May 27, 2012 | Read Time: 4 minutes
Even in today’s struggling economy, donors are pouring billions of dollars into charitable foundations.
That is not entirely good news, some critics note. Donors could make a vastly greater difference by providing direct and immediate contributions to nonprofits that work on critical issues. And the level of criticism may grow thanks to a new trick that is making it harder than ever for nonprofits to figure out how to get a share of the money, or even to guarantee that any money ever flows to community groups that so desperately need the cash.
To understand what is happening, it’s useful to remember the basic philosophy that undergirds the federal rules that govern the ways wealthy people choose to give.
If a family establishes its own private foundation, its members have the right to maintain great control. Most notably, they can populate the board with relatives and friends.
But in exchange for that control, they must disclose each and every grant (along with many other details) in their federal tax return, which is part of the public record.
The notion is: “Hey, wealthy family! You have control of this tax-exempt entity, so you are subject to significant scrutiny!”
On the other hand, a different family may choose to create a donor-advised fund at a community foundation, a national charity, or a commercial fund run by Fidelity, Schwab, Vanguard, or another investment house.
In this case, the donors have less control. They can recommend grants only from the funds that those entities support: The final decisions are up to the boards of the community foundations or other organizations that manage the assets.
Such funds also face less scrutiny. The names of the donors can be anonymous, and they are not required to list which grants came from which funds. The charity overseeing the advised funds has an independent board, so the theory goes that its members will keep an eye out for any chicanery and the public doesn’t need to know every detail.
Now, however, I have seen instances that undermine the philosophical distinction between private foundations and donor-advised funds.
Here’s what’s happening:
Instead of the private foundation making, say, 50 grants to nonprofit organizations, all of which would be itemized in its tax return, it makes a single grant to a donor-advised fund within a community foundation or at a commercial gift fund. Then the donor-advised fund makes the grants—but it is not required to disclose the names of which grant recipients got money from which funds.
For nonprofits, this is an unsettling turn of events.
In years past, they could easily research foundations and see their pattern of grant making, learning how much went to which nonprofit for what purpose. That is a critical way to gauge what sort of new grant request might succeed in getting money.
With this new approach, the trail goes cold. Knowing that Foundation A made a single grant of $1.5-million to a community foundation tells us nothing about its charitable interests, because we don’t know who the final beneficiaries are.
That’s assuming that the donor-advised fund made any grants at all. Indeed, that is the biggest concern of all: Donor-advised funds don’t have to distribute anything in grants in a given year. Though most, of course, do, and though the average donor-advised fund actually distributes quite generously, they don’t have to.
In other words, a hypothetical $100-million private foundation is required by federal law to distribute $5-million in grants this year—5 percent of the market value of its assets. The foundation could meet that rule by making a single $5-million grant to a donor-advised fund it controls but then not make any grants from that fund.
Technically, the foundation has followed federal regulations. But not a single homeless person has received shelter as a result. Not a single hungry person has been fed. No students have received scholarships, no books have been purchased for libraries, and no patients have been treated.
This is unnerving. Though it’s easy to see why family members overseeing a private foundation don’t want their every move analyzed, the family received a big tax break and great control when they established the foundation. In exchange, the federal government said: We want the community to benefit, and we want everyone to be able to see what you do with the money.
Channeling grant making through a donor-advised fund means nobody can trace what happens to the money. Neither the government nor the public can see who ends up getting charitable funds. Only the name of the intermediary (the charity that houses the donor-advised fund) must be disclosed.
There’s nothing illegal about this maneuver. But that doesn’t make it right. It essentially provides the kind of privacy that specifically is not allowed by federal regulations for private foundations. It reduces transparency—drastically.
This sleight-of-hand approach to grant making strikes me as disingenuous at best. And if this practice grows in popularity (as I’m guessing it might), it may attract the scrutiny of regulators and encourage the creation of new restrictions on donor-advised funds. And, frankly, it should.
