THE NEW UNIFORM POWER OF ATTORNEY ACT
By William LaPiana
The project to revise the Uniform Durable Power of Attorney began with a study of
current law commissioned by the Joint Editorial Board for Uniform Trust and Estate Acts. The study
was conducted by Susan Gary, Linda Whitton, Rebecca Morgan, and Karen Boxx. The study showed
that although the Uniform Act had once been the law almost everywhere, states had increasingly
enacted non-uniform provisions designed to meet problems which had become obvious since the
promulgation of the Uniform Act and which the Act did not address. As summarized by Prof. Whitton,
Reporter for the new Act, in the Prefatory Note to the current draft of the Revised Act, the principal
topics with respect to which there was increasing divergence among the states included: 1) the authority
of multiple agents; 2) the authority of a later-appointed fiduciary or guardian; 3) the impact of dissolution
or annulment of the principal’s marriage to the agent; 4) activation of contingent powers; 5) the authority
to make gifts; and 6) standards for agent conduct and liability. Other topics on which states have
enacted legislation include “successor agents, execution requirements, portability, sanctions for dishonor
of a power of attorney, and restrictions on powers that have the potential to dissipate a principal’s
property or alter a principal’s estate plan.”
The study was followed up with a national survey of practitioners designed to determine
if there was agreement on topics not covered by the existing Uniform Act. As Prof. Whitton observes
in the draft Prefatory Note:
“The survey responses demonstrated a consensus of opinion in excess of seventy
percent that a power of attorney statute should:
(1) provide for a confirming affidavit to activate contingent powers;
(2) revoke a spouse-agent’s authority upon the dissolution or annulment of the marriage
to the principal;
(3) include a portability provision;
(4) require gift making authority to be expressly stated in the grant of authority;
(5) provide a default standard for fiduciary duties;
(6) permit the principal to alter the default fiduciary standard;
(7) require notice by an agent when the agent is no longer willing or able to act;
(8) include safeguards against abuse by the agent;
(9) include remedies and sanctions for abuse by the agent;
(10) protect the reliance of other persons on a power of attorney; and
(11) include remedies and sanctions for refusal of other persons to honor a
power of attorney.”
Armed with this information, The National Conference of Commissioners on Uniform
State Laws (“NCCUSL”) created a Drafting Committee, chaired by Jack Burton of Santa Fe, New
Mexico with Prof. Whitton as Reporter. Abigail Kampmann is RPPT Advisor to the Committee and
the author of this article is ABA Advisor. The Committee met for the first time in April 2003 and the
draft Act had its first reading at the NCCUSL Annual Meeting in August 2004. The Committee met in
October 2004 and is scheduled to meet for the last time in April 2005. The Act is scheduled for its final
reading and promulgation at the 2005 Annual Meeting of NCCUSL.
The draft that emerged from the October 2004 meeting of the Drafting Committee is
currently being revised in light of comments made at meetings between Prof. Whitton and interested
parties, included a meeting held as part of the RPPT fall leadership meeting. The latest version of this
“rolling draft” will be posted on the RPPT web site as soon as it is available in late January. In the
meantime, what follows is a brief discussion of some of the most important provisions of the current
draft and the major issues that still face the Committee. The next version of the draft will of course
embody the latest thinking on those issues and comments are actively sought. The rest of this article
points out the most important provisions of the draft Act as well as subjects that are not yet settled and
on which comments are especially needed. The views expressed in this brief article are those of the
author and should not be attributed to NCCUSL, the Drafting Committee, the Reporter, nor anyone
The new Act has been renamed. It is now the Uniform Power of Attorney Act. The
Drafting Committee has decided that the default rule for powers of attorney should be durability. The
section dealing with the scope of the Act, therefore, excludes from its operation powers of attorney that
do not involve financial management such as those that authorize corporate officers to act on behalf of
the corporation. Also excluded is a power of attorney for health care. Such powers are the subject of
a unique body of law which should be kept separate from that governing financial powers of attorney.
The section dealing with definitions includes one important innovation. The attorney-in-
fact is referred to throughout the Act as the “agent,” a term which should be more easily understood by
the lay public. This section also includes the standard NCCUSL definition of “sign” accommodating
The formal requisites for a power of attorney are few. The principal must sign the
instrument granting authority to the agent or must direct another to sign the instrument in the principal’s
presence. The principal must also acknowledge the signature before a notary or another person
authorized to take acknowledgments in order for the signature to carry a statutory presumption of
The presumption of validity is a very important part of the Act. In order to preserve the
power of attorney as a convenient, simple, and low cost alternative to guardianship or equivalent forms
of supervision, those to whom the power of attorney is presented must be able to act on it without fear
of liability. A countervailing concern, however, is abuse of the power of attorney by faithless agents.
As noted above, several of the points of agreement revealed by the survey of practitioners involved
prevention of abuse, remedies for abuse, protection for those accepting the power of attorney, and
sanctions for refusals to accept the agent’s authority.
The Drafting Committee is still working on these important and difficult details. The next
version of the draft probably will protect from liability any third party relying on a power of attorney
which is notarized and otherwise regular on its face unless the third party has notice of the revocation or
termination of the power of attorney. The definition of “notice” is still under consideration as is the
proper period of time during which the third party can decide whether to accept the power of attorney.
Also important is the drafting of a provision which will recognize the nature of modern branch banking
by providing some brief but practical time period during which notice to one branch of the bank is
assumed to reach the entire organization.
Closely linked to the provisions protecting parties who rely on a power of attorney are
provisions sanctioning those third parties who unjustifiably refuse to honor a power of attorney. Such
provisions exist in several states and the respondents to the survey strongly supported such provisions.
The current draft of the Act makes the third party liable to the principal or the principal’s successors in
interest to the same extent the third party would be liable had the third party refused to accept the
authority of a principal who has capacity to act in his or her own behalf. The minimum recovery is
$1000, plus costs and attorney’s fees.
Also related to reliance and sanctions is the question of portability. The goal is to create
a workable framework within which a power of attorney valid in the jurisdiction where executed is
honored in other jurisdictions. The provisions in the current draft (section 107) will be revised in the
next draft to make clear that the Act will not enlarge the scope of a power beyond that given it under the
law of the jurisdiction where it was executed.
The provisions described above all deal with the acceptance of the power of attorney
by third parties, with the relationship between the principal and the agent on one hand and the rest of the
world on the other. Another set of provisions deals with the relationship between the principal and the
agent. The goal is to erect obstacles to abuse of the agent’s powers and thus provide protection for
vulnerable principals. Perhaps the most important provision is currently contained in section 115(a)
which states that the agent’s acceptance of the authority given by the power of attorney creates a
fiduciary relationship between the agent and the principal. The next version of the draft will have
language dealing with the nature of the required “acceptance.” Section 115 also describes the nature of
the fiduciary duty which includes the duty to keep compete records and to take the principal’s estate
plan into account to the extent known to the agent. The revised draft will also include language dealing
with conflicts of interest on the part of the agent.
Another protective provision is found in section 108 which deals with the agent’s
authority. Current section 108(b) requires that express authority be granted to the agent if the agent is
to have authority to dispose of the principal’s assets by, for example, making or modifying a trust,
funding a trust created by someone other than the principal, changing rights of survivorship, and making
gifts. The requirement of express authorization will help to prevent overreaching by an agent.
The current draft facilitates review of the agent’s actions by giving several categories of
persons, including a governmental agency having authority to protect the principal’s welfare, the right to
request judicial review of the agent’s actions. The list also includes the principal’s family and a caregiver
or any other person “who demonstrates sufficient interest in the principal’s welfare. The court may
award attorney’s fees and expenses to the prevailing party in such a proceeding. Again, this provision is
designed to help protect a vulnerable principal, whether or not incapacitated, by giving those who have
an interest in the principal’s welfare perhaps coupled with an interest in the principal’s property, the
ability to bring an erring agent to court. In addition, the possibility of the court awarding attorney’s fees
to the prevailing party will help to deter frivolous challenges.
