Donor-led and family foundations use creative alternatives to charitable giving
Despite the economic recession, private foundations (PFs) led by individual donors and by families continue to form, grow and increase their grant making — in one way or another. Indeed, a recent analysis of the giving patterns of 700 Foundation Source clients revealed a nearly 15 percent increase in the number and value of grants of less than $1 million made in 2009. This runs counter to trends among large institutional PFs that have decreased their giving in the face of the economic downturn.1 It also suggests that PFs remain extremely popular as vehicles for charitable giving, particularly smaller PFs that are governed by individuals or families. (See “Foundation Giving 2008-2009,” p. 36.)
There are many reasons for the continuing popularity of PFs, including donor control over grants and investments, the ability of a family to work together toward a common philanthropic mission and using the PF as a means to transmit personal values over generations. Another reason frequently overlooked is the remarkable flexibility that only PFs afford their donors for creative giving with tax-privileged assets.
As savvy donors and advisers increasingly realize, PFs aren't limited to conventional grants or donations only to public charities to satisfy PFs' charitable goals or their annual 5 percent minimum distribution requirement. In fact, there's a range of grant-making alternatives such as program-related investments (PRIs), grants to individuals and direct charitable activities that are becoming increasingly popular for donors looking for greater flexibility, creativity and impact.
PRIs are an alternative to grants. They're loans, loan guarantees and equity investments that the PF makes for charitable purposes. Unlike grants, which are gone once they're paid out, PRIs can be “recycled” and the assets used over again multiple times. Just like grants, however, they count towards a PF's 5 percent annual distribution requirement. Used appropriately, a PRI strategy allows PFs to make loans directly to charitable organizations and, under the right conditions, non-charitable organizations that meet special criteria, resulting in highly targeted philanthropy that doesn't drain the PF's assets.
As with conventional investments, PRIs are made with the intent of getting the principal back from the borrower. The key difference is that they're used for charitable purposes, not for earning a return on investment.
The genesis of PRIs lies with the jeopardizing investment rules Congress promulgated in the federal tax code. Put simply, these rules forbid PFs from making investments that are so speculative that they place the PF's assets at unreasonable risk and thus endanger its ability to carry out its mission. Traditional investments may run afoul of these rules, but in Internal Revenue Code Section 4944(c), the Internal Revenue Service includes an exception that allows PFs to make PRIs.
A PF often makes a PRI loan when a commercial loan isn't feasible or attainable. It can be low interest, no interest, secured or unsecured or provided in the form of a guarantee. IRS letter rulings permit interest rates as high as 15 percent on PRIs under certain circumstances involving significant risk.2 An even higher interest rate may be appropriate in charitable situations that are so risky that no commercial lender would consider it. As with commercial loans, the amount of the loan depends on the risk profile of the borrower.
Typical borrowers of PRI loans are community-based organizations (for example, schools, houses of worship and community development organizations). Families in dire situations may also qualify for mortgage assistance and other forms of relief. The chain of events leading to a PRI loan usually begins with a request from a church, a synagogue, a community organization or an individual seeking help because a bank denied a commercial loan application. The PF then makes a low or no-interest loan and takes back a promissory note. Repayment terms can vary widely from a pre-set annual repayment over a determined period of time to balloon payments. It's even possible to structure the loan so that it will be incrementally forgiven if the borrower meets certain pre-determined milestones for financial stability. For example, a Foundation Source client made a $20,000 loan to a church that ran into cost overruns on a needed construction project. Interest was set at 6 percent; the church executed a promissory note and committed to a repayment plan over several years. The project was finished on time and the church was able to accommodate more congregants and activities.
It's also possible to provide a loan guarantee instead of an actual loan. This allows a PF to shore up the borrower/grantee's credit to secure financing that wouldn't be available otherwise when credit is tight. Instead of a grant, the PF guarantees a loan with a low-interest deposit at the bank. One PF established a no-interest loan fund to cover immigrant families that lacked access to credit and had difficulty providing rent and utility deposits, which limited access to safe and suitable places to live. The loans allowed families to move into apartments in better neighborhoods and to stabilize their daily lives.
PRIs may also be structured as equity investments in enterprises that have a clear charitable mission. Examples include venture financing to start local businesses that help lift people out of poverty or to support important social causes that for-profit investors may ignore. Such businesses might include bakeries employing homeless people, craft shops in undeveloped parts of Africa or, on a more ambitious scale, small biotech research companies in the United States working on therapies for rare types of cancer or other legitimate, cutting-edge medical research that falls outside the funding mainstream. Whether as an innovative way to fight poverty or fight cancer, PRI equity investments appeal to donors who wish to use business techniques to dramatically change lives through modest, targeted investments.
