Three Key Benefits of Establishing a Corporate Foundation

Provides Consistent Funding for Charitable Programs
A corporate foundation can be a vehicle to build up a charitable reserve in years of higher profits, allowing for a steady flow of charitable grants to organizations in leaner years.[1]  Companies can donate appreciated assets or make a large infusion of cash to establish an endowment. Corporate foundations can be used to fund grants to public charities, pay employee matching grants, or administer scholarship programs for employees’ family members.

When grants are made directly out of a corporate giving department, the funds may be required to be expended during the period for which they are budgeted.  This reduces the control the corporation has over the strategic timing of grants, including support of larger charitable projects.  It should be noted, however, that many companies simply fund their foundation with the same amount as they grant out each year. When considering the compliance obligations that come with the operation of a tax-exempt entity (see below), a company with this type of funding and grant-making strategy may not find that a corporate foundation provides sufficient value vis-à-vis the regulatory burdens.

Accomplishes Strategic Programmatic Objectives
Companies are increasing their focus on issues that align with the companies’ brand(s) and the philanthropic concerns of their customer base.  Financial institutions, for example, may emphasize financial literacy and inclusion issues, while athletic and outdoor gear companies may align their charitable giving towards healthy living and environmental protection initiatives.  In many instances, companies want to not only make strategic grants, but also to operate their own programs that further their charitable objectives. Having a dedicated charitable entity through which the program will operate can help the business maintain its charitable mission focus.

Companies that decide to establish corporate foundations must ensure that they do not use charitable assets to improperly benefit the business.  Companies should review any such initiatives with legal counsel to safeguard against violations of the IRS’s rules prohibiting self-dealing.[2]

Allows One Charitable Entity to Receive Steady Contributions Triggered by All or a Portion of Sales of the Company’s Goods or Services
A number of companies have formed corporate foundations that receive donations triggered by customer sales. Through this structure, the charitable cause becomes part of the brand identity. The IRS, recognizing that payments to charities can, in fact, benefit a business’s bottom line, issued a General Information Letter in 2016, stating that a new group of socially conscious companies formed as “benefit corporations” may treat payments to charitable organizations as a business expense rather than as a charitable donation so long as the payments “bear a direct relationship to the taxpayer’s business and are made with a reasonable expectation of a commensurate financial return.” The General Information Letter therefore clarifies that benefit corporations can take unlimited business expense deductions on their charitable contributions as opposed to limiting such deductions to the standard 10% cap for corporate donations to charitable organizations.

While IRS regulations do provide other advantages that come with the operation of a corporate foundation, such as facilitating employee matching grants and scholarship programs, today, a number of independent public charities exist that manage such programs for companies, obviating the need to form a separate foundation for this purpose.  As such, these charitable programs no longer seem to be key drivers for companies to form corporate foundations.

Three Reasons Companies May Not Want to Establish a Corporate Foundation

Meeting the Compliance Obligations of Corporate Foundations Can Be Costly and Time-Consuming
A corporate foundation is a separate legal entity, whose board members owe a fiduciary duty to act in the best interest of the foundation.  In addition, a separate annual financial report must be filed with the IRS.  Corporate foundations that fundraise, either by being the beneficiary of charitable sales promotions conducted by their founding company, or by soliciting customer donations, may need to register to solicit charitable contributions in up to 38 states, each requiring annual renewal.  The state registration process also requires the foundation to prepare and file audited financial statements, adding to the compliance burden.

Companies should evaluate whether the anticipated annual donations and the sought-after social impact outcomes are significant enough to warrant taking on the cost of compliance.  In many cases, the same results could be achieved through a direct relationship with one or more existing charities, wherein the partner charities are responsible for their own compliance.

The Self-Dealing Rules Can Be Challenging
The IRS prohibits private foundations from engaging in certain financial transactions with certain “disqualified persons,” a category which includes the founding company.  For example, the company’s provision of goods or services to the foundation at a significant discount would be a violation of the self-dealing rules (although donating such goods or services is permitted).  Companies must carefully navigate any financial transactions, including shared expenses, to ensure that the corporate foundation’s charitable assets are not used in a manner that violates the self-dealing rules.

