanguard Group, into the donor-advised arena.

Fidelity’s Charitable Gift Fund, which was created in 1991, placed No. 5 last year on The Chronicle’s Philanthropy 400, a ranking of the organizations that raise the most in private donations. The gift fund reported donations of $456-million, almost as much as the total amount raised by the American Cancer Society.

Among the ideas being discussed by Congress to help insure that donor-advised funds are subject to adequate oversight: the creation of a new category of non-profit group — a hybrid of a charity and a private foundation — that would have its own set of rules. One name being floated for this new category is “foundation-management organization.”

If that idea were adopted, the tax status of organizations that offer donor-advised funds would change from a charity to this new type of organization. Those groups would have to follow rules similar to the ones that govern private foundations.

One of the most significant changes would be a requirement that each fund distribute a minimum of 5 per cent, on average, of its assets each year to charities. Currently donor-advised funds have no payout requirement, but private foundations are held to that minimum standard.

Some distinctions would still remain between private foundations and groups that oversee donor-advised funds. For example, the annual 2-per-cent excise tax that private foundations pay on their assets’ net investment income would probably not be applied to foundation-management organizations.

In addition to donor-advised funds, Congress also has plans to look at supporting organizations, which are typically created to raise money for a specific charity but which sometimes have general purposes and support a variety of causes. Congressional staff members say they worry that some supporting organizations are currently set up with the sole aim of skirting the restrictions placed on private foundations.

Congressional aides stress that they are in the early stages of deliberations and that they plan to consider a range of options before recommending any particular action. They say they hope to distribute a paper this spring that would present several options and then provide opportunities for charity leaders and others to respond.

While none of the proposals has been put into writing yet, the informal Congressional discussions have sounded an alarm among community foundations, which solicit gifts to build permanent endowments to benefit the geographic area in which they are located. Community foundations and similar organizations are currently classified as charities because no single donor is responsible for the majority of their assets.

Last month, the Council on Foundations sent two memos to its community-foundation members alerting them to the changes being considered by Congressional staff members and asking for reactions.

Some community-foundation leaders fear that new laws could stunt the growth of community foundations and similar groups, causing many donors to set up private foundations or scale back their charitable giving altogether.

Jennifer Leonard, president of the Rochester Area Community Foundation, in New York, says such a shift “would be counterproductive for those who want less donor control and better philanthropy.” She says that while she welcomes clearer definitions about what are appropriate activities for donor-advised funds, she feels that community foundations in particular “have been scrupulous in observing the law” and do not require additional regulations.

Many charity leaders also question the wisdom of imposing a minimum annual distribution requirement on donor-advised funds. C. Dennis Riggs, president of the Community Foundation of Louisville, in Kentucky, offers as an argument against such a requirement a hypothetical example of a married couple who wants to let the assets in their advised fund grow for three years before making a large gift to their church — one that would qualify them for recognition as major supporters of the construction of a new sanctuary. “What’s wrong with that?” he asks.

Most organizations that oversee donor-advised funds say they give away far more than 5 per cent of their total assets each year. The California Community Foundation, for example, says it distributed about 12 per cent of its assets last year.

Many community foundations worry that they might be punished for what they see as problems with the gift funds started by financial institutions. They say such company-related funds grant donors too much control over their accounts and sometimes fail to spot abuses because they operate nationally rather than focusing on a specific geographic area. They also say that gift funds like the one run by Fidelity, which charge fees for managing investments and administering donor accounts, have business rather than philanthropic motives at heart.

Such concerns led the Council on Foundations to meet with federal officials last spring to ask them to take regulatory or legislative steps to rein in commercial entities that set up donor funds (The Chronicle, April 9, 1998).

But the council’s questions have helped to convince Congressional aides that a broad review of donor-advised funds might be in order, in part because few differences appear to exist between the operations of some community foundations and those of gift funds started by commercial entities.

Officials of Fidelity’s Charitable Gift Fund definitely believe that the organization’s work is little different from that done by other organizations that offer donor-advised funds. And, like community-foundation leaders, they feel that additional federal regulation of donor-advised funds is unnecessary.

Cynthia L. Egan, president of the Charitable Gift Fund, says that the steps her organization took last summer, with the help of the I.R.S., already insure that the advised accounts that Fidelity’s gift fund oversees are used exclusively for charitable purposes. The changes included prohibiting donors from using their advised funds to make gifts to private foundations or to overseas organizations. The gift fund also promised to give away, on average, at least 5 per cent of its total assets every year and not to allow the accounts of any of its donors to remain inactive for more than seven years (The Chronicle, July 30, 1998).

Ms. Egan says the organization distributed $315-million to charities last year, or about 20 per cent of its total assets.

“It’s fine for Congress to look at this,” she says. “But anybody proposing a change really needs to understand this giving model and all of the good that it’s bringing to philanthropy so that we don’t end up interrupting what’s going on now.”