These and other provisions governing the operation of powers of attorney, such as
termination of the agent’s authority, the relationship between concurrent and successor agents,
resignation by an agent, are all dealt with in Article 1 of the Act. Article 2 sets forth in detail the powers
that can be granted to an agent, each section dealing with power related to one subject, for example,
real estate. The Act provides that these powers can be incorporated into a power of attorney by
reference to the section number or to the descriptive caption of the section. Use of these sections
allows a principal to grant powers to an agent sufficient to deal with almost every sort of transaction the
principal could accomplish for herself. The Committee especially welcomes comments on the statutory
powers so that they may be as comprehensive as possible.
Article 3 sets forth a statutory short form power of attorney. The statutory form would
allow a principal to create a power of attorney granting all or as many of the statutory powers as the
principal wishes in a form that will be widely recognized and, it is hoped, widely accepted. There are
many issues related to the content and graphical presentation of the statutory form on which the
Committee is still working. The Committee believes, however, that the availability of a statutory form
will promote the acceptance of powers of attorney.
Article 4 completes the Act by setting forth miscellaneous provisions governing effective
date, effect on existing powers of attorney and coordination with existing statutory provisions.
The next version of the draft will be available on the RPPT web site in late January.
Comments may be sent to the Reporter at firstname.lastname@example.org, to the RPPT Section Advisor at
email@example.com, or to the ABA Advisor at firstname.lastname@example.org.
UNIFORM TRUST CODE 2005
LEGISLATIVE PROCESS, ENACTMENT PROSPECTS
AND HEALTHY DEBATES
By Michelle W. Clayton
Legislative Counsel, National Conference of Commissioners on Uniform State Laws
The Uniform Trust Code (“UTC”) enters its fifth year with ten enactments in the following
jurisdictions: District of Columbia, Kansas, Maine, Missouri, Nebraska, New Hampshire, New Mexico,
Tennessee, Utah and Wyoming. UTC bills are pending in Pennsylvania and Massachusetts. Legislative
prospects for 2005 are very good with at least ten states planning introductions, many of which already have
support from their state bar and bankers.
Although the UTC does have some detractors, mainly due to misunderstandings about the creditor
rights provisions in Article 5, many legislatures are expected to enact the UTC because it improves trust
law, particularly in states that have very little or many gaps in their statutes. This article includes a brief
discussion of the legislative process, a short synopsis of the states expected to introduce UTC bills as well
as those studying it for future enactment, and a very brief statement of some of the “issues” that might cause
unnecessary concern in the states. More in-depth and scholarly articles on these issues will be published in
The Legislative Process
In some articles about the UTC, information on legislative activity has been somewhat misleading,
suggesting that some states are “rejecting” the UTC. Each state legislature has a different power structure,
legislative traditions and differing relationships with the bar, bankers and other groups. Factoring in the
major budget crisis in most states which dominated the legislatures’ attention, it is fortunate that the UTC
(which has no fiscal impact) was taken up for consideration at all, much less enacted in ten jurisdictions.
It is important to look at the circumstances since the states are each unique in their legislative
process and personalities. Some states and/or bar associations tend to take longer to study and enact
uniform acts than others. Large states, like Texas, with comprehensive trust law already on the books, are
naturally slower to adopt something as complex as the UTC. While it was reported that Texas “rejected”
the UTC, the comments to the current bill draft to revise the Texas Trust Code tell a very different story.
Many of the proposed revisions to the Texas trust statutes are taken straight out of the UTC and the
comments indicate from which UTC section the new language is derived. Furthermore, the current Texas
Trust Code was the source of many of the provisions in the UTC.
In some states, any controversy, legitimate or not, will kill a bill. Therefore, to say that a state has
“rejected” the UTC is simply not accurate, particularly in cases like Oklahoma. The Oklahoma bill had
strong support from the bar and bankers, passed out of one House unanimously, but was killed when one
legislator unilaterally moved the bill off the agenda of the last committee meeting. One could not accurately
say that the Oklahoma Legislature “rejected” the UTC. Similarly, some UTC bills, like Virginia’s, are
introduced without the intention of passing them that year. Instead, it is introduced to give notice to any
interested parties that it is pending in that state to allow time for the most input possible. When those bills
do not pass, they are not “rejected” by the legislature, and legislators do not view it in those terms unless an
overwhelming negative vote is recorded.
Even in Arizona, where the UTC was repealed, the legislative note on the repeal is not a clear
“rejection.” Instead, the bill that repealed the UTC specifically stated that the Arizona Legislature
“[a]ffirms the efforts of the NCCUSL and the intent of the Legislature to continue studying the UTC
so that acceptable elements may be implemented to improve Arizona trust laws.” The Arizona Bar
continues to meet about the UTC and has resolved many of the issues that caused the repeal.
Additionally, many of the already enacted UTC states, such as Nebraska, will amend their versions
of the UTC by including the 2004 amendments and potentially other changes that will enable the UTC to
better meet the needs of particular states. Because the UTC, with comments, is over 150 pages long and
quite complex, these amendments are normal and reflect the simple fact that the law is never static.
The twenty or more state bar associations working to enact the UTC in their states are doing so
enthusiastically, making necessary changes and recognizing that passing a large complex statute may not
happen overnight. But, even if it takes some years, most think it worth the effort because clear statutory law
will be a major improvement for trust lawyers, administrators, and, most of all, the many citizens now using
UTC Introductions Expected in 2005
Alabama is expected to introduce a UTC bill through the Alabama Law Institute in cooperation
with the Alabama Bar Association and the Alabama Bankers Association.
After a two-year study, the Arkansas Bar Association is sponsoring a UTC bill with some
modifications. It will be introduced in the General Assembly in January and has support from the Arkansas
The Colorado Bar continues its push to enact the UTC, despite some setbacks in the past few
years. After a full debate on the impact of the UTC on special needs trusts, the Trust and Estates Section of
the Colorado Bar voted down a motion to temporarily withdraw support for the UTC and plans to continue
to move forward towards enactment within the next two years.
The Connecticut Bar Association and the Connecticut Bankers’ Association continue discussions
in an attempt to find common ground and an agreed upon version of the proposed Connecticut UTC.
However, the bankers’ first priority is reform of Connecticut’s probate system before they will consider the
UTC, because of the additional powers the UTC would confer on our court system. Therefore they are
considering stand alone provisions of the UTC that would not affect courts powers or jurisdiction until the
probate courts can be modernized or reformed. In the meantime, the bar is working diligently on the
probate court issue.
A broad based UTC study committee is expected to start meeting in Massachusetts in January
2005. It is hoped that the UTC bill already introduced in the Legislature will be supported once the study is
complete and the bill is modified to meet the needs of that state.
The North Carolina Bar will help sponsor the UTC after a thorough review of several years. The
UTC Committee is currently finishing the comments to their version of the UTC.
The Ohio Bar and Bankers Associations expect the UTC to be introduced and passed in 2005. It
is now working through a list of simple technical issues to the Ohio version and will be introduced in the new
General Assembly early in the session. If enacted early in the session, it could be effective the first of 2006.
The Oklahoma Bar Association passed the UTC Resolution at its annual meeting in November
2004 by unanimous consent. It will be introduced in the Oklahoma legislature in January of 2005. The
Oklahoma UTC Bill will have a November 1, 2005 effective date.
The Oregon Bar conducted a two year study that included numerous other interest groups. The
bill has been drafted and will be introduced in 2005.
The Pennsylvania UTC was introduced in 2004 and is expected to pass in 2005.
A UTC bill is expected to be introduced in South Carolina in the next two months after a study by
The Trusts and Estates Section of the Virginia Bar Association will seek reintroduction of the
UTC in January. A bill implementing the Section's recommendations is being prepared by the Division of
Current UTC Studies
The Florida Bar subcommittee studying the UTC has almost concluded its three-year study of the
UTC. Its draft will soon go to the full RPPT section of the Florida Bar and then through the full Bar. A
Florida UTC bill is likely in 2006.
The Georgia Bar is currently conducting its review of the UTC and expects to complete the study
for possible introduction in 2006.
The Idaho Bar continues its study of the UTC, but will not have a bill in 2005.
The Michigan Bar and Bankers Associations each continue to study the UTC for possible
The Montana Bar, having just enacted the Uniform Principal and Income Act and the Uniform
Prudent Investor Act, expects to complete a study of the UTC for an introduction in 2007 (Montana’s
Legislature skips every other year.)
A task force in Washington began studying the UTC in 2003.
