TAX SMART GIFTING
Community foundations (CF) were suggested to our family business clients Bob and Judy as a way to overcome the problems they identified with setting up a Family Foundation .
Bob said he was not familiar with CFs. The first thing that came to his mind were charitable organizations such as United Way.
"Unfortunately, Bob is not alone. Too many family business owners AND their advisors do not know or understand the many advantages of a community foundation and how they can be used as an "umbrella" to develop a family foundation," suggests leading family business expert
Schwerzler has been studying and advising family business entrepreneurs for more than 40 years and is the founder of the Atlanta-based
Family Business Institute.
To help define what a community foundation is and how it works,
Schwerzler asked his friend Ray Caraway to talk to Bob and Judy about the role and function that a community foundation can play as part of the succession strategy for family businesses.
Ray is an attorney who has been the executive director of community foundations in Georgia and Colorado. He was asked to respond to the following questions about community foundations:
#1. What is a Community Foundation? In simple terms, a community foundation is a collection of individual charitable funds, each separately accounted for, and each with its own design and purpose. A community foundation provides a wide range of services designed to help donors achieve their charitable dreams. Community foundations also promote philanthropy in a general way and give leadership to community initiatives.
#2. How does it work? Establishing a fund at a CF is simple. The donor will sign a brief fund agreement that will define the nature of the fund. Funds can be established with a minimum donation of usually around $10,000. Most community foundations provide their donors with a great deal of flexibility. It is not necessary to endow the fund, though the donor may choose to do so. If a donor advised fund is established, the donor will receive many of the benefits of having a private foundation, but without the costs, limitations and administrative burdens.
#3. My friends and advisors have never heard of a community foundation - are they new? Community foundations date to the early 1900's, and today there are over 600 CFs collectively managing over $30 billion in assets. However, CFs were primarily a big-city phenomenon up until the last 20 years. Also, some CFs started very slowly and did not experience substantial growth until about the mid-80's. During the 90's CFs grew from about $5 billion in assets to $30 billion and have become a much more substantial force in philanthropy in recent years.
#4. Why do so few people seem to know about Community Foundations? CFs generally do not market to a wide audience. The typical CF donor is more affluent and older than the donor to most other nonprofits. Whereas your local United Way will receive thousands of small donations during its annual campaign, a CF may only establish a handful of new funds in a given year. Even a large CF may establish only a few dozen new funds each year. Yet, nationwide, CFs give away more money each year than do United Ways. Marketing of CFs tends to be done by communicating with professional advisors rather than by trying to approach potential donors directly. Gifts to CFs are often "event-driven" (for example the sell of a business) and may even be once-in-a-lifetime gifts that result from a transfer of stock or real estate.
#5. Will my financial advisors loss their commissions or income if I move my assets into a CF? This would vary from CF to CF, but the trend is to find ways of working in partnership with financial advisors. Many community foundations have arrangements with American Funds, a large mutual fund company, that would allow any broker or financial advisor who sells mutual funds to obtain a commission on a gift to a CF. A new arrangement with Merrill Lynch has also been established that would allow any Merrill Lynch broker to receive a commission from a gift to a CF and continue to be actively engaged in the investment management process. Also, if the gift is very substantial in size (usually at least several hundred thousand dollars) it may be possible for a CF to make a special arrangement regarding investments. And finally, gifts of $1 million or more could be handled through a "supporting organization" arrangement that could give the donor significant control over the investment process. (see question #15 for information on supporting organizations.)
#6. Is there a minimum amount of money one must have to establish a fund with a CF? A $10,000 minimum is common, but this can vary from CF to CF.
#7. Are there geographic restrictions or can a CF be chosen in another state or region of the country? No geographic restrictions apply. And a CF in one region can make a grant to a nonprofit in any area of the country or potentially anywhere in the world. Of course, most donors will want to work with the CF in their region and will usually benefit much more by doing so. It is interesting to note that community foundations around the country come together frequently to share information and ideas and have increasingly found ways of working together. For example, community foundations are now beginning to work together to create web-based resources that can be shared by their donors. And there is a growing trend that sees CFs working together to form alliances with national and regional financial institutions.
