Legal Basics for Trustees

Legal Basics: What Every Leader Should Know Andrew Schulz Deputy General Counsel Council on Foundations Agenda  The Legal Framework  Operational Issues  Board Responsibilities Legal Overview Who Are We? Givers Doers The Nonprofit Universe Nonprofit Exempt Charity Public Private All Charitable Organizations  Defined in section 501(c)(3)  Organized and operated exclusively for charitable purposes  No private inurement  No involvement in partisan elections, limits on lobbying  Includes both charities and foundations Charitable Purposes     Relieving poverty Promoting health Education Religion  Relief of a government burden  Other purposes that benefit the community Public v. Private  Public charities • Houses of worship, educational institutions, hospitals and other health care organizations • Publicly supported • Supporting organizations  Governmental Entities  Private Foundations • None of the above • Single or limited sources of support Public Support Test  509 (a)(1) and 170(b)(1)(A)(vi)  Two tests • Mechanical test = 1/3 public support • Facts and circumstances test = • Less than 1/3 but at least 10% • Various factors showing spirit of public support  Public Support / Total Support = 33.3%  Tests based on 4 years of data Public Support - 2% Limit  PUBLIC support can’t include more than 2% (of TOTAL support) from any one donor  Exception for gifts from government or other publicly supported charities  Example: 4-yr total = $100,000 • Mrs. Jones gave you $20,000 • All $20,000 = part of total support • Only $2,000 (2%) = public support The Private Foundation Rules       Excise tax on investment income (§4940) Self-dealing* (§ 4941) 5% distribution requirement (§ 4942) Excess business holdings (§ 4943) Jeopardy investments* (§ 4944) Taxable expenditures* (§ 4945) * Penalties can be imposed on foundation managers Tax on Investment Income Private Foundations Only (Section 4940)  Initial tax – 2% of net investment income • • • • Interest Dividends Capital gains Rents, royalties, other income paid  Reduced to 1% if qualifying distributions exceed average of past 5 years Self-Dealing Private Foundations Only (Section 4941)  Basic rule: No transactions with ―disqualified persons‖ • Officers, directors, trustees • Substantial contributors • Family members of the above • spouse, ancestors, children, grandchildren, great grandchildren and the spouses of children, grandchildren and great grandchildren • Businesses they control Self-Dealing Private Foundations Only (Section 4941)  Excise tax penalty: • 5% of amount on the self-dealer • 2.5% of amount on manager who knowingly approves • No abatement  Exception: Reasonable compensation for personal services (more later) Calculating Payout Private Foundations Only (Section 4942)  Basic rule • Each year, make qualifying expenditures equal to at least approximately 5% of average investment assets  Qualifying expenditures • Grants • Reasonable administrative expenses, direct charitable activities, program-related investments, cost of assets purchased to carry on charitable activities, set asides • Not - investment management fees • Credits: • Excise tax paid • Cash held for charitable purposes Excess Business Holdings Private Foundations Only (Section 4943)  A private foundation cannot own a controlling interest in a business  Generally 20% of voting stock (or profits interest) is the limit (35% if effective control elsewhere) • Includes interests owned by disqualified persons • Safe harbor – foundation may own up to 2% of voting stock and 2% of value Jeopardy Investments Private Foundations Only (Section 4944)  No investments are per se violations  Failure to ―exercise ordinary business care‖  Certain investments may draw extra scrutiny • commodity futures, puts, calls, straddles, warrants, selling short, and working interests in oil and gas wells.  Exclusion for program-related investments  State law also governs foundation investments Taxable Expenditures Private Foundations Only (Section 4945)      Partisan political activity Lobbying Grants to individuals for travel, study or research* Grants to other than public charities* Grants for purposes that are not charitable * Permitted if proper procedures are followed Intermediate Sanctions Public Charities Only  No ―excess benefits transactions‖ permitted with insiders  Excess benefit transactions: • Excessive compensation • Financial transaction if unfair to the charity • NOTE: Transaction with insider = OK if fair!  