The South Dakota State Bar is reviewing the UTC and hopes to complete the study by mid-April
so that it can be submitted for Bar approval at the annual bar convention in June. If approved it would then
be submitted in the January 2006 legislative session for implementation on July 1 of 2006. The committee is
working in conjunction with the Governor’s Task Force and the Banking Commission. Introduction in
2006 is expected.
Although the UTC has been introduced several times in the West Virginia Legislature, it has had
no success because a full study has not been conducted. The West Virginia Law Institute has recently taken
the UTC up as a project for review. We expect to see an introduction in 2006.
The Wisconsin Bar recently formed a UTC study committee with representation from the Bankers
Association. The committee expects to start meeting in early 2005.
Latest “Issues” Addressed
Several recent articles about the UTC claim that it will cause problems with protecting assets,
permitting special needs trusts, encouraging divorce litigation, and attorney malpractice. These claims are
based on a misunderstanding of the UTC and its provisions.
The UTC largely codifies traditional American trust law with regard to spendthrift clauses and most
of the traditional exceptions to the spendthrift rule. The current majority rule regarding the exception of
spouses, former spouses and children with valid support claims is codified because of its important policy
implications. However, because there is considerable variation among a number of the states on the
exceptions to spendthrift, it is not surprising that several states have changed the exceptions to reflect their
Arguments are being made that the elimination of a separate category for support trusts and their
treatment as the same as other discretionary trusts is somehow detrimental to special needs trusts. In fact,
this change actually strengthens and clarifies the right to beneficiaries regarding distributions and their
protection against government intrusion. Furthermore, the UTC clarifies and improves creditor protection in
third-party special needs trusts because it prohibits creditors from forcing trustees to exercise discretion
regardless of the standard employed.
Another misreading relates to the good faith standard for trustee’s exercise of discretion regardless
of trust terms such as “uncontrolled” or “absolute.” The standard does not increase the beneficiary’s ability
to compel distributions and does not prevent asset protection planning for the interests of beneficiaries. The
standard is consistent with the common law.
It is also incorrect to claim that the UTC will impact divorce litigation since the UTC has little or no
effect on a beneficiary’s right to compel a discretionary distribution. Therefore, it does not change how or
if such trust interests are considered for spousal and child support purposes. The division of property in
divorce proceedings is not even addressed in the UTC. The UTC does not alter existing law on the
characterization of trust interests for this purpose.
Finally, because the above claims are false, the argument that creating a trust in a UTC state will
cause attorneys to be sued for malpractice is wrong as well. This grasping argument could be made the
other way and is simply an effort to cause confusion and panic in the estate planning bar, most of which
supports the UTC.
The UTC will likely have its best year in 2005. As state bar associations finish up two and three
year studies, fine-tuning of this important legislation combined with state-by-state educational programs and
discussions will continue to increase the knowledge and expertise of the estate planning bar. Although there
is a national debate about what the common law is and should be, these discussions are helpful to the
process. All over the country, attorneys are refining their knowledge of trust law through the study of the
UTC. NCCUSL benefits from this scrutiny by carefully considering each valid critique offered and making
amendments where necessary. Because each state will be responsible for the final determination of public
policies relating to trusts, the UTC will never be fully uniform from state to state. However, it will greatly
improve American trust law for those who work in the field of trusts, and, most importantly, for the millions
of Americans now using trusts.
UTC ARTICLE 5 ON CREDITORS’ RIGHTS
By Professor Valerie J. Vollmar
Willamette University College of Law
Co-Chair of the Oregon State Bar UTC Committee
A BASIC DESCRIPTION OF UTC 501 THROUGH 504
Article 5 of the Uniform Trust Code governs the rights of creditors to reach trust
property. These provisions of the UTC have created a great deal of controversy, in part
because of misunderstandings about what the UTC actually says. For the most part,
Article 5 simply restates the traditional rules about the rights of creditors. Although
Article 5 does include some more innovative provisions, many of the states that have
adopted the UTC have elected to reject or modify these provisions.
Section 505 of the UTC covers the rights of creditors of the settlor of a trust.
Sections 501 through 504, on the other hand, cover the rights of creditors of a trust
beneficiary who is not the settlor of the trust. Most of the confusion involves Sections
501 through 504, which are described below.
Section 501 applies only to trusts that do not contain a spendthrift provision.
Most trusts today are spendthrift trusts, so this section rarely applies.
In the rare case in which a trust does not contain a spendthrift provision, Section
501 conforms to the traditional rules that (1) a beneficiary of a non-spendthrift trust can
voluntarily transfer the beneficiary’s interest in the trust, and (2) creditors of the trust
beneficiary may be able to force involuntary access to the bene ficiary’s interest to satisfy
their claims. Before an assignee or creditor can reach the beneficiary’s interest through
the procedures authorized by state law, however, Section 501 requires that a court give its
approval. Moreover, the court may limit access to a non-spendthrift trust based on
equitable considerations such as the support needs of the beneficiary and the
Section 502, unlike Section 501, does apply to spendthrift trusts. But Section 502
does not describe specifically what rights particular creditors have.
Instead, subsections (a) and (b) say that a spendthrift provision is valid only if it
restrains both voluntary transfers by a trust beneficiary and involuntary transfers forced
by the beneficiary’s creditors, and that words like “spendthrift trust” are sufficient to
create a valid spendthrift trust. Subsection (c) states the traditional rules that (1) a
beneficiary of a spendthrift trust cannot make a voluntary transfer of the beneficiary’s
interest, and (2) a beneficiary’s creditor cannot force involuntary access to a spendthrift
trust unless the creditor is an “exception” creditor given special treatment for policy
Section 503 identifies the “exception” creditors that may be allowed to reach a
beneficiary’s interest in a spendthrift trust.
Two categories of “exception” creditors are traditional ones: (1) a beneficiary’s
child, spouse, or former spouse with a valid support judgment or order that has not been
paid; and (2) a state or federal government claim authorized by state or federal law (such
as a claim for unpaid taxes). One category of “exception” creditors under Section 503 is
more novel, but is unlikely to apply in very many cases: a judgment creditor who has
provided services for the protection of a beneficiary’s interest in the trust (such as a
beneficiary’s lawyer in trust litigation who has obtained a judgment against the
beneficiary for failing to pay the lawyer’s fees). Section 503 also shrinks the list of
traditional “exception” creditors, by eliminating creditors who have supplied
“necessaries” (such as food, clothing, or shelter) to the trust beneficiary.
One very important fact about “exception” creditors is that Section 503 permits
them to reach only distributions required by the express terms of the trust (such as
mandatory payments of income) and distributions a trustee has already decided to make
anyway (such as through actual exercise of the trustee’s discretion to make certain
distributions). Section 503 does not authorize any creditor—including a child or spousal
claimant—to compel a discretionary distribution. See UTC Sec. 503 cmt.
Section 504 is the UTC provision that has generated the most controversy about
the rights of a trust beneficiary’s creditors. This section, unlike Section 503, potentially
permits a beneficiary’s creditor to compel a distribution from a discretionary trust, even
one that contains a spendthrift provision.
Section 504(b) states the traditional general rule that a beneficiary’s creditor may
not compel a distribution from a discretionary trust, even if the trustee has violated a
standard of distribution (such as “health, education, support, and maintenance”) or abused
the trustee’s discretion. (Of course, as Section 504(d) makes clear, the beneficiary could
compel a distribution for his or her own benefit by proving that the trustee violated a
standard or committed an abuse of discretion.)
The controversial part of Section 504 is in subsection (c), which creates a special
exception to the traditional general rule governing discretionary trusts. Under this
exception, a beneficiary’s child, spouse, or former spouse with a valid support judgment
or order that has not been paid may claim that the trustee of a discretionary trust has
violated a standard or abused the trustee’s discretion in failing to make a distribution, and
that the court therefore should compel the trustee to make a discretionary distribution to
satisfy the claim. (Of course, the court may limit the amount paid to an amount the court
determines is “equitable under the circumstances.”)
States that have adopted or are considering adopting the UTC are all over the map
in their response to Section 504. Some states favor the UTC approach to creditors’
claims against discretionary trusts. Other states, however, reject this approach. Some of
these states have deleted Section 504 entirely; other states expressly provide that no
creditor can compel a distribution from a discretionary trust; others give special rights to
the beneficiary’s children but not to former spouses.
