Published in the March/April 2009 issue of Nonprofit World magazine
As the United States undergoes one of its most challenging economic times in recent history, charitable organizations are among the groups most hard hit. Charitable donations have slowed or disappeared altogether in recent months, and that trend is expected to continue into the new year. Many service-oriented charities are adversely impacted by the increasing cost of providing services, coupled with the higher demand for services by those who have lost jobs due to the economic downturn, suffered at the hands of ongoing natural disasters, or are otherwise financially constrained. Moreover, charities are impacted by the increased restrictions upon the credit market, which has affected the ability of some charities to obtain much needed short-term credit to help pay for ongoing expenses. In light of these pressures, this article discusses five potential options charitable organizations might consider to help enhance fundraising efforts and stay afloat during difficult financial times.
A. Encourage Donors to Take Advantage of Low Interest Rates
Certain charitable giving techniques take advantage of low interest rates. Each month, the IRS publishes an interest rate (known as the Section 7520 rate), which is the rate used for a number of charitable planning techniques. The Section 7520 rate for November is 3.6%. By comparison, the Section 7520 rate for November of 2007 was 5.2%.
One technique that is more attractive to donors when interest rates are low is the charitable lead trust (CLT). The mechanics of a CLT provide that a charity receives an interest for a period of years. The interest could be expressed either as a dollar amount or as a percentage of the assets held in the trust. At the remainder of the term, whatever amount was left in trust would pass to the specified individuals. Depending on the structure of the CLT, the donor may receive an income tax deduction, and, significantly, the individual donees receive the remainder interest at little or no gift tax cost to the donor.
Consider a hypothetical donor who might contemplate this technique, particularly when interest rates are low. Mother is interested in setting up a trust fund for her children. Her stock portfolio is down, but she anticipates that it will grow over time. She is also interested in benefitting her favorite charity, to which she typically makes annual gifts, but her primary goal is giving as much to her children as possible without incurring gift tax. Mother could transfer $1.0 million of her stock to a CLT that would pay her favorite charity $120,849 each year for ten years. Even if the stocks contributed grew as little as 5% annually, there would still be $108,871 left at the end of the term for her children. An 8% return would provide $408,241 for her children.
If Mother had made the same transfer in November of 2007 when interest rates were higher, the amount that would be required for the charity would be $130,765, and 5% growth would have left nothing for her children. From the perspective of a donor like Mother, a low Section 7520 rate makes a CLT look more attractive.
From a charity's perspective, it is true that low interest rates will decrease the amount required to be distributed to the charity each year by a relatively small amount. The attractiveness of the technique to donors, however, means that charities may be able to encourage more donors to take advantage of it.
B. Draw on Demand for Fixed Income by Offering Charitable Gift Annuities
In difficult economic times, a donor may find security in receiving a fixed payment for life. A charitable gift annuity may be the answer to a donor interested in benefitting a favorite charity while receiving such a payment. The donor may find the gift annuity to be more favorable than a technique, such as a charitable remainder trust because the charity's assets, not just the amount donated, are on the hook for payment.
In a charitable gift annuity, a donor contributes property to a charity (typically appreciated property) in exchange for an annuity payment for the remainder of the donor's lifetime. The annuity would be lower than fair market value, and the difference is the gift element to the charity.
Although donors may find this arrangement more favorable in difficult economic times, charities should take particular care to ensure compliance with regulatory and tax rules regarding charitable gift annuities. For example, in order for the charity to avoid unrelated business income tax, the gift portion of the annuity must have a value of at least 10% of the value of the property. This is more difficult to achieve when interest rates are low. Nevertheless, with careful planning, a charity may find that a charitable gift annuity is a valuable tool for attracting donors.
C. Stay Ahead of the Charitable Rollover Rules
The Tax Extenders and Alternative Minimum Tax Relief Act of 2008 extended the time available for making a tax-free direct distribution from an IRA to a charity. The law as originally enacted under the Pension Protection Act of 2006 only provided this ability to donors making such distributions in 2006 and 2007. The new Extenders Act version allows the same treatment for distributions made in 2008 and 2009.
During this time, an individual over age 70-1/2 can exclude from gross income a distribution up to $100,000 made directly from an IRA to a qualified charity. Qualified charities do not include private foundations or donor-advised funds.
At first glance, this provision does not seem particularly favorable, as donors may simply withdraw from an IRA, include the withdrawal in gross income, make a charitable contribution with the funds, and receive a charitable deduction. However, there are a number of hidden rules in the tax code that make this treatment less favorable. In some cases, a donor is limited in the amount of deduction that can be taken, and in others increased gross income results in other negative tax effects.
This new law may appeal to donors who are over age 70-1/2 and who have significant IRAs. Because this treatment is only available for a limited time, this is a good time to encourage these donors to make charitable gifts using their IRAs in compliance with these rules.
