Keeping it Together: Foundations, DAFs, and the Problem of Bifurcated Payments
The end of the year brings a flood of gifts and grants to public charities, as well as perennial questions about how the donor will benefit in return.
As a general matter, individual donors may receive “benefits” in connection with their contributions to charities without jeopardizing their charitable contribution deduction (provided, of course, that the value of any more-than-incidental benefits will reduce the amount of the donor’s deduction) or triggering adverse tax consequences for the recipient charity. In contrast, different considerations apply when individuals or corporations receive benefits in connection with grants made by related private foundations or donor-advised funds (“DAFs”) (e.g., where the individual or corporation is a substantial contributor or trustee or, in the case of a DAF, holds advisory privileges, etc.) with potential consequences for both the entity making the grant and the party receiving the benefit.
The Code imposes an onerous excise tax on “acts of self-dealing” involving private foundations and so-called disqualified persons, including foundation directors, officers, and substantial contributors and certain members of their families (e.g., children and spouses). The receipt by a disqualified person of benefits (other than certain incidental benefits, such as public recognition) resulting from a foundation grant will implicate these rules. Just as charitable assets may not be used to buy a personal membership to a cultural institution or pay for a year of performance tickets, neither may those assets be used to “purchase a table” at a fundraiser for use by members of the founding family and their guests — or, if a foundation is funded by a company, for use by employees and guests of the company. Generally speaking, such a transaction could constitute an act of self-dealing and might be treated by the IRS as a taxable expenditure attracting a further layer of excise tax. In egregious situations, it could even be treated as private inurement (resulting in revocation of the foundation’s tax-exempt status). Note that the self-dealing excise tax is imposed on the person who benefits from the self-dealing, while the taxable expenditure excise tax is imposed on the foundation itself. Foundation managers also may face tax liability. And failure to make a timely “correction” of an act of self-dealing or a taxable expenditure can result in even greater excise taxes.
Although the IRS has issued rulings indicating that disqualified persons who are directors or officers of a foundation may accept tangible benefits (such as tickets to an event) in a “foundation” capacity, e.g., if the purpose of attending the event is to monitor a grantee’s use of grant funds, it may be hard to establish that guests of a director or officer are playing that role. Similarly, the IRS may be dubious of the need for an entire family (even if all of them are on a foundation’s board) to attend a gala dinner in order to monitor a perennial grantee’s worthiness for more funding in the subsequent year.
On occasion, donors who are involved with a foundation suggest bifurcating their contribution. That is, they ask the grantee charity to split the cost of an event ticket in two — so that the “charitable” portion of the ticket is paid with foundation assets and the “benefit” portion is paid by family members (or by the company). Imagine that, in the example above, the cost of a table of ten at the fundraising dinner is $10,000, with the food and entertainment being assigned a value of $200 per ticket (or $2,000 for the whole table). In the bifurcation scenario, the foundation would write a check for $8,000 and the disqualified persons would pay $2,000. In a variant approach, the foundation would pay the full $10,000 and the disqualified persons would chip in an additional $2,000, as a donation to the grantee, in order to offset the value of the food and entertainment. However, even though bifurcation of payments may appear to be a logical and practical solution to the self-dealing problem, the IRS doesn’t seem to agree.
In a 1990 private letter ruling relating to the purchase by a foundation of tickets to various fundraisers, the IRS ruled that bifurcation of the costs of such tickets between the foundation and the corporation that was its main funder (i.e., a substantial contributor and therefore a disqualified person) constituted self-dealing. The IRS determined that the price of admission to a fundraising event is, in fact, fixed. In other words, no one could attend the event simply by paying the charity the fair market value of the evening’s meal and entertainment. So, under the logic of this ruling (and other rulings in this area), if a disqualified person couldn’t attend but for the foundation’s aid in paying the price of admission, the IRS would view the arrangement as an act of self-dealing.
A similar analysis applies in the case of contributions made by DAFs. The Code imposes an excise tax if an advised contribution from a DAF results in “more than incidental benefit” passing to the donor, advisor, or certain others, including some family members. In explaining the concept of an “incidental benefit,” the congressional Joint Committee on Taxation Report on the DAF regulations explained that a person receives more than incidental benefit if, as a result of a distribution from the DAF, the person receives a benefit that would have reduced (or eliminated) a charitable contribution deduction if the person had made the contribution directly. A table at a fundraising gala likely would fall into that category. Accordingly, although the Code does not explicitly forbid bifurcation in the DAF context and the IRS has not issued specific guidance related to DAFs, the legislative history and the 1990 ruling involving the closely analogous context of private foundations have led many practitioners to conclude that bifurcation in the DAF context should be avoided as well.
Foundations and DAFs are not the only organizations that need to be mindful of the bifurcation issue. Recipient organizations may be asked to provide a written statement representing to a funder that no goods or services were provided in connection with a grant. (DAFs in particular make it a practice to seek such statements.) If a recipient organization is aware of a bifurcation arrangement, it may conclude that it is unable to provide a foundation or DAF with the requested statement. And, of course, if a recipient organization has led funders in the direction of bifurcation of payments in the first place, the funders may be upset if they later face tax penalties because of that practice.
Whatever the appeal of keeping donors happy, the possibility of long-term consequences may mean that the short-term benefits simply are not worth it.