The important point here is that UTC Section 504 is not some “monolithic” new
rule likely to sweep the country. Individual states will continue to make their own policy
decisions about whether child and spousal claimants should be afforded special treatment
that departs from traditional trust rules about discretionary trusts.
PUBLIC SCRUTINY OF EXEMPT ORGANIZATIONS
Alan F. Rothschild, Jr.
The rapid growth of the nonprofit sector, the demands for corporate accountability after
Enron, and the wide availability of information about nonprofit organizations on the Internet
have significantly impacted the operation, governance and public accountability of these
organizations. Professional advisors must be aware of this changing operating environment in
order to effectively advise nonprofits today.
There are over 2 million exempt organizations which file reports with the Internal
Revenue Service each year and at least as many non-reporting religious organizations.
Americans gave $241 billion to these organizations in 2002, a ten- fold increase since 1975.
Nearly 10.5 million Americans work in the nonprofit sector today and the nonprofit workforce is
growing 50% faster than the for-profit sector.
Like the for-profit sector, the nonprofit sector has seen its share of high profile scandals:
• Conviction of James and Tammy Faye Bakker for illegal activities in
connection with their tele-evangelism network.
• Conviction of Bill Aramony, CEO of the United Way of America, for misuse
• New York Attorney General Spitzer’s lawsuit related to Dick Grasso’s $187
million compensation package from the New York Stock Exchange.
• The Washington Post’s exposure of the Nature Conservancy’s questionable
land deals with its Trustees.
These scandals have undermined public confidence in the nonprofit sector and raised
questions about the sector’s effectiveness and public accountability.
Some public advocates think that the very fact that nonprofits have tax-exempt status –
preferential treatment from federal and state government – is in and of itself reason why they
should expect closer public and regulatory scrutiny of their activities.
Yet, there must be some balance between public disclosure and the protection of the
independence of exempt organizations. In NAACP v. Alabama, 357 U.S. 449 (1958), the United
States Supreme Court held that an Alabama State Court order requiring the NAACP to disclose
its membership list was unconstitutional. More recently, there have been similar state action
versus privacy concerns in the abortion, labor relations and immigrant rights areas.
There is ongoing debate whether the news media is an effective steward of the public
interest in the nonprofit sector or whether the media has created a negative image of nonprofit
organizations that far exceeds the sector’s actual wrongdoings. Certainly, the news media is
often the first source of public information about nonprofit misdeeds. A large number of abusive
charitable situations that the IRS and state agencies have investigated and prosecuted were
brought to their attention from such reports. On the other hand, the media rarely puts any bad
news in context with the tremendous good accomplished by the nonprofit sector.
B. Sarbanes-Oxley Act and Nonprofits.
Congress passed the American Competitiveness and Corporate Accountability Act of
2002 (commonly known as the Sarbanes-Oxley Act) for the purpose of rebuilding “public trust”
in America’s corporate sector after Enron and the other recent high profile corporate scandals.
Under Sarbanes-Oxley, publicly traded companies must implement new governance standards
that broaden the board of directors’ role in overseeing the financial operations and auditing
procedures of the company.
Highlights of the Sarbanes-Oxley Act:
• Independent and competent audit committee – each member of the company’s
audit committee must be a member of the Board of Directors and independent.
Independence is defined as not being a part of the company’s management team
or receiving any indirect compensation from the company for professional
services. Generally, a public company must also have a financial expert on its
• Responsibilities of auditors – the Act requires that the main partners of the
auditing firm reviewing the company’s books serve for no more than five years.
In addition, Sarbanes-Oxley prohibits the auditing firm from providing most non-
audit services to the company at the same time it serves as auditor.
• Certified financial statements – perhaps the most well-known provision of the
Sarbanes-Oxley Act is the new requirement that the chief executive officer and
chief financial officer certify the accuracy of their company’s financial
statements. There can be criminal sanctions for false certifications.
• Insider transactions and conflicts of interests – the Act prohibits loans to directors
and members of the company’s management team.
• Disclosure –a number of new disclosures are required under the Act, including
corrections to past financial statements and significant off-balance sheet
• Whistleblower protection –there are new protections for whistleblowers and
criminal penalties for retaliatory actions against whistleblowers.
• Document destruction – in direct response to the Enron case, the Act makes it a
crime to alter, cover-up, falsify or destroy any document to prevent its use in any
official proceeding, including a lawsuit, investigation or bankruptcy proceeding.
While most of the provisions of the Act are directly applicable only to public, for-profit
companies, the whistleblower protections and document destruction prohibitions in Sarbanes-
Oxley apply to all corporations, both for-profit and nonprofit. Absent more specific guidelines
on whistleblower protection and document maintenance in other federal and state laws, it is
likely that Sarbanes-Oxley will become the standard by which nonprofit conduct is governed.
Although Sarbanes-Oxley’s other provisions are not on their face applicable to nonprofit
organizations, nonprofit law and practice frequently evolves from corporate law developments.
Thus, nonprofits must be familiar with the governance and accounting standards required by
Sarbanes-Oxley in anticipation that some of these concepts will also become the standard in the
For example, the provisions of Sarbanes-Oxley could have an impact on nonprofits
through increased disclosure requirements imposed by the IRS or under state nonprofit law, or
through auditing and accounting requirements as certified public accountants adopt Sarbanes-
Oxley as the standard for auditing the nonprofit industry.
Nonprofit watchdog groups, like the Better Business Bureau’s Wise Giving Alliance,
have issued standards for charitable accountability which contain Sarbanes-Oxley-like
requirements for governance, protection against conflicts and financial accountability. Some
state attorney generals are also proposing that elements of Sarbanes-Oxley be applied to
nonprofit organizations doing business in their state.
Voluntary compliance has already begun. Drexel University in Philadelphia attracted
significant media attention when it announced in November 2002 that it would adopt much of
Sarbanes-Oxley, including an independent audit committee, at least one financial expert on the
audit committee, whistleblower protections, the prohibition of loans to directors or the university
president, and an annual certification of the University’s financial reports. While a number of
other nonprofits have followed Drexel’s lead, most have not.
Nonprofit leaders and advisors should look carefully at the provisions of Sarbanes-Oxley
and determine whether their organizations should voluntarily adopt these governance practices to
head off federal or state implementation of standards which may be more burdensome and
expensive to their organization.
C. Statement of Auditing Standards No. 99.
In October 2002, the American Institute of Certified Public Accountants (“AICPA”)
issued Statement of Auditing Standards No. 99, Consideration of Fraud in a Financial Statement
Audit (SAS 99). SAS 99 is the central component of the public accounting profession’s efforts
to restore public trust in the accounting profession after Enron and the other recent corporate
We are all familiar with the collapse of Arthur Andersen as a result of the Enron debacle,
but its troubles in the exempt organization area are less well known. The Baptist Foundation of
Arizona (“BFA”) engaged in one of the most significant nonprofit fraud schemes ever.
Andersen was also its auditor.
BFA was a nonprofit agency of the Arizona Southern Baptist Convention whose mission
was to solicit donations in support of Southern Baptist causes. In its early days, BFA focused on
funding church start-ups and providing aid for children and the elderly. In 1984, BFA changed
its focus and decided to invest in Arizona real estate and to sell retirement programs to members
of the Convention. In 1985, it took in over $210 million from its members.
BFA’s retirement accounts were “funded” by the rising valuations of Arizona real estate.
When the real estate bubble burst in 1989, BFA set up independent, off-book corporations to
which it sold property (at inflated values) and received notes that were recorded at the purchase
price, rather than the current diminished property value. By using a Ponzi- like inflow of ne w
investor money and over 90 off-book entities, BFA was able to disguise its true financial
Arthur Andersen provided unqualified (clean) audits of BFA’s finances. As a result of its
failure to recognize the financial irregularities taking place, Andersen was forced to settle
Arizona Board of Accountancy and investor lawsuits for over $200 million.
In reviewing the BFA matter, the AICPA determined there were a number of key
warning signs which, if properly investigated, would have put Andersen on notice of BFA’s
financial problems. The core concept in SAS 99 is that auditors cannot rely too heavily upon
management assurances. SAS 99 places increased emphasis on professional skepticism by the
auditor, who must analyze how fraud could occur and adjust their audit program to better detect
SAS 99 is effective for periods beginning on or after December 15, 2002, so most
nonprofits will learn of this new requirement during the audit of their 2003 financial activity.