D. Team Up
One of the most effective ways charitable and other nonprofit organizations can maximize their resources, while expanding the breadth of their missions and services, is to partner with other organizations. These partnerships can be limited in scope (e.g., a one-time fundraising campaign) or ongoing. Charities that have similar missions may want to consider how they can combine programs to expand the reach of their services in a particular region. But partnering does not have to be limited to like-minded organizations. For example, nonprofit organizations with differing missions can pool administrative resources. Alternatively, a charity can team up with a for-profit entity to engage in a commercial co-venture (e.g., an arrangement that promotes a product or service with a representation that a part of the sale proceeds will benefit the charity) or a joint venture (e.g., a partnership with a nonprofit or for-profit entity that helps further the charity's exempt purpose).
Before teaming up with another organization, consider the following:
- Scope, duration, and termination - Clearly define the scope of the relationship, including the resources that will be placed into the joint enterprise, the outcomes that will be derived from the joint enterprise, and the anticipated length of the relationship. Equally important is planning for a sound exit strategy at every step of the joint enterprise. Although all parties hope for the best, it is important to anticipate and prepare for an earlier termination.
- Intellectual property - Preserve the integrity of your organization's name, logo, and other forms of intellectual property through one or more written agreements. These agreements should outline the basic terms for granting another entity the right to use your organization's intellectual property, such as the manner and conditions under which the intellectual property may be used (and a provision outlining when further approval is needed), clear identification of ownership rights, and an ability to terminate use of the intellectual property at the owner's discretion. In addition, there should be a clear agreement regarding the ownership and license rights of any intellectual property that is created through the joint enterprise (e.g., will it be jointly owned by the parties, owned by the joint enterprise itself, or owned by one of the partnering entities with perhaps a license to the other party(ies)?).
- Tax considerations - Tax-exempt organizations must take care to ensure that any joint activity does not interfere with the organization's tax-exempt status. To this end, a charity must ensure that the joint enterprise furthers its tax-exempt purposes. Carefully consider whether the joint enterprise might adversely impact your organization's tax-exempt status (e.g., through excessive private benefit) or result in unrelated business income. Moreover, when engaging in a joint venture with for-profit entities, be sure that the joint venture adheres to the requirements set forth by the IRS, including that, at a minimum, the tax-exempt organization controls (e.g., voting control, veto power) either: (a) the entire joint venture in a whole joint venture (joint enterprise with a for-profit where the tax-exempt organization devotes all of its assets to the joint venture); or (b) the charitable aspects of the joint venture in an ancillary joint venture (joint enterprise with a for-profit where the tax-exempt organization only devotes a portion of its assets to the joint venture).
- State/local compliance - Ensure that the joint enterprise complies with all applicable state and local requirements. For example, if the joint enterprise will seek charitable contributions or proceeds, make sure that the activities adhere to the requirements of state charitable solicitation and/or commercial co-venture laws of each state in which it actively seeks charitable contributions or proceeds. In addition, where the joint enterprise results in a separate legal entity (e.g., a limited liability company), ensure that the entity complies with all corporate formalities, including having separate organizing documents, board meetings, and financial books and records, among other formalities. Also, where the joint enterprise will be managed/staffed by one of more of the participating nonprofits, use an affiliation agreement to help ensure arm's length transactions and that the separate legal status of the joint enterprise will be respected.
E. Consider Tax-Exempt Bond Financing
Charitable organizations also should consider taking advantage of the potentially lower interest rates available to tax-exempt organizations to finance capital needs using tax-exempt borrowing. Such borrowing typically requires the involvement of a government unit to act as the conduit that enables the tax-exempt characterization of the interest for the lender. Many state and local governments have programs available to assist tax-exempt organizations in accessing the tax-exempt debt markets. Such financings may range from a capital lease financing to acquire equipment to a long-term loan to acquire office facilities (e.g., in some high rent markets, even relatively small and moderate size charitable organizations have used tax-exempt financing to acquire condominium office facilities for their headquarters in lieu of continuing to pay rent).
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Charitable organizations can use the foregoing strategies to help enhance their fundraising efforts despite the challenges presented by the current financial crisis. Consider expanding or enriching your organization's fundraising efforts to include CLTs, charitable gift annuities, and charitable rollovers. In addition, find innovative ways in which you can partner with other entities to expand your fundraising and revenue-generating opportunities while minimizing your expenses. Finally, considering utilizing the lower interest rates available through tax-exempt bonds to help finance capital projects.
For more information, please contact Ms. Kahl at (410) 244-7584 / sbkahl@venable.com, or Ms. Thomas at (202) 344-4596 / azthomas@venable.com.
This article is not intended to provide legal advice or opinion and should not be relied on as such. Legal advice can only be provided in response to specific fact situations.