#8. What criteria should a family be looking for in selecting a CF to work with? The donor should evaluate the strength of the organization. How qualified is the staff? Who serves on the Board? How fast is it growing compared to other community foundations of similar size? How does its budget compare to other CFs of similar size? (A larger budget may reflect an ability to provide a higher level of service.) How pleased are its current donors? Has the CF adopted the national standards for CFs established by the Council on Foundations? If so, a binder is available to the public with all the CFs policies and procedures. These national standards are new, and many CFs are now in the process of compiling information that will bring them into compliance with these standards.
#9. How does the family know the CF is doing a good job? Talking to current CF donors, grant recipients and local professional advisors (attorneys, CPAs and brokers) is the best way to gage the quality of any CF. Many community foundations have advanced significantly in recent years, so make sure the opinions you get are not based on "ancient" history.
#10. What happens if their CF is not doing a good job - to whom do they complain? As with any service-oriented organization, community foundations are almost always going to be concerned about pleasing their donors and maintaining a good public image. If your fund is not endowed, one option is simply to recommend grants from the fund that would deplete it. Most CFs do not require that you endow your fund. Before depleting the fund, however, the donor should complain to the executive director and, if necessary, the chairman of the board. CFs value their reputations, and a letter to the editor could also be an excellent tool. Consulting with a professional advisor in the community that is familiar with the particular CF would also be a good route to take.
#11. Are the monies in a CF insured by the federal government? No. Likewise any charitable endowment a donor establishes at a university or hospital foundation or any charitable foundation will lack federal insurance. And most any non-charitable investment a donor elects to make, outside of a bank CD, will lack federal insurance. For example, it is unlikely that your IRA or other deferred savings plan is invested in a manner that would be federally insured.
#12. Can a family get involved with a CF before they actually create a family foundation? Yes. Before establishing their own family fund at a CF, a donor can make a contribution to an existing fund. Most CFs have a variety of general funds for various purposes. Most CFs host various events, have web sites and send out newsletters. There should be plenty of opportunities for a potential donor to get to know the board and staff and existing donors.
#13. Under what circumstances would a CF be a wrong consideration for a family business succession plan strategy? There are some CFs that are simply too small or too rigid to be of much help to larger donors. A well managed CF that has adopted a mission focused on "donor services" is almost always a good option to consider as a partner in carrying out your charitable dreams. But, some CFs are more flexible and "donor-focused" than others. The supporting organization arrangement offers a high level of donor control for those who do not feel completely comfortable with a donor advised fund. One prominent estate planning expert has suggested that a private foundation is not an attractive option unless the donor plans to contribute $15 million or more. Obviously, the larger the potential gift, the more viable a private foundation becomes. Yet, it is not at all uncommon for CFs to receive gifts of $15 million or more. In 2003 the Cleveland Foundation (a community foundation) received a $60 million gift, and the Community Foundation Serving Coastal South Carolina received a $34 million gift. Both gifts were from donors who had very specific visions for the use of these funds. The size and type of gift you have in mind, and the level of staffing and sophistication of your local CF are the key factors to consider.
#14. Does the family lose control over the family foundation if it is part of a CF? Yes. The family must part with legal control of the asset to receive a charitable deduction for the gift. CFs are not banks. However, as we have discussed, it is the policy of CFs to provide the donor with a very high level of "practical control." CFs are interested in promoting philanthropy in a general way and in facilitating gifts to a wide variety of community needs. While CFs have an obligation to perform the due diligence necessary to assure that grants are going only to legitimate charitable organizations, CFs are not interested in second guessing advice given to them by their donors. Any CF that fails to respect the advice of its donors will lose favor with existing donors and the professional advisors in its region and will cease to grow. (See question #15 regarding the differences between a donor advised fund and a supporting organization and how these differences might impact the level of influence the donor maintains over the fund.)