For example, one donor was very focused on raising people out of poverty in remote villages in Rwanda. The PF liked the idea of providing micro-loans to Rwandan seamstresses, bakers and crafts makers, but it didn't want to be directly involved in managing the support. The answer was to make an equity investment in a Rwandan bank whose sole mission was providing these types of micro-loans. Similarly, donors have made PRI equity investments in companies that provide water purification systems for remote villages in South America, as well as for manufacturing mass-market AIDS testing kits.
In a recent letter, the American Bar Association provided comments on proposed additional examples of PRIs and asked the IRS for its opinion concerning a PF interested in investing in biotech space and research on treatments for a rare form of cancer.3 The PF wanted to know if this investment would qualify as a PRI. Studies indicate that a cure might be found within 10 years. A small biotech company is working on a promising drug, but the development costs are so high that no pharmaceutical company is willing to invest. The PF decided to make a direct equity investment in the biotech company to fund its research. From the IRS' perspective, this investment should qualify as a PRI because the biotech company is simply the agency through which the PF is pursuing its charitable mission.
Direct Charitable Activities
Most PFs erroneously believe that they must set up an operating foundation to run their own programs. However, it's also possible for a non-operating foundation to run charitable programs by engaging in what's called “direct charitable activities.” Direct charitable activities are those in which a PF maintains significant involvement in directly running a charitable program rather than making a grant to a recipient who carries out the activity. For many years, large institutional PFs have used them to convene conferences, provide training and support staff. More recently, entrepreneurial-minded heads of smaller PFs have begun to realize that direct charitable activities can also be an excellent way to achieve their charitable objectives.
For example, Foundation Source clients are supporting direct charitable activities as diverse as removing old lockers from a country club and installing them at a charter school; erasing gang tattoos from paroled California prison inmates preparing to re-enter society; establishing a museum dedicated to introducing kids and young adults to the wonder of mathematics; supporting unwed Korean mothers who face severe social stigma having children out of wedlock; providing highly durable soccer balls to kids in war-torn and disaster ravaged countries; and teaching Western science to Tibetan monks. These kinds of direct charitable activities provide donors with the ability to have a direct and immediate impact on their philanthropy.
Grants to Individuals
Donors and advisers often aren't aware that PFs may make grants to individuals for emergency relief or hardship assistance without prior IRS approval, provided that the PF attaches no conditions on how the grant proceeds will be spent and that it follows specific guidelines.
In the past, PFs often avoided making grants directly to individuals and households because they found the rules ambiguous and difficult to decipher, and many donors feared they would inadvertently violate them. Foundation Source has worked with the IRS to create appropriate procedures and guidelines to enable its clients to make these grants much more easily.
We've developed a special program for clients to award up to $5,000 annually to economically disadvantaged individuals and households suffering a transitory hardship, such as job loss, illness or temporary displacement. Hardship victims must meet certain income and asset criteria, and a trusted third party (for example, a clergyman, healthcare provider, social worker or guidance counselor) must validate the need for support. Here are some examples of the different types of hardship grants.
One PF took advantage of hardship assistance grants to provide help to low-income families facing credit problems, eviction, utility shut-offs and other onerous legal challenges. The PF partnered with a local non-profit organization that identifies qualifying hardship cases to the PF and helps the individuals in need fill out simple application forms. The PF then directed small but significant grants to the qualified individuals through the nonprofit. For example, the PF directed $1,200 to an impoverished grandmother to pay electric bills and avoid utility shut off, which in turn threatened her ability to obtain public benefits. The PF has made over a dozen similar grants over a nine-month period, helping it to achieve its core mission of helping people of limited means and resources stay out of poverty.
Similarly, PFs can make donations of up to $5,000 in any 12-month period to those unable to meet their basic needs due to a life-altering emergency, tragedy or natural disaster, such as hurricanes, floods, fires, earthquakes, storms or riots.4 Recipients, regardless of their financial status, can use emergency assistance for food, clothing, housing, transportation, medical treatment and professional counseling. However, the PF can't stipulate precisely how recipients may use these funds.
In another case, a PF was asked to provide emergency financial relief to the victims of the Samoan tsunami. Because such emergency funding (whether in-kind or cash) wouldn't be for travel study or similar purposes, the PF was able to distribute aid without getting prior IRS approval of the program. The PF made numerous grants in this way, which were documented with photos and details concerning the date and place of its disbursements, the type of assistance (cash, food, etc.) and the number of victims assisted.
In fall 2007, a series of wildfires wiped out hundreds of homes in the San Diego area. Several PFs set up programs to identify displaced families in need and speedily provide them with grants ranging from $1,000 to $5,000 to rent apartments and to buy clothing, household and school supplies.
