In 1969, John D. Rockefeller III suggested private foundations could act as risk-takers. He believed they should undertake “an adventurous approach to funding unpopular social causes,” which he described as venture philanthropy.
Today, venture philanthropy describes philanthropic models that go far beyond the writing of checks. Instead, they often take a long-term view of what it means to invest in solving global and local problems.
This article highlights an April 2004 paper, originally written by attorney Julie King. We updated her original article for this August 2019 republishing. The law office of Julie A. King, PLC is a Charlottesville, VA based law firm that provides legal services in all aspects of estate planning, trust and estate administration, probate, fiduciary litigation, tax-exempt organizations and charitable giving.
Helping to Broaden Your Understanding of Philanthropy
At Henry V. Kaelber, CPA, CFP®, CGMA, we are committed to providing our clients and readers with every advantage when trying to preserve and grow their human, intellectual and financial wealth. We seek to explain how philanthropy provides opportunities.
In this article we will provide you some insight as to how philanthropy supports projects and endeavors that may be too unpopular or controversial to gain the widespread support of the general public or the government. For this reason, philanthropy is a very important part of a democratic society.
Henry V. Kaelber, CPA, CFP®, CGMA is a CPA firm in Charlottesville, Virginia, providing quality accounting & tax services for individuals, business, trusts & estates. We also offer business consulting services and private equity structuring support.
Philanthropy, In General
Most of us learned as children that sharing is a good thing. We didn’t know we were practicing philanthropy. We just knew that giving to other people or important causes made us feel good. Decades ago, many people tended to give to the organizations that touched their lives, such as churches, hospitals and schools.
A philanthropist is a lover of humanity, a person who looks towards the greater good of humanity. A donor’s deeds towards welfare (charity, public service etc.) characterizes this. The label is most often applied to someone who provides a large fraction of the money that supports the efforts in a particular category. Yet, donors have become savvier and now require greater accountability from the charities to which they give and are not always content to simply turn over her assets to a charitable organization and hope for the best.
Today, there are more than 1.5 million nonprofit organizations registered in the United States, representing, it seems, every conceivable cause on the planet. Charities are making their presence known through elaborate ad campaigns, web sites and high-profile fundraisers. These more organized, more visible efforts are necessary, charities say, because:
- Their services are more in demand than ever.
- Government funding is declining and, in many cases, disappearing.
- The cost of everything continues to spiral upward.
Americans have responded generously — charitable giving in 2018 totaled nearly $428 billion, according to Non-Profit Consultants, Graham-Pelton. Yet, donors have become savvier and now require greater accountability from the charities to which they give. And they are not always content to simply turn over her assets to a charitable organization and hope for the best. For example, there are currently more than 105,000 private foundations in existence in the Unites States (up from 2,000 in 1950) and it is predicted that the next 25 years – as Americans experience the largest intergenerational transfer of wealth in history – will see the formation of more family private foundations than at any other time in history.
This trend, sometimes referred to as “venture philanthropy,” is reflected not only in the growth of family private foundations, but also by the surge in popularity of two of the primary alternatives: the supporting organization and the donor-advised fund.
By strict tax law definition, a private foundation is any charitable organization that is not a public charity. That definition does not give us much guidance, so it is more helpful to think about a private foundation as a charitable organization having three main features: (i) a single major source of funding, typically a family or corporation; (ii) a grant making program instead of direct operation of a charitable program; and (iii) payment of grants and expenses from endowment income instead of from the proceeds of a fund-raising program.
Organized into Five Categories:
(i) The Endowed Private Foundation. The most familiar kind of private foundation, endowed foundations are typically funded by an individual or family and usually build up their endowments by expending only the minimum distributable amount in a variety of grant programs. Family members frequently participate as officers and directors, and grants tend to focus on an area of concern to the donor and his family, such as health or education.
(ii) Un-Endowed Private Foundation. This kind of foundation usually receives its funding annually from its founder (frequently a corporation) and has little or no endowment. This kind of foundation is frequently used to extend the donor’s giving over a period of a few months or for other timing reasons.
(iii) Pass-Through or “Conduit” Foundation. This kind of foundation is required to pass through contributions within two and a half months after the end of the year in which the contributions were made. In addition to more favorable income tax deduction treatment, timing issues are a motivating reason behind this type of foundation. For example, the owner of low-basis stock who wishes to make an immediate contribution before the company goes public might use it.
(iv) Pooled Common Fund. This is a fund in which the donor and the donor’s spouse retain the right to annually designate which charitable organizations will receive the income earned on contributions by the donor. The income recipients must be public charities. At the end of the donor’s (or surviving spouse’s) life, the corpus of the fund goes to a charity designated by the donor.