#15. How involved can the family be in a foundation or fund that operates under the umbrella of a CF? Very involved. Donor advised funds provide an opportunity for donors to remain actively involved with their fund. It is the policy of CFs to follow the advice of their donors as long as the donor recommends grant recipients that serve the community in a way that is consistent with the very broad mission of the CF. The better question may be: "To what extent will the CF and the donor work together in the grantmaking process?" This will depend largely on the donor. Some donors express a desire to get input from the CF and to be taken on site visits to nonprofits before making grant recommendations to the CF. Donors who want to take full advantage of the CF's staff and board by requesting information on area nonprofits, connecting with other CF donors and becoming involved in the CF will be given ample opportunities to do so. Other donors have a very clear sense of who they wish to see benefit from their donor advised fund, and they desire little contact and input from the CF.
For large gifts in the $1 million or more range, the supporting organization (SO) arrangement goes one step further than the donor advised fund in allowing flexibility and active involvement to the donor. The SO is a separate legal entity with its own governing board. It can operate independently for the most part, or it can contract with the "supported organization" (the CF) for a variety of services, such as accounting, tax filing, grantmaking administration and investment management. Hence, an SO could exercise greater control over investment and accounting functions if the donor elects to do so. However, the most common form of SO must, by law, allow the CF to appoint a majority of its board members. (This is known as a Type I SO.) Most CFs, however, will accept advice from the donor regarding the 51% of the SO board that the IRS requires the CF to appoint. Hence, the donor ends up with a board that understands his or her charitable vision, and the CF maintains a level of oversight that serves as an insurance policy against potential abuse. Private foundations have been subject to abuse, and the IRS looks favorably on the SO arrangement due to the oversight role the CF plays. Essentially, an SO is an arrangement whereby the donor obtains the advantage of "public charity" status in exchange for allowing the CF an oversight role. As a result of this public charity status, donations to an SO receive more favorable tax treatment and are less stringently regulated by the IRS than a donation to a private foundation. If the donor understands and respects the oversight role of the CF, and if the CF appreciates and values the charitable vision the donor wishes to carry out through the SO, this arrangement can be the "best of both worlds", combining the best qualities of both a private foundation and a community foundation.
#16. What are the costs associated with creating a charitable fund with a CF? There is no fee to establish a donor advised fund. The fund will be charged an annual administrative fee which usually is between .75% and 1.50% depending on the particular CF and on the size of the fund. Very large funds may be charged even less than .75%. Most CFs charge an administrative fee that is very competitive with the commercial options available to donors while attempting to provide unique opportunities to the donor along with a level of personal service and donor recognition that commercial organizations don't event attempt to provide. The donor should also be happy to know that the fee he or she pays to the CF helps to promote philanthropy and to build a better community in a variety of ways. By contrast, the fee paid to a commercial entity simply serves to generate a profit for the organization's stockholders.
#17. How long does it take to create a charitable fund with a CF? The donor advised fund can be created in a few minutes at the CF office and with no legal fees or initial costs of any kind. Ongoing costs will be limited to the annual administrative fee mentioned above. The SO requires an attorney to create the new legal entity and must apply to the IRS for separate 501c3 status. This could cost as much as a few thousand dollars. Maintenance of the SO will also be more expensive since it will require an annual audit and the filing of a separate tax return.
#18. As a family business owner thinking about developing an exit strategy from my business and interested in the concept of a family foundation, who should I first contact to get the ball rolling - my financial advisor, the CF, my CPA or my attorney? Any professional advisor experienced in working with private foundations and CFs would be a good starting point. It is best to select one professional advisor as the "quarterback" for the process, but to include one or more additional professional advisors to assure a full range of expertise. An attorney will always be needed to draft legal documents. And a knowledgeable CF staff member experienced in working with similar donors is a great resource to you and your team of advisors. Many professional advisors have a passing knowledge of CFs, but few have worked with them enough to fully understand their advantages and limitations.
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Ask our experts for help in devising your family foundation under
a community foundation umbrella.
* Don Schwerzler has been studying and advising family businesses for more than 40 years. His web site located at http://www.family-business-experts.com provides tips and success strategies that help family businesses grow and maintain healthy family relationships - and then when the time is right, to help transition the business to the next generation.
* Ray Caraway is the Executive Director of the Community Foundation of Northern Colorado. An attorney, Ray served as Executive Director of two other foundations. The Community Foundation of Northern Colorado is governed by a thirteen-member Board of Trustees with Local Advisory Boards in Fort Collins, Loveland, Estes Park and Berthoud. www.nocofoundation
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