Certain Grants Require Burdensome Oversight Obligations
International grants and grants to non-charitable entities to support charitable activities may be undertaken by corporate foundations, but the federal tax code requires the foundation to follow special grant oversight procedures.  Foreign grants also require additional oversight.  Today, a number of charities serve as charitable giving vehicles through which donors (including corporations) can make such grants, and will undertake the required grant oversight, while the corporation can receive the full tax-deductible benefits. The fees charged by these third party charities to provide grant administration and oversight services may be less than the costs of operating an affiliated foundation, and come with the benefit of staff trained in the IRS’s requirements and best practices for grantmaking.

Companies Can Achieve Their Social Impact Objectives Using Strategies That Work Alongside, or in Place Of, a Corporate Foundation

Direct Corporate Giving
Companies can make direct tax-deductible donations to 501(c)(3) tax-exempt charities, either in the form of restricted gifts (documented through a grant agreement) to support a specific charitable purpose or program, or unrestricted grants. Companies are also uniquely positioned to donate significant volumes of in-kind goods to organizations that will distribute them to individuals, families, or organizations in furtherance of charitable purposes.  Sponsorship agreements allow the company to connect its brand to the brand of a charitable partner and its programs. Many longstanding businesses strategically utilize direct corporate giving alongside the work of their corporate foundation. Walmart recently rebranded the collective corporate giving efforts of the company and its foundation under the new philanthropic name, Walmart.org.

Cause Marketing
Cause marketing campaigns, whereby the company advertises that the sale of its goods or services will result in a donation to a charitable organization or cause, or otherwise engages its customers to take actions to support a cause, can be conducted to benefit an unrelated charity or a company’s own corporate foundation.  Partnering with a reputable independent charity allows the company to benefit from a charity’s strong reputation and proven record of making a real impact on a charitable issue. During the last decade Subaru of America achieved success by donating $140 million to four national charities and hundreds of local nonprofits as part of its annual Share the Love cause marketing campaign.

While less common, a few companies have made their own corporate foundations the beneficiary of cause marketing campaigns, and either fund the foundation’s own charitable program or support other charities addressing specific causes through strategic grants. Since 2000, the Ralph Lauren Corporation has sold a line of pink products to benefit the Pink Pony Fund, a program of the Polo Ralph Lauren Foundation focused on fighting cancer.

Collaborations and Joint Ventures with Established Nonprofits
Companies can collaborate with existing nonprofits to generate social good without forming their own nonprofit entity. This collaborative strategy is increasingly evident in companies’ corporate social responsibility (CSR) reports, which often highlight partnerships with nonprofits as a core strategy for fulfilling their CSR objectives.  Given that nonprofits often have expertise and on-the-ground implementation capabilities on social and environmental issues, this strategy makes sense. In 2015, American Diabetes Association launched a joint marketing and communications initiative with the Hispanic television network Telemundo, aimed at improving overall health and wellness for Latinos in the United States. These types of collaborations are particularly successful because they leverage each partner’s core strengths in order to achieve their shared charitable and social impact objectives.  Companies have also made strategic grants to fund research that will hopefully lead to more sustainable and responsible business practices.

Determining whether a corporate foundation will provide good value for a company ultimately depends on the company’s overall objectives, and should take into account the benefits and challenges of, and alternatives to, operating a corporate foundation.  For this reason, performing a strategic assessment on whether to form a corporate foundation is a worthy upfront investment.

[1] Corporate foundations classified as private foundations under the Internal Revenue Code must distribute a minimum amount annually, equal to approximately 5% of their net investment assets each year, which must be used for charitable purposes, typically in the form of charitable grants.

[2] The IRS has carved out benefits to the company that are “incidental and tenuous” from the self-dealing prohibition, such as through positive goodwill and recognition received by the company arising from the shared name, but how that rule applies in various contexts should be carefully reviewed with legal counsel.

The post Should Our Company Establish a Corporate Foundation? first appeared on Perlman Sandbox.