Insider: anyone in a position to exercise ―substantial influence‖ over the charity  Tax penalty: • 25% of the excess benefit (on the insider) • 10% on organization manager who approves Questions Specific Operational Issues Compensation  Reasonable: • What similar people get paid for similar work in similar circumstances • Generally no percentage based compensation  Necessary: Consistent with exempt purposes  Personal Services (for private foundations only): • • • • Banking, legal, accounting, investments Not maintenance, janitorial, and security services Property management?? Services not of a professional or managerial character?? Determining Compensation  Data – use appropriate comparability data  Decision by disinterested governing board or committee (where possible)  Document, document, document Compensation Example Chief Executive Officer/ President of Family Foundation Asset Group (in millions) Salary Median $ 77,175 Mean $ 86,618 Range $46,350 to $145,000 $10 to $24.9 From Council on Foundations, 2005 Grantmakers Salary and Benefits Report Grants to Non-Charities  You can make a grant to any organization—as long as it is for charitable purposes  Safest grants are to IRS recognized charities  Otherwise — ―expenditure responsibility‖ • • • • • Pre-grant inquiry Written agreement Funds held separately by grantee Regular reports from grantee Summary status on Form 990-PF  Not required for public charities, but prudent to do as much as is reasonable Grants Outside the U.S.  Foundations can make grants anywhere in the world  Three Options • Grantee is recognized by IRS • Expenditure Responsibility • Equivalency Determination  Not required for public charities  Anti-terrorism concerns  Pending legislation could limit grants from donor-advised funds and supporting organizations Grants to Individuals    Must further charitable purposes No grants to disqualified persons Most common are study or travel grants • • • Charitable class Objective and non-discriminatory Pre-approval of process for private foundations   “I know so much that I don’t know where to begin.” Disaster relief and grants to alleviate poverty do not require pre-approval Check your governing documents Questions Board Responsibilities The Three Duties (state law)  Duty of Loyalty • The foundation comes first • Avoid conflicts of interest  Duty of Care • Reasonable diligence • Often higher for trustees than directors  Duty of Obedience Conflicts of Interest  Personal interest differs from the foundation’s  Conflicts range from per se legal violations to ethical considerations  Economic conflicts • Compensation decisions • Foundation investment practices benefit foundation insiders  Other conflicts • Grants to charities with links to directors or top staff • Hiring family or friends The Range of Conflicts Self-Dealing Ethical Private Foundations State Law Conflict Criminal Violations Per se Illegal Resolving Conflicts  Adopt a policy and follow it • Disclose the conflict • Abstain from voting (some leave the room)  Policy should apply to board members and staff (consider volunteers)  Document, document, document Investment Responsibilities  UMIFA (Nonprofit Corporations)  Prudent Investor Rule (Trusts)  UPIA Organizational Risk     General liability Worker’s compensation Fidelity insurance Other potential liabilities • • • • • • • Wage and withholding OSHA Securities laws Environmental laws ERISA EEO IRS violations, etc. Personal Risk  Directors can be held personally liable for their actions as directors  Directors can be named as defendants for actions of the foundation  Defending a case can be expensive for both the individual and the foundation Minimizing Risk for Directors  Indemnification  Charitable Immunity  D & O Insurance Indemnification  Coverage depends on state law • Good faith • Best interest of the foundation     If the standard is met, coverage is broad Permissive vs. mandatory Third party claims vs. derivative claims Doesn’t protect the foundation at all Charitable Immunity      Availability depends on state law Often limited to volunteers Typically exclude gross negligence willful misconduct Often limited to personal injury and property damage Doesn’t cover costs of defending – just stops liability Directors and Officers Insurance  Protects directors and the foundation  Coverage depends on the policy • Breach of duty, neglect, error, misstatement, omissions, etc. • Attorney fees and court costs • Excludes bodily injury and property damage  Usually excluded • Knowing and willful violations of the law • Dishonesty, criminal acts, state law fines and penalties, nuclear waste, ERISA. Questions The General Counsel’s Office: A Resource for Foundations      Janne Gallagher, 202-467-0288 or gallj@cof.org Andrew Schulz, 202-467-0459 or schua@cof.org Jane Nober, 202-467-0387 or nobej@cof.org Kelly Shipp Simone, 202-467-0464 or simok@cof.org Andras Kosaras, 202-467-0399 or kosaa@cof.org