Although many auditors have not determined how they will implement the requirements of SAS
99, most are expected to increase their focus on detecting fraud and to be more skeptical when
evaluating company-provided information. There will be more examinations of internal
controls, especially if the exempt organization manually overrides these controls, and more
examination of fraud “risk factors”. While SAS 99 will lead to more thorough audits of exempt
organizations, the time and corresponding costs of these audits will certainly increase.
D. IRS Disclosure and Compliance Programs.
Prior to 2000, most exempt organizations (other than private foundations) were required
to provide requesting individuals with copies of their exemption application and annual tax
returns. Effective March 13, 2000, this requirement was extended to private foundations.
Under the present rules, exempt organizations are generally required to provide, to any
person who requests, copies of their exemption application and three most recent tax returns.
Copies must be provided immediately if the request is made in person or within 30 days if in
writing. The organization may charge a fee to defray the actual cost of postage and
Under a significant exception to these requirements, an organization need not comply
with a request for copies of documents that are “widely available.” Treasury Regulations
provide that a document is considered widely available if it is posted on a web site that complies
with applicable IRS guidelines. An orga nization may satisfy this exception either by posting its
exemption application and annual returns on its own web site or by relying on the fact that
another organization has posted the documents.
If an organization’s documents appear on a web site, the organization may respond to
requests for copies by providing the address of the site where the documents may be
downloaded. The address must be provided immediately if the request is made in person or
within seven days if in writing. Even if an organization makes its exemption application and
annual returns widely available, the documents must remain available for public inspection
during normal business hours at the organization’s office.
If the IRS determines that document requests to an exempt organization constitute a
campaign of harassment and that compliance with these requests would not be in the public
interest, the organization need not comply with any request that it reasonably believes is part of
that campaign. In addition, Treasury Regulations provide that, even without an IRS
determination of harassment, an organization may disregard the third (or more) request within a
thirty day period for all or part of a particular document and the fifth (or more) request within
any one- year period from the same individual or the same address.
With the 2000 law changes, private foundations are now subject to the same requirements
that apply to most other tax-exempt organizations for the retention and disclosure of their annual
returns and exemption application. While private foundations are no longer required to publish
the availability of their annual returns, they must, like public charities, disclose their balance
sheet, grants and compensation paid to officers, directors and employees. Unlike public
charities, private foundations must also disclose their substantial contributors.
The IRS has declining personnel in the exempt organizations area and flat financial
resources for monitoring and enforcement. Except in certain egregious situations and targeted
enforcement areas, like nonprofit health care organizations, the IRS conducts only cursory
reviews of nonprofit filings, and audits of nonprofits are down significantly in recent years.
Although the IRS work plan includes a comprehensive audit program for community foundations
and donor-advised funds, due to the Service’s severe lack of resources, there has been little or no
activity on this plan.
E. Internet Resources.
There are a number of online resources available to grantmakers, grant seekers, and
professional advisors. The IRS’s online database of exempt organizations
(www.irs.ustreas.gov/charities/article/o,,id=96136,00.html) is a useful tool for confirming the tax
status of an organization. The Foundation Center (www.fdncenter.org) and The Council on
Foundations (www.cof.org) are excellent resources for grantmaking organizations, including
families and advisors seeking more information about grant making, family foundation
operation, governance and succession. Regional associations of grantmakers, like Philanthropy
Northwest (www.philanthropynw.org) and the Southeastern Council of Foundations
(www.secf.org) are also good resources.
Independent watchdog groups, like the Better Business Bureau’s Wise Giving Alliance
(www.give.org) and the American Institute of Philanthropy (www.charitywatch.org) provide
non-partisan online evaluations of charitable organizations. These efforts have not been
particularly successful – too few charities are actually evaluated, and even fewer donors seem to
avail themselves of the evaluation reports that have been posted.
Another effort with real promise, but with only limited success so far, is the independent
accreditation of nonprofits. One of the better efforts to date is the voluntary certification
program sponsored by the Maryland Association of Nonprofit Organizations
(www.mdnonprofit.org) called Standards for Excellence in the Nonprofit Sector. Accreditation
will likely never achieve broad acceptance until there is a nationally-recognized organization
conducting the evaluation and certification process. Only then will the nonprofit sector have a
true “Good Housekeeping” seal of approval.
The Internet resource which has had the most significant impact is GuideStar
(www.guidestar.org). GuideStar is a free, online database of over one million U.S. nonprofit
organizations. Its database includes financial statements, governing board members, mission
statements, grant requirements and PDF copies of recent Form 990s.
Founded in 1994 as a centralized source of information for the nonprofit sector,
GuideStar struggled in its initial years. The confluence of the Internet as a broadly available
information source and the public’s demand for nonprofit accountability after Enron and
September 11th gave GuideStar new life. Today, it is the leading private source of information
on exempt organizations and has a $6 million annual budget funded in part by several national
GuideStar has a unique partnership with the IRS. When Form 990s are filed with the
IRS, they are scanned and transmitted to GuideStar. GuideStar digitizes each return into a PDF
file, loads it into its database and makes it available to the public.
While the transparency Guidestar provides is welcomed by many participants in and
beneficiaries of the nonprofit sector, certain giving patterns may change as a result of the wide
availability of this information. For example, some donors may choose the relative anonymity of
donor-advised funds at community foundations over private foundations.
F. State Regulation.
In addition to the IRS filing and disclosure requirements, nearly every state requires
exempt organizations to register before doing business in the state and to make additional
disclosures about the organization to ensure the ongoing tax-exempt nature of their organization.
However, while most states have agencies charged with enforcing these nonprofit disclosure and
operational rules, most are inactive, ineffective or significantly understaffed.
The one arm of state nonprofit regulation which had generally been effective is the state
attorney general’s office (“AG”). In most states, the AG’s office is charged with the
responsibility of protecting the public’s interest in exempt organizations. Traditio nally, many
AGs would “rubber stamp” the actions of a charitable trustee or organization, including
significant modifications of the trust or termination of the charitable entity. Some AGs have
become more pro-active – both in responding to such requests and in initiating action against
charitable entities for alleged wrongdoings.
• While Eliot Spitzer has received significant press coverage for the New York
AG’s office enforcement efforts, Pennsylvania’s AG’s office has been very active
on the nonprofit front as well:
- It brought suit in 2002 to block the sale of Hershey Foods by the Hershey
Trust Company and the Milton Hershey School.
- In 2000, as a party to the proposed transaction involving two nonprofit
health care organizations, the AG’s office expanded its inquiry beyond
just the fairness of the transaction. The AG insisted the two organizations
more fairly negotiate the transaction to minimize future disputes and to
achieve a fair division of charitable assets.
- In Estate of McCahan, 564 A.2d 1011 (PA Superior Ct. 1989), the
Pennsylvania AG, acting on behalf of charitable remaindermen of two
charitable remainder trusts, sued the trustees – alleging investment in tax-
exempt bonds impermissibly favored the income beneficiaries over the
G. State Sunshine Laws.
As more and more functions traditionally performed by federal and state government are
being turned over to (or assumed by) nonprofit organizations, questions are being raised about
the applicability of state sunshine laws (Open Records and Open Meetings Acts) which require
the meetings and records of state and local government be open and accessible to the general
public. While some disclosure activists contend that exempt organizations, as publicly subsidized
entities through preferential tax treatment, should open all of their meetings and records to the
public, the courts have traditionally held that most charities are private nonprofit entities and are
not subject to state sunshine laws. However, with the increasing involvement of private
nonprofits directly and indirectly in public projects or traditionally governmental functions, some
nonprofits are finding themselves subject to these laws.
In Colorado, for example, an independent nonprofit corporation was created to redevelop
the 4700 acre site of Denver’s former airport. The development corporation solicited bids from
real estate firms seeking to become partners in the project. The Denver Post filed an Open
Records Act request to see the real estate developers’ bid proposals. The Colorado Court of
Appeals held that, although the development corporation was a private entity not usually subject
to the Colorado Open Records Act, the City of Denver retained substantial control over the
project because it provided funds to the corporation and appointed its board. In addition, Denver
would receive the proceeds if the corporation opted to sell any portion of the land it owned.
Therefore, the Court concluded, the development company was a “political subdivision” of the
state and required to comply with Colorado’s Open Records Act.