(v) Operating Foundation. This kind of foundation operates its own charitable programs (such as a museum, clinic, or historical building) instead of making grants to other charitable organizations.
Vehicle of Choice
Donors who wish to maximize control exercised over both the investment and the distribution of the donated funds consider a private foundation the vehicle of choice. However, the private foundation donor weighed the burdens and costs of administration against the advantages. In addition, a donor to the typical endowed private foundation is subject to more restrictive income tax deduction limitations.
A donor forms a separate entity and operates a supporting organization exclusively for the benefit of one or more designated public charities. It is attractive to many donors because contributions to it qualify for more generous income tax deduction treatment. However, supporting organizations do not afford the ability of the donor to control the organization’s assets and may limit future philanthropic endeavors if, for example, the goals and purposes of the designated charitable beneficiaries later vary from those of the donor.
A supporting organization must demonstrate one of three types of relationships with designated public charities. (i) Either one or more public charities “operates, supervises or controlls” it (described as a “parent-subsidiary” relationship). Or, (ii) the benefited public charities “supervise or controll in connection with” it (a “brother-sister” relationship). Or, (iii) the benefited public charities “operates in connection with” it.
A donor comparing a supporting organization to a private foundation will most likely consider the latter type to be the best alternative, as it requires the least supervision by the designated public charities. However, even this kind of supporting organization must demonstrate its connection to an existing public charity by satisfying various tests. A detailed discussion of these tests is beyond the scope of this article. But, generally, the tests require a supporting organization to demonstrate that its operations and activities are inextricably and substantially linked to one or more public charities.
From a practical perspective, the restrictive rules applicable to supporting organizations probably limit their attractiveness only to those donors who have: (a) a particular public charity beneficiary in mind that is motivated to cooperate with the donor; (b) a group of friends or other non-disqualified persons suitable to be directors without violating the control rules; and (c) sufficient assets to make a stand-alone entity worthwhile.
A significant event in philanthropy went unnoticed. There are now more donor advised funds than foundations in the United States. In a study by National Philanthropic Trust, in 2017, there were 463,622 individual donor-advised funds across the country. Donors contributed $29.23 billion to these donor-advised funds and used them to recommend $19.08 billion in grants to qualified charities. Both grants and contributions reached record highs. Charitable assets in donor-advised funds totaled $110.01 billion, surpassing the $100 billion mark for the first time.
No statute or Treasury regulation defines the term “donor-advised fund” . In practice, a donor-advised fund is a fund established by a donor at a community foundation, a university, a public charity, or a mutual fund company.
The donor, or a designee, exercises the privilege of making nonbinding recommendations to the governing body administering the fund. The donor may only suggest which charitable entities should receive grants from that particular fund. The administrator holds and invests the assets in the fund, handles checks for distributions, collects and retains receipts from charities and is responsible for all federal and state reporting. For these services, the administrator charges an annual fee, typically 1 to 2 percent of the fund’s assets. The administrator will also establish the minimum donation required to establish a fund. Minimums can be between $5,000 or $10,000 at a mutual fund company or $250,000 or $1 million at a university.
An attractive feature is that contributions to donor-advised funds qualify for the more advantageous “public charity” income tax deduction limitations. And, while the donor retains some involvement in the grant making process, the administrator handles all administration of the fund. This makes the cost significantly lower than for a private foundation or supporting organization.
D-A Fund Disadvantages
The primary disadvantage to a donor-advised fund, especially when compared to a private foundation. The donor must give up control over the fund’s assets. Grant recommendations by the donor, or by a designee of the donor, can be advisory only. And, typically, the the lifespan of the donor or other designated advisor limits the right to advise. Another disadvantage is that a community foundation may restrict grants to only charities in a particular community, region or state. Others have policies against funding charitable organizations unfamiliar to staff members or that do not support certain core beliefs.
What does this mean for philanthropy? On the one hand, it means that philanthropy is becoming “democratized”. Instead of the exclusive province of individuals of significant wealth where you need $3-$5 million to set up your foundation. Now, the “price” of entry is a few simple forms, and $10,000.
It also means that philanthropy is maturing. For decades, financial experts have been advising their clients to diversify their portfolios. Also, to allocate their investments among a number of asset classes to minimize their risk and maximize their return. Now the same is occurring in philanthropy. A generation ago, wealthy individuals equated philanthropy as two options — the checkbook or the foundation. Over the last 40 years, with the emergence of community foundations, national donor advised funds, and planned giving specialists, coupled with an interest among financial service firms to serve high net worth clients, the same message is being delivered to philanthropists. Don’t tie up all your charitable assets in a foundation. Establish a donor advised fund, set up a charitable remainder trust, or charitable gift annuity.