 |
 |
 |
 |
 |
 |
 |
Archives
May 2001
 |
|
| Cover Story |
The Ups and Downs of Being Public, Part II: Frequently Encountered Problems with the Support Test |
| Fundraising Focus |
Fiscal Sponsorships: Do It Right and Stay Out of Trouble |
| Employment Matters |
The Perils of the Employee Reference |
|
|
The Ups and Downs of Being Public, Part II: Frequently Encountered Problems with the Support Test
We left off last month summing up the basic features of the public support test from Form 990-Schedule A and describing the characteristics that determine what money may be considered "public" for purposes of the test. This month, the Navigator will identify common problems that confuse charities when they perform the calculation and cause them to incorrectly assess their level of public support.
Cash Versus Accrual Accounting
One problem which arises when preparing the support grid from Schedule A particularly affects large charities. While Form 990 can be prepared using either the cash or the accrual method of accounting, the IRS requires that the public support test in Schedule A be performed using the cash method. In other words, charities can only report grant funds that they have actually received and over which they exercise control.
Where Do I Report This Income?
Charities may need to allocate income from a single project or activity between several lines on Schedule A. For example, suppose that at Charity X's annual conference, 10% of the income generated came from fees related to participation in the conference; 20% of the income came from the sales of advertisements placed in programs; and 70% of the income came from impressed attendees who pulled out their checkbooks and donated money to Charity X after the conference. In this case, the charity would have to report income related to the conference on three separate lines ("gross receipts from exempt purpose activities," "income from unrelated business activities," and "contributions," respectively) instead of lumping it all together in the "gross receipts" line. Charities should attempt to allocate income consistently each year.
A grant earmarked for a specific project or activity which generates "gross receipts" should nevertheless be reported in the line for "gifts, grants, and contributions." For example, suppose Charity X received a large donation to help underwrite the costs of its annual conference. Charity X should report this income as a contribution even though it helped support a conference that ultimately generated gross receipts.
Another common problem occurs when charities have not maintained accurate records of contributions received in each fiscal year. Since the 2% threshold exclusion [see NN 4/01, p. 4] pertains to the total amount given to the charity by an individual over the calculation period, the charity must be able to tally how much a donor gave during each fiscal year. Charities should begin keeping records from the moment they receive their first donations, regardless of the size of these early donations.
Finally, many larger charities are fiscal sponsors of smaller unincorporated or non-exempt quasi-independent projects and accept restricted-fund, earmarked contributions made by third-party donors (often private foundations) for these projects [see page [insert page from this issue]]. A charity serving as a fiscal sponsor for such a project should report these earmarked grants in the gifts, grants, and contributions line on its own 990 and Schedule A. Failure to do so could endanger a charitable contribution or raise questions as to whether the grantor foundation should have exercised expenditure responsibility over the grant.
"Unusual Grants"
The concept of "unusual grants" allows some nonprofits to maintain their status as publicly supported charities. The IRS defines an unusual grant as one that is attracted by the publicly supported nature of the charity; one which is unusual or unexpected in amount; and one whose size would have a significantly negative impact on the organization's calculation of public support. In addition, the grant must meet a number of other specific characteristics laid out by the IRS in Publication 557.
An unusual grant could have a "negative impact" on the organization's level of support because a very large grant from one particular source, such as a private foundation or individual, is subject to the 2% threshold. Therefore, a significant portion of the grant will not be counted as public even though the entirety of the grant is counted as total support. Large "startup" grants that are designed to assist newly created public charities are frequently considered unusual.
If a grant meets the IRS' definition of "unusual," the organization should report it to the IRS and should exclude the grant from its calculation of "gifts, grants, and contributions" for each year that funds were received. Form 1023, Form 990-Schedule A, and Form 8734 all require the charity to attach a statement for each year that unusual grant funds were received, detailing the name of the contributor, the date and amount of the grant, and a description of the nature of the grants. However, if an unusual grant threatens to nudge a charity's public support significantly below 33%, it may be wise to receive a definitive ruling from the IRS that the grant may be excluded from the public support calculation. To do this, the organization should file a ruling request, explaining and justifying why the grant is unusual, with the IRS office in Covington, Kentucky. If a favorable ruling is issued, both the charity and the grantor organization may rely on the ruling as assurance that the grant will not be counted against the charity's level of public support. Annual or multiple installment payments of a single unusual grant are all excludable.