A Minnesota State court found that the Minnesota Partnership for Action Against
Tobacco, a private nonprofit organization formed as part of the State’s $6 billion settlement with
tobacco makers, was subject to Minnesota’s Open Record and Open Meetings Act because of the
amount of “public money” it received and the “importance” of its mission. The Georgia
legislature specifically amended Georgia’s Open Records and Open Meetings Acts to expand its
coverage to apply to private charitable organizations which succeeded to the operation of county
The Missouri sunshine law references “quasi-public governmental bodies”. These are
defined as organizations performing a public function, carrying out activities through contracts
with public bodies, or receiving direct appropriations from public bodies. In North Carolina, the
State Court of Appeals held that an organization that began as a public body but then became a
private nonprofit organization was obligated to comply with North Carolina’s sunshine laws. In
addition, if the private organization was formed by a public body or agency and the initial board
of directors was selected by the public agency, North Carolina’s Open Meeting and Open
Records laws likely apply, even if the board becomes self-perpetuating.
Clearly, the trend is away from protecting private nonprofit organizations that contract
with or perform normally (or previously) public functions. Every nonprofit organization must be
aware of this trend and consider whether its participation in joint ventures with public agencies,
the performance of previously public functions or the acceptance of direct appropriations from
state or local government will subject some or all of the organization’s books, records and
meetings to disclosure.
Counsel to nonprofit organizations (and their donors) must be prepared to advise their
clients on the emerging laws regarding the public’s (and, increasingly, the media’s) access to
their organization’s meetings, minutes, budgets, contracts and other corporate records, including
H. Professional Ethics.
Attorneys who render charitable planning advice must be ever- mindful that charitable gift
planning is governed by the same rules of professional conduct as other areas of law practice.
Oregon Formal Ethics Opinion No. 1991-16 involved a very typical fact pattern. The
attorney was a long-serving member of the charitable organization’s Board of Directors and had
provided legal advice to the organization on a continuing basis. An individual donor, likely a
fellow board member, asked the attorney to represent the donor and their spouse in two estate
planning projects: an inter vivos charitable remainder trust where the charitable organization will
be the remainder beneficiary, and in the preparation of last will and testaments under which the
charity was also one of the beneficiaries.
The Ethics Opinion specifically addressed three questions:
1. May the attorney represent both the donors and the charity in the charitable
remainder trust transaction?
No. Because of the potential differing interests or positions between the charity
and the donors concerning the terms of the transaction, representation of both the
charity and donors in this CRT transaction would constitute a conflict of interest.
2. May the attorney represent only the donor in the CRT transaction?
Yes. With full disclosure and the consent of both the charity and the donors.
3. May the attorney prepare the donors’ last will and testaments?
Yes. With full disclosure to and consent from the donors. The consent of the
charity was not required in this situation since its interests were deemed not to be
adverse under this document, unlike the charitable remainder trust transaction.
In Maryland Ethics Docket 2003-08, the Committee on Ethics of the Maryland State Bar
Association ruled that a lawyer who encourages parishioners of his church to leave bequests to
the church in their wills may not also prepare their wills due to Rule 1.7 of the Maryland Rules
of Professional Conduct governing conflicts of interests. This Rule (which is similar to Rule 1.7
of the ABA Model Rules of Professional Conduct) prohibits a lawyer from representing a client
if that representation will be directly adverse to another client or may be materially limited by the
lawyer’s responsibilities to another client or to a third person, or by the lawyer’s own interest.
In this situation, the lawyer chaired the church’s Development Committee and offered to
prepare estate planning documents on a pro bono basis for church members interested in leaving
bequests to the church. The Maryland Committee on Ethics ruled that the lawyer’s interest in
helping his church’s planned giving efforts compromised his independent professional judgment.
The lawyer could not represent both the interest of the client and the Development Committee at
the same time.
Attorneys with ties to charitable organizations must carefully evaluate their relationship
with the organization to determine whether it creates a conflict of interest or concerns about
undue influence with a prospective client who is considering gifts or other transactions with the
charitable organization. Full disclosure of the attorney’s relations hip with the charitable
organization, in writing, is well advised. The attorney might also consider obtaining a written
acknowledgement and waiver of any potential conflicts.
In the past, most nonprofits operated outside of the public’s eye. Corporate scandals, the
Internet, and the tremendous growth of the nonprofit sector have led to increased media
attention, new governmental regulation, and the expectation of greater public accountability.
Nonprofit organizations and their professional advisors must be aware of and effectively respond
to these new expectations.
THE DOS AND DON’TS OF DONOR CONTROL
By Alan F. Rothschild, Jr.
Hatcher, Stubbs, Land, Hollis & Rothschild
Donors increasingly desire to designate gifts for specific purposes or to impose
other conditions on their charitable contributions. Alumni magazines and planned-
giving journals regularly announce significant donations to fund the construction of a
named building or professorship, the creation of an endowment fund for a particular
purpose or a grant to further a particular individual’s research efforts.
Some donors impose restrictions on the property contributed to charity, such as
limiting its use to a particular purpose or prohibiting its sale or deaccesioning. Others
contribute a partial interest in the property and retain control over the remaining
Many of these conditions and restrictions are well-intended efforts to ensure that
a donor’s wishes are carried out by the donee exempt organization, but careful thought
and planning must be given to structuring these types of gifts to ensure they do not run
afoul of the IRS’ rules on the deductibility of in life or testamentary charitable
B. Definition of Gift
For a transfer of property to be deductible for income tax or estate tax
purposes, the transfer must be a contribution or gift to an exempt organization. The
rules for deductibility assume no quid pro quo for the gift. If there is a benefit to the
charity and an economic disadvantage or detriment to the donor, the deduction will be
allowed. On the other hand, there is no deduction if the donor received a benefit, either
directly or indirectly, in return. Signom v. Commissioner, 79 TCM 2081 (2000).
Under the income tax and estate tax provisions of the Code, gifts are only
deductible if they are made to exempt organizations and not for the benefit of a specific
individual, no matter how worthy the individual may be.
When providing advice and counsel in this new era of donor control, we must
also remember that the gift of a partial interest in property is not deductible unless it
meets certain very specific exceptions in the Code.
C. Retained Control
In 2001, the Catherine B. Reynolds Foundation pledged $38 million to the
Smithsonian Museum for an exhibition honoring “the power of the individual”.
Museum curators balked at some of Ms. Reynolds’ exhibit requirements and expressed
concern over the perceived control she appeared to have over the exhibit. The Museum
and the Foundation could not resolve their differences, and, after significant negative
publicity, the Foundation cancelled its pledge.
Is the Reynolds case an example of a nonprofit organization failing to understand
and adapt to the new breed of donors? Or is it an example of the new generation’s
failure to understand the boundaries between philanthropy and self-interest?
Whether due to donors’ lack of confidence in exempt organizations today, or due
to the fact that many donors are self-made successes who desire to share their
entrepreneurial energies with the nonprofit sector, planned-giving advisors must be
aware of donors’ desires to exercise more control over their contributions and the
practical and legal implications arising from these desires.
Old Style: Private Foundations
Previously, private foundations were the most common way for a donor to
exercise control over donated funds. The donor simply established a private foundation
in lieu of giving assets directly to a public charity, so the donor could continue to control
the disbursement and use of the funds in the future.
Many of the traditional legal issues raised regarding donor control are based
upon concerns that the private foundation’s substantial contributors and board
members could use their position of influence to benefit themselves or their family
members. The excise tax provisions of IRC §§4941-4945 were intended to address these
potentially abusive situations.
New Style: Venture Philanthropy
In 1997, a Harvard Business Review article entitled, “Virtuous Capital: What
Foundations Can Learn From Venture Capitalists”, identified a new form of giving –
venture philanthropy. Venture philanthropists attempt to not only make traditional
grants to nonprofit organizations, but to develop in depth relationships with their donee
organizations, including closer monitoring and management assistance.