Clients new to the world of private foundations (including clients who suddenly find themselves at the helm of family foundations) are often unsure of how to compensate directors, and if it is even legally permissible.  This is not surprising, since, at first glance, the law in this area is puzzling, and several different pieces of the law must be fit together to reveal the full picture.

Among the many peculiar and non-intuitive features of the tax rules for private foundations is that, in the first instance, compensation by a foundation to a “disqualified person” is categorized as an impermissible act of “self-dealing.”  (Foundation directors, their spouses, and their family members – among others – all fall within the law’s definition of a “disqualified person.”)  However, as with many areas of tax-exempt organizations law, this blanket prohibition is followed by a list of exceptions.  The key exception regarding compensation provides that payment of compensation by a private foundation to a disqualified person will not be considered impermissible self-dealing as long as the compensation is not excessive and the compensation is for “personal services which are reasonable and necessary to carrying out the exempt purpose of the private foundation.”

“Personal services” is not a defined term in the statute, but the Treasury Regulations include as examples of personal services: legal services, investment management services, and general banking services.  Further, the term is generally understood to include professional and managerial services rendered by a disqualified person in her capacity as an officer, director, trustee, or executive director of the private foundation.   Much ink has been spilled by others attempting to define “personal services,” and there is a hefty pile of private letter rulings devoted to the topic.  This is understandable since all self-dealing transactions, including impermissible compensation to a director, can result in excise taxes imposed on the self-dealer (e.g. an improperly compensated director), and in certain circumstances, on the other foundation managers and on the foundation itself.  One reason for this onoing uncertainty is that, in the leading case on this issue, Madden v. Commissioner of Internal Revenue, T.C. Memo 1997-395, 74 T.C.M. 440 (1997), the tax court held that the term “personal services” should be construed narrowly and that personal services are “essentially professional and managerial in nature.”  This of course begs the question:  what counts as “professional and managerial?”   That is a question for another day.  For current purposes, however, it is clear that non-excessive compensation to a director for her duties as a director falls squarely within the exception, and is therefore not “self-dealing.”

This background helps illuminate the odd way in which Form 990-PF is structured with respect to reporting on director compensation.  If a private foundation does compensate, or reimburse expenses of, a director or other disqualified person, the organization must answer “Yes” to question 1a(4) of Part VII-B on its Form 990-PF.  That question is straight-forward enough.  It simply asks:  did the foundation “pay compensation to, or pay or reimburse the expenses of, a disqualified person?”

Unfortunately, the crucial follow-up question “1b” is not nearly as straight-forward.  In my practice, I have seen that even experienced preparers will sometimes answer it incorrectly or simply leave it blank.   The awkwardly worded question, which cries out for an English teacher’s red pen, asks:  “If any answer is “Yes” to 1a(1)-(6), did any of the acts fail to qualify under the exceptions described in Regulations…?”  Unless a foundation is intentionally disclosing impermissible activity and including a check to the IRS for excise taxes, the correct answer to this question should be “no”.   By answering “no,” a foundation informs the IRS that “yes” – the compensation (or other transaction) is within the exceptions to self-dealing described in the Treasury Regulations, and therefore is permissible and not subject to excise taxes.

Perhaps what trips up preparers and foundation officials is the section heading for Part VII-B:  “Statements Regarding Activities for Which Form 4720 May Be Required.”   As most informed foundation managers know, Form 4720 is not a form you want to file.  Form 4720 is used to calculate and pay excise taxes for activities that are disallowed under the Internal Revenue Code, and private foundations almost never have a reason to file them voluntarily.  Since Part VII-B, Question 1b refers to the “exceptions” to “self-dealing,” preparers and managers may be eager to answer this question “yes” with the hope that doing so signals “yes, these activities were exceptions to self-dealing.”  However, because of the clunky wording of the question, the answer should almost always be “no.”   A private foundation intending to answer this question “yes” likely has bigger problems than bad grammar.

The post Form 990-PF Filers Beware! The Tricky Double Negative of Part VII-B first appeared on Perlman Sandbox.