When Hurricane Ivan devastated the Florida panhandle in 2004, a donor living in the area wanted to act quickly to help local victims. The donor was able to make emergency grants for food, shelter, clothing, necessities and cash assistance to 100 families in immediate dire need.
These examples of aiding people in times of urgent need through hardship assistance grants describe charity in its most basic and fundamental form. They are also classic examples of how alternative approaches to charitable giving can make a huge difference in people's lives. (See “More Real-life Examples,” this page.)
Attorneys and Advisers
PRIs, grants to individuals, and direct charitable activities are innovative approaches to charity that enable donors to expand their philanthropic toolbox, do more and derive greater satisfaction from their philanthropy. Navigating federal and state rules and regulations to take advantage of these creative approaches need not be a discouraging experience. Attorneys and other philanthropic experts who are well-versed in Treasury Regulations Section 53.4944-3 can help make using these methods easy and enjoyable for donors.
Rules of Thumb
Keep in mind a few general rules when considering these kinds of approaches:
- Emergency and hardship assistance can be given to individuals known to the PF so long as the PF also provides assistance to those outside the immediate sphere of the donors' social contacts. The decision to provide funding must be based on an objective evaluation of the factors that influenced the selection of the grant recipient.
- Loan guarantees made by PFs only count towards satisfying the 5 percent annual payout requirement if and when the PF is called upon to honor the guarantee in the event of the borrower's default.
- Conventional grantees are required to submit reports on how their grants are used, but when the borrower or investee is a public charity, the report requirement is waived. The best practice, however, is for PFs to choose to require borrowers and investees to provide reports.
- When making a direct equity investment in a company for a charitable purpose, it's usually desirable to create a side agreement between the investing PF and the company to clearly memorialize the charitable intent of the investment.
More Real-life Examples
Private foundations that have made a difference through program-related investments (PRIs) and direct charitable activities
The Martin Family Charitable Foundation Inc. helps a church in Northeast Washington D.C. A $20,000 PRI loan at 6 percent helped an inner-city church complete a stalled construction project. The loan was secured by a first deed of trust on the church property and a promissory note.
Renova International Foundation supports laser tattoo removal program for prison inmates. Concerned about helping paroled prisoners make a successful return to society, including finding gainful employment, and encouraged by area district attorneys and prison authorities, the Renova International Foundation began a program to remove gang tattoos from those in prison, juvenile hall, on parole or on probation. Through its direct charitable activity, the PF bought a special laser and organized area dermatologists to volunteer to perform removal operations.
The Elizabeth & Michel Sorel Charitable Organization Inc. funds music competitions. Begun by a family member who was a child piano prodigy, the Sorel Organization's direct charitable activities support its mission of promoting women musicians by launching competitions for female pianists, vocalists and choral composers.
The Mathenaeum Foundation launched the Museum of Mathematics in New York City. A former university professor and hedge fund manager discovered that the largest math museum in the United States, the National Museum of Mathematics, was just a small room in a building in Queens, New York. His newly created Mathenaeum Foundation provided funding to help transform the museum into a professional exhibition space capable of supporting programs that would draw attention to the importance and wonders of math.
The Carl Marks Foundation Inc. supports Korean unwed mothers. Rick Boas adopted a girl from Korea over 20 years ago and later learned that unwed Korean mothers face tremendous social stigma in their native country. In response, he created the Korean Unwed Mothers Support Network (KUMSN), which directly helps Korean unwed mothers and their children through support and empowerment programs and works to change attitudes towards unwed mothers. KUMSN maintains an office in Seoul.
— Foundation Source
Jeffrey D. Haskell is chief legal officer and Page Snow is chief philanthropic officer of Foundation Source in Fairfield, Conn.
- The Foundation Center, Foundation Growth and Giving Estimates, 2010 Edition, http://foundationcenter.org/gainknowledge/research/pdf/fgge10.pdf and The Giving USA Foundation and The Center on Philanthropy at Indiana University press release, “U.S. charitable giving falls 3.6 percent in 2009 to $303.75 billion,” June 9, 2010.
- Private Letter Ruling 8301110 (Oct. 8 1982) (approval of construction loan in blighted area at 15 percent annual interest over a 25-year term).
- Stuart M. Lewis, Chair, The ABA Section of Taxation to Hon. Douglas Shulman, Commissioner, Internal Revenue Service, March 3, 2010, www.abanet.org/tax/pubpolicy/2010/Comments_Concerning_Proposed_Additional_Examples_on_Program_Related_Investments.pdf.
- The $5,000 limit reflects informal discussions with the IRS and is recommended by Foundation Source as a program guideline.