Rather than simply making a passive grant to an organization, these new era
donors “invest” in their nonprofits, much like the venture capitalists in the for-profit
world who both invest their financial resources and provide their expertise and
oversight to start-up corporations. As part of this new venture philanthropy,
grantmakers attempt to exercise significantly more control over the grantee than was
generally seen in the past. For ex ample, the grantmaker may condition his or her grant
on very specific actions to be taken by the prospective donee, provide business advice
and governance through management and director positions, seek to provide products
or services to the nonprofit and help network the nonprofit into his or her existing
This hands-on-approach to charitable giving raises a number of interesting legal
Under general corporate law, if one entity exercises significant control over
another, the controlling organization may be liable for the torts or contracts of the
controlled or subsidiary organization. While this is unlikely to be an issue in hands-on-
philanthropy, if there is excessive control by the donor, either directly or indirectly, it is
possible that the donor could be responsible for the controlled organization’s liabilities.
IRC §4942 requires private foundations to distribute five percent of their assets
annually. The distribution by a private foundation to a public charity is not a qualifying
distribution if the recipient is controlled, directly or indirectly, by the private
foundation. Treas. Reg. §53.4942(a)-3(a)(3) finds “control” exists if any disqualified
person may, by aggregating their votes or positions of authority, require the donee
organization to make an expenditure or prevent the donee organization from making an
expenditure, regardless of the method by which the control is exercised or exercisable.
Venture philanthropy can also put the public charity status of the grantee at risk.
If a donor makes a long-term commitment to fund an exempt organization, the donor
and the organization must ensure that the organization receives financial support from
other sources in order to meet the public support test under IRC §509(a)(1). Where
significant support and control comes from a single source, it is often hard for the donor
to obtain broad community support for the effort.
CRT’s and CLT’s
Donor control can create unexpected results in more traditional forms of giving
as well. Rev. Rul. 76-8, 1976-1 CB 179, provides that the grantor of an inter vivos
charitable remainder trust can retain the right to substitute charities or to add
additional charitable remainder beneficiaries without jeopardizing their income tax
charitable deduction. Rev. Rul. 76-7, 1976-1 CB 179, also provides that the grantor of an
inter vivos CRT can delegate this power to another, including the granting to the income
beneficiary of the CRT a testamentary power of appointment to name new additional
charitable remainder beneficiaries.
When donors desire to exercise as much control over their charitable gifts as
possible, then some type of provision allowing the addition or removal of the charitable
remainder beneficiaries is frequently included in their CRT. However, the donor should
not retain the power to change the charitable remainder beneficiary if he or she (or,
perhaps, their spouse) is not the income beneficiary of the inter vivos CRT. To do so
would cause the CRT’s assets to be included in his or her estate at death when it
otherwise would not. This could cause an increase in the estate tax if the assets have
appreciated in value since the original gift because the estate is not entitled to a full
charitable deduction if someone other than the donor is entitled to a continuing income
stream from the CRT.
Similarly, the grantor of a lifetime charitable lead trust should not retain the right
to designate or alter the charitable beneficiaries. If the grantor dies during the CLT
term, the trust property will be included in his or her estate and all of the transfer tax
benefits of the trust will be lost. See PLR 200328030, where the IRS disallowed a gift
tax charitable deduction for a contribution to an inter vivos CLT and included the trust
property in the donor’s estate because the donor retained the right to change the
charitable beneficiary. Treas. Reg. §25. 2511-2(c) and Rev. Rul. 77-275, 1975-2 CB 346,
also provide that a gift is incomplete if the donor reserves a power to name new
beneficiaries or to change the interest of the beneficiaries. The grantor may avoid this
result by giving the trustee or an advisory committee designated in the CLT the power to
select an alternate charitable beneficiary.
D. Conditions and Restrictions
A contribution is deductible under IRC §170(a) only if it is made “to or for the use
of” a charitable organization. Under Treas. Reg. §1.507-2(a)(a)(i), a donor may earmark
a contribution to charity for a particular use without jeopardizing the charitable
deduction, provided that the restriction does not prevent the charity from freely and
effectively employing the transferred assets, or the income therefrom, in furtherance of
its charitable purposes. See also Phinney v. Dougherty, 307F.2d 357 (1962). Treas. Reg.
§1.170A-1(e) provides that so long as the contribution is earmarked for a permissible
charitable purpose, the deduction is allowable. It illustrates this principle with
examples which include the contribution of land to a city to be used as a public park,
where the city intends to use the land for such purpose at the time of the gift; the
creation of an endowment fund for a particular department or college at a university;
and the construction of a building sought to be built by an exempt organization.
However, if the gift is designated or earmarked for a non-charitable purpose, or
even a charitable purpose that is outside of the donee organization’s mission, the gift
may not be deductible by the donor.
Planned gift advisors should draft gift agreements that specifically recognize that
the conditions placed upon the gift are in furtherance of and consistent with the donee
organization’s exempt purpose. For substantial gifts, a board resolution by the
governing board of the donee organization which contains a similar acknowledgment is
When designing gift agreements that contain conditions and restrictions, reverter
clauses are sometimes used. A reversionary provision creates great uncertainty since it
will cause the charitable transfer to be nondeductible if the IRS determines that the
reversion is not “so remote as to be negligible” (see below). It is wise to consider an
alternative charitable beneficiary rather than a reversion provision for this reason.
If restrictions or conditions are to be placed upon a gift, it must be done at the
time the gift is made. The donor must not retain the continuing right to change the use
or purpose of the contribution. This could result in the retention of dominion and
control over the property which could render the gift incomplete.
If the donor merely retains the right to make nonbinding recommendations
regarding the distribution of previously contributed property, the deduction is
allowable. This is the reason that community foundation donor-advised funds are
qualified donees for charitable deduction purposes.
Treas. Reg. §1.170A-1(e) also provides that a charitable income tax deduction
under §170(a) is not allowable if a transfer for charitable purposes is, as of the date of
the gift, dependent upon the performance of some act or the happening of an event in
order for the transfer to become effective, unless the possibility that the charitable
transfer will not become effective is so remote as to be negligible. In Briggs v.
Commissioner, 72 TC 646 (1979), the Tax Court defined “so remote as to be negligible”
as a “chance which persons generally would disregard as so highly improbable that it
might be ignored with reasonable safety in undertaking a serious business transaction”
or one “which every dictate of reason would justify an intelligent person in disregarding
as so highly improbable and remote as to be lacking in reason and substance.”
Obviously, this is a very high standard and estate planners would be well advised to
counsel prospective donors on the risks inherent in placing conditions or reversions on
For similar reasons, if a transfer for charitable purposes may be defeated by the
occurrence of some event or the performance of some act, no deduction is allowable
unless the “so remote test” is also met.
In Rev. Rul. 2003-28, 2003-11 IRB 594, the donor transferred a patent to an
educational institution on the condition that a specific faculty member continue to be on
the faculty during the patent’s fifteen-year effective date. Because of this condition, the
charitable deduction was denied. The IRS rightly determined that the possibility that
the faculty member might not remain on the faculty for fifteen years was not so remote
as to be negligible. On the other hand, Treas. Reg. §1.170A-1(e)’s city park example
illustrates that where the circumstances at the time of the gift indicate a strong
likelihood that there will be no reversion, the charitable deduction will be allowed.
Gifts contingent on successful fundraising for a project should be avoided. In
Rev. Rul. 79-249, 1979-2 CB 104, a gift to a public board of education to build a new
school contained a reverter to the donor if insufficient funds were raised to complete the
project. The IRS ruled that until it was known there were sufficient funds, the
possibility that the funds would be returned was not so remote as to be negligible.
Therefore, the deductions were not allowed until it was clear that the school would
retain the funds and construct the new building.
Again, to avoid the risk of disallowance for the charitable deduction, donors
should consider providing for an alternative charitable beneficiary, or an alternative use
within the original donee organization, so that there is no possibility that the property
will revert to the donor or be used for another non-charitable purpose.
Some commentators are also concerned that if the donor places too many
restrictions on a gift, the IRS will treat the gift not as a contribution to the charity, but
rather as the establishment of an independent charitable trust, which would be subject
to the strict rules governing private foundations. This could cause tax headaches for
both the donor and donee, due to the deduction limitations, as well as for the ongoing
operation of the fund, which would not otherwise be operated either separately or under
the strict restrictions imposed by the private foundation rules.
The cases and rulings regarding the gift of artwork discussed in Section F. below
also provide general guidance on the lines the IRS might draw for restricted gifts.
Many donors desire to create tangible monuments to themselves or to others by
naming scholarship funds, buildings or professorships at exempt organizations. So long
as these gifts further the organization’s charitable mission, the deductibility of a gift
contingent upon the naming of the item at the time of the gift should not be questioned.
