Why do Donors overlook Supporting Organizations?
by Randy Fox
In the considerably complex world of philanthropy where the goal is to give away money in order to effect positive change in the world, donors are faced with a number of choices: where to give their donations; what to give; and how to give are all part of the decision process. While much of giving is evidenced by emotional response and writing a quick check, the realm of planned giving is decidedly different. With planned gifts there is a considerable amount of thinking, structuring and, well, planning entailed. When large gifts are contemplated, the what and the how of the gift become very important. Often overlooked in the pantheon of planned gifts, is the Type one Supporting Organization (SO). Used in its place as the default is the Private Foundation (PF). This article will compare and contrast the two and allow the reader to make his own conclusion about the benefits and drawbacks of each.
Private foundations are independent legal entities (organized as either corporations or trusts) established solely for charitable, religious, educational, scientific or literary purposes and controlled and funded by a single family, individual or business. There is no public fundraising involved with a PF. PFs are mandated to distribute 5% of their assets on annual basis. PFs allow the family to employ children for reasonable compensation for work performed and can be a good training ground for financial and philanthropic responsibility. Unlike public charities more liberal tax regime, PFs are governed by different, more restrictive tax rules. Table 1.Private FoundationPublic CharityAdjusted Gross Income (AGI) Limits on Cash Gifts 30% 60% AGI Limits on Appreciated Property 20% 30% Fair Market Value Deduction for Gifts other than publicly traded stock No. Limited to Cost basis Yes
While PFs can receive low basis assets and sell without incurring long term capital gains tax like other charitable vehicles, the tax efficiency is otherwise severely limited. The most distinctive and positive factor for the PF is that the founding family (or business) has complete control over the decision making at every level.
Supporting Organizations (SOs) are little appreciated and often misunderstood. Since they fall under public charity status. That is to say that the limits on AGI for tax deductions are like any other public charity. SOs are formed by a public charity to “support” that charity in some way. They must pass four tests: the organizational test, the operational test, the control test and the relationship test. While this might seem overly complex, the governing 501 (c)(3) is responsible for all of the necessary compliance steps in much the same way as hiring an outside firm to administer a PF. In its simplest form, then a type 1 SO can function much like a PF. The major drawback is that the family does not have the same absolute control. The governing charity must have the final say. Therefore, for those interested in a type 1 SO, the trick is to find a charity that is established for these very purposes.
There are a few other advantages to the SO structure to consider. PFs are subjected to their own set of rules. Elegantly known as the Private Foundation Rules, they include a limit on “Excess Business Holdings” as well as rule against “Jeopardizing Investments.”
The excess business holdings rules are meant to prevent families from controlling their private businesses inside of a tax exempt entity. They restrict the percent of ownership of any business enterprise to strict limits in order to avoid over concentration of holdings. This can be a significant drawback to the PF when a family desires a charitable outcome and much of their wealth is concentrated in a closely held business. The SO is not governed by the same rule. Therefore there is much more flexibility available to the family when they desire to give their business away and still operate it at some level.
Jeopardizing investments provides another differentiation between the SO and the PF. Though not strictly defined in the code, the guidance provided by the IRS considers many investments unsuitable for a PF. These include option trading, oil and gas working interests, short selling and other risky strategies. Even a highly concentrated position in one stock might fall under these rules. Once again, an SO does not fall under these rules since the service knows that the governing charity must agree with all investment decisions suggested by the SO’s stake holders.
One other minor benefit of the SO is that unlike the PF, the donors name does not appear in public records. A PF files an organizing document and a form 990 PF. The names of the donors are fully disclosed to the public, making the name private foundation a bit of a misnomer. With a SO, the charity’s organization is what is disclosed, and the donors can remain anonymous. Table 2.Private FoundationPublic CharityLimits on Excess Business Holdings Yes No Subject to Jeopardizing Investment Rules Yes No Donors Public or Private Public Private
For many advisors and many families, the default to private foundations or, alternatively, Donor Advised Funds is often the easy way out. However, the type 1 Supporting organization offers a viable, and in many ways’ superior alternative, to these other structures for the family who is willing to cede a small amount of control. Of course, one challenge is to identify a charitable organization that is equipped to provide the SO structure as described. Such organizations are available and willing to serve the advisory community and the willing public.
For more information contact: randy@twohawksconsulting.com