For more information on the public support test, download Publication 557 on the IRS' Publications and Notices page at www.irs.gov/forms_pubs/pubs.html. Form 990, Schedule A, and instructions for both forms are on the IRS' Forms and Instructions page at www.irs.gov/forms_pubs/forms.html.
By Mark Sawchuk
Fiscal Sponsorships: Do It Right and Stay Out of Trouble
501(c)(3) organizations are often approached about acting as fiscal sponsors for organizations that do not have (or do not yet have) IRS recognition of their 501(c)(3) tax-exempt status. While such arrangements may be beneficial to all concerned, if not structured and conducted properly they can also have serious negative effects.
Key Legal Considerations
A 501(c)(3) organization's most important legal obligation is to ensure that its funds are spent in furtherance of its charitable purposes. Failure to do so can result in excise taxes, fines, revocation of exempt status, and in extreme circumstances, denial of tax deductions for donors or criminal prosecution for tax fraud. This risk is why fiscal sponsorship agreements must be carefully crafted to comply with IRS requirements.
A prospective fiscal sponsor may not allow non-exempt organizations to simply "use" its 501(c)(3) status as a fundraising vehicle. In a series of decisions going back to the mid 1940s, the Internal Revenue Service has expressed a strict policy against "conduit" and "pass-through" arrangements. For example, if a donor makes what she hopes to be a tax deductible contribution to a 501(c)(3), but earmarks the contribution for a non-exempt independent project, in the absence of a conforming fiscal sponsorship arrangement, the IRS will treat the donation as having been made from the donor directly to the non-exempt project. Accordingly, the contribution will not be tax deductible.
If the donor is a private foundation, the transaction may be construed as a taxable expenditure, unless the foundation exercises "expenditure responsibility." Private foundations are generally disinclined to undertake this responsibility; they often choose to make grants to a fiscal sponsor in order to avoid expenditure responsibility, effectively transferring oversight responsibility to the project's 501(c)(3) sponsor.
While the 501(c)(3) may make grants to or otherwise support a non-exempt project without risking the deductibility of contributions or its own exempt status (as long as the project is consistent with the exempt organization's charitable purposes), the IRS requires the 501(c)(3)-not the original donor-to have complete discretion and control over funds in its care.
There are additional concerns if the sponsored project intends to engage in lobbying. Depending on the structure of the relationship, lobbying expenditures by the project may be charged against the fiscal sponsor's lobbying limits. As a result, any lobbying activity needs to be carefully tracked. This is even more important when government grants are involved. More explicit political activities by sponsored projects can have devastating effects on the sponsor. In the 1984 presidential campaign a sponsored organization's near-political intervention almost resulted in the sponsor's loss of its tax-exempt status.
In short, in order for donors to treat grants and contributions as made to the 501(c)(3) fiscal sponsor, the sponsor must, at all times, treat funds received as its own money. This treatment should be consistently reflected in its procedures, its accounting, and on its Form 990.
Different Models of Fiscal Sponsorship
There are several different models for conforming fiscal sponsorship agreements. An excellent resource for organizations contemplating a fiscal sponsorship is Gregory Colvin's Fiscal Sponsorship: Six Ways to do it Right (Study Center Press, 1993). Colvin outlines the procedures to follow for most of the major methods.
The most obvious way for a non-exempt organization to achieve virtual tax exemption is to become a direct project of a 501(c)(3) with complementary or similar goals. Under the direct project model, the (c)(3) directly pays the salaries, bills and other expenses of the project. The project will not have a separate legal existence from the sponsoring charity. Sometimes this arrangement happens more or less by accident, as a charity starts a particular project that slowly gains increasing programmatic independence, with an eye toward eventually spinning off the project as its own tax-exempt entity.
Another common method is the independent contractor model. In this arrangement, a 501(c)(3) develops a project that furthers its charitable purposes, but farms out the actual work to a non-exempt independent contractor. The sponsor will ultimately "own" the project even though the work is performed by others.
There are other models, and which one is most appropriate depends on the particular circumstances of the charity and the project. In realty, however, most non-exempt projects seeking fiscal sponsorship simply want a 501(c)(3) to serve as their fundraising agent. As noted above, this raises problems for both potential donors and the (c)(3) serving as the sponsor. One way to properly achieve this goal is the "pre-approved grant."
How to Establish Conforming Pre-Approved Grants
A pre-approved grant fiscal sponsorship arrangement is closely related to donor-advised funds, such as those administered by community trusts. In that context, the goal is to allow the non-exempt project to solicit funds from individuals, government agencies, and other organizations, who will, in turn, make a donation to the sponsoring organization coupled with a "suggestion" that the contribution be used to support the non-exempt project. The IRS requires, however, that the donor's suggestion be treated as non-binding advice to the sponsoring organization. In order for this to work in practice, the sponsor must adhere to a (preferably pre-existing) grant-making system.
The prospective sponsoring organization first decides to accept written grant requests from non-exempt projects. After investigating the project, and making a determination that it furthers the charity's tax-exempt purposes, the board (not a staffer) should vote to approve a particular sponsorship sponsorship. Once done, the charity and project should develop a budget and sign a grant agreement.
Under the agreement, the project is responsible for sending periodic narratives of the project's progress and financial reports. If the project fails to submit the required reports, the charity should withhold further funding. Continued funding can be contingent on successful fundraising efforts for the project, carried on by either the charity or the project itself. In all cases, however, the charity should have responsibility for submitting reports to donors.
Prospective donors typically want to earmark their contributions for use by the sponsored project. Projects want to consider funds they raise as their own. As discussed above, this can create serious tax complications for both the donor and the 501(c)(3) fiscal sponsor. However, the sponsor may permit a donor to restrict contributed funds to be used for a specific charitable purpose. The charity exercises the required level of discretion in control by its pre-approval of the project. If the project fails to comply with the grant agreement, the sponsor may refuse to transfer further funds, although the sponsor will have an obligation to donors to use those funds for the project's purposes, either directly itself or through another grantee. So long as the project does comply with the agreement, it would have a contractual right to the funds.
The pre-approved grant model of fiscal sponsorship is one of the best ways for new charitable enterprises to get off the ground, and can also be used effectively to obtain 501(c)(3) funding for a charitable project of a non-501(c)(3) organization. It is critical, however, to follow the forms of a grantor-grantee relationship. The considerable administrative oversight this task requires accounts for the fees typically charged by sponsoring charities.
By Beth Kingsley and Doug Smith
The Perils of the Employee Reference
For most employers the following is not a hypothetical scenario: you receive a call from a prospective employer asking for information about a former employee. Should you give complete assessment of the former employee's character including work habits and reason for termination? Should you withhold all information other than work dates and salary history? Is there an appropriate middle road?
A 1998 survey regarding employer references conducted by the Survey for Human Resources Management found that while most employers provide such objective and neutral information as dates of employment, less than 20% of employers will discuss the reason for the former employee's termination or his or her work habits. Only 8% of employers provide information regarding violent or bizarre behavior of former employees. The reason employers are reluctant to provide other employers with such important information is, of course, fear of litigation.
This apprehension is, in some measure, justified. The causes of action that may be asserted by former employees who receive less than favorable job references include common law claims of defamation and intentional interference with prospective economic relations. Claims alleging violation of state anti-blacklisting laws and Federal Civil Rights statutes may also be available. Employers that provide misleadingly positive job references regarding violent or criminal former employees may find themselves liable to future employers and co-workers injured by the former employee. Finally, an employer could be held liable for disclosing private information about a former employee without permission.
Employers that provide job references in response to requests from prospective employers enjoy a qualified privilege that insulates them from liability for defamation; however, the privilege will be defeated if the statement was motivated by an improper purpose, such as personal animosity, or it was communicated to someone other than a person with a need to know. Moreover, this privilege will not provide protection from non-defamation claims.
A number of states have enacted shield statutes intended to protect employers from liability when they provide references in good faith, even if the references contain false and damaging information. Many of the statutes establish a presumption of good faith, which must be affirmatively rebutted by the former employee in order to hold the employer liable.
Despite these legal protections, a policy that prohibits release of all but dates of employment and salary history is probably the safest avenue for most employers. On the other hand, providing an honest evaluation of an employee's performance and personality serves a clearly beneficial societal and economic function. The information a former employer can provide may prevent a prospective employer from making a costly mistake. This rationale is especially compelling when the employee in question was terminated as a result of illegal, violent or threatening behavior. Moreover, a careful employer should not unduly fear litigation resulting from employment references- communication of non-private information that is accurate and not misleading will not give rise to liability.
|
By Paul J. Tanis
This publication is designed to provide accurate and authoritative information about the subject matter covered. It is not distributed with the intent to render legal, accounting, or other professional advice. The services of a competent professional should be sought if legal advice or other expert assistance is required.
Newsletter Home | HarmonCurran Home