However, the recent series of corporate scandals serve as a reminder that exempt
organizations should protect themselves by establishing “un-naming” policies and
procedures in their gift acceptance policies or in the gift agreements which establish
naming opportunities. Absent clear policies, it is unclear what will become of Seaton
Hall University’s Koslowski Hall, named after the dethroned CEO of Tyco International,
the University of Missouri-Columbia’s Kenneth Lay Professorship or the Richard
Scrushy Building at the University of Alabama-Birmingham. Absent un-naming rights
in an agreement or gift acceptance policy, the donee organization may not be able to
remove the donor’s name, or may be required to return the contribution if it does.
In 1987, Elroy Strock gave $500,000 to Augsburg College to construct a building
in his honor. After the acceptance of the gift, the school learned that Mr. Strock was a
racist who had written numerous letters criticizing interracial marriage. The school
refused to place Mr. Strock’s name on its new building. Strock sued for return of his
contribution, claiming that the school had breached its gift agreement with him. After
protracted litigation, the Court determined that the college could keep the contribution
but did not have to name the building after Strock. In an ironic twist, the college
received significant criticism because it elected to retain Mr. Strock’s contribution (due
to his beliefs). In the end, Augsburg created a $500,000 minority scholarship fund with
the donated funds.
These real life stories raise an interesting point – who does have standing to
enforce the conditions or restrictions placed upon a charitable gift?
Standing to Enforce
Historically, donors have had few rights to enforce charitable gifts. Once a gift is
complete, many courts have held that the donor no longer had standing to enforce the
terms of the gift. Rather, these rights inure to the benefit of the public, usually
enforceable by the state attorney general’s office.
That changed in 2001 when a New York State Appellate Court ruled that Adele
Smithers-Fornaci, the personal representative of her late husband’s estate, could sue St.
Luke’s-Roosevelt Hospital Center for failing to abide by the terms of her husband’s $10
million, thirty-year old gift. The widow alleged that the hospital had misappropriated
$5 million from the endowment fund established by her husband and was planning to
put the proceeds from the sale of a townhouse, also given by her husband, into its
general operating funds.
The Court held that the donor’s estate had standing to sue the charity and to
enforce the terms of the gifts under New York common law. While this case settled in
October 2003 (with the hospital agreeing to rename a building in Mr. Smithers’ memory
and to give nearly $6 million to another nonprofit organization), the courts have become
increasingly open to the idea that donors, their estates or descendants, may have the
right to rescind gifts or to take legal action if their conditions are not honored.
Take the case of Sybil Harrington, a Texas oil heiress who gave $33 million to the
Metropolitan Opera to support opera “in the traditional manner”. In 2001, the Met used
part of her gift to televise an abstract production of Wagner’s Tristan und Isole. Last
year, in reliance upon the St. Luke’s trend, Harrington’s estate sued the Met to recoup
the funds expended on its television production and to obtain veto power over how the
remaining funds are spent.
In 1996, Paul Glenn, through his Foundation for Medical Research donated $1.6
million to the University of Southern California for the study of aging. In 2001, Mr.
Glenn sued USC on the grounds that it did not honor the contract entered into through
oral and written communications with the foundation at the time of the gift. This case
received significant attention in the courts and press and reaffirmed the tendency of
courts to allow legal action when charitable gifts do not turn out as planned.
While these cases have begun to alter the common law concept that the donor
does not have standing to sue, these decisions are quite new and not widespread. As
such, the donor is advised to create standing by including provisions in their gift
agreement that the gift will either be returned to the donor (not recommended – see
Section D. above) or given to another charity if the donee ceases to abide by the gift
agreement. A properly drafted provision which gives standing to the donor, his estate or
to some other definable person or entity should suffice.
E. Benefiting Individuals
To be deductible, a donation must be “to or for the use of” a charitable
organization, not a designated individual. An individual is not entitled to a charitable
deduction for gifts to individuals, no matter how deserving the individual may be. As
such, taxpayers should not indirectly be able to get a deduction by designating a gift for
a particular individual and flowing the gift through a charitable organization. This is
known as “earmarking” and may be any oral or written understanding that the money
will be used in a specific way.
Thomason 2 T.C. 441 (1943) held that “charity begins where certainty in
beneficiaries ends, for it is the uncertainty of the object and not the mode of relieving
them which forms the essential element of charity.” In Rev. Rul. 62-113, 1962-2 CB 10,
the IRS ruled that to be deductible, the charity must have control and discretion over the
contribution without any obligation to benefit a designated individual.
The two tests used by the IRS to determine if an “earmarked” gift is deductible
1. Does the donee organization have discretion and control over the contribution
notwithstanding the donor’s desire to benefit a specific individual? If the
charity has the option to apply the donated funds to other purposes, this
supports deductibility of the contribution.
2. Does the donor intend to benefit the charitable organization or the designated
individual? Obviously, a written agreement between the donor and donee
provides the clearest evidence of how each side understands its rights and
responsibilities. In addition to a gift agreement or correspondence between
the donor and the donee organization, the donee organization’s fundraising
literature and the donor’s receipt for the gift can be used by the IRS to
determine whether an earmarked gift is made.
To ensure deductibility, the IRS suggests the following language in the donor’s
receipt: “this contribution is made with the understanding that the donee organization
has complete control and administration over the use of the donated funds.”
There are many cases and rulings in this area where family members want to
provide funds for relatives to cover living expenses while doing missionary work. If the
gift is an impermissible earmarked gift, then the charitable deduction is denied. Some
of the facts which play in favor of a deductible gift include the missionary organization’s
fundraising material, where it states that the exempt organization retains full discretion
over the donated funds and that the organization will assess the needs of all of its
current projects before distributing any funds.
In one particularly egregious case, Tim Mosley, a San Rafael, California insurance
agent, created a donor-advised fund with a national charitable gift fund. Over a five-
year period, Mr. Mosley sent contributions to the donor-advised fund, advised his tax
preparer that these were charitable contributions, and claimed significant tax
deductions on his annual income tax returns. Unbeknownst to his tax preparer, Mr.
Mosley recommended distributions from his donor-advised fund to a religious
organization and instructed the religious organization to use the funds to pay his
children’s tuition at the church-sponsored school they attended. Not only did the IRS
deny Mr. Mosley’s deduction for his contributions to the charitable gift fund, but the IRS
also charged him with five counts of tax evasion. On June 19, 2003, Mr. Mosley was
sentenced to five months in prison and forced to pay the Department of Treasury
$275,000, $165,000 of which represented penalties and interest.
Generally, the rules for calculating an income tax and estate tax charitable
deduction provide that when a charitable contribution is made, the amount of the
contribution is equal to the property’s fair market value on the date of the gift.
According to Rev. Rul. 85-99, 1985-2 CB 83, if a donor places a restriction on the
marketability or use of the contributed property, the charitable deduction must be
reduced to take the restriction into account.
Rev. Ruling 2003-28, 2003-11 I.R.B. 594 (discussed in Section D. above) also
addressed the deductibility of the contribution of a patent which the donee was
prohibited from selling for three years. The IRS ruled that although the three-year
prohibition could never cause the patent to revert to the donor and would not otherwise
provide the donor with a benefit, such prohibition reduced the fair market value of the
patent and the corresponding charitable deduction allowable under IRC §170.
In Rev. Rul. 85-99, 1985-2 CB 83, an agricultural college sought to acquire a
parcel of land for farming research purposes. The landowner agreed to contribute the
property and did so by deed which contained restrictive covenants limiting the land’s
use for agricultural purposes only. Since the highest and best use of the unrestricted
parcel was development, the IRS ruled that the amount of the deduction for income tax
purposes must be determined in light of the restriction. A very similar conclusion was
reached in PLR 8641017, where a donor restricted mining on the property in the deed
conveying it to an exempt organization.
PLRs 200202032, 200203013 and 200203014 highlight the special
considerations that must be given to placing restrictions on charitable bequests of art
collections and provides guidance on what restrictions the IRS will allow. The types of
restrictions commonly found in donations of artwork include:
1. A requirement that the work be permanently displayed;
2. A prohibition on lending work to other institutions; and
3. A prohibition on the sale of the work of art.
In these PLRs, the donor bequeathed artwork to a major art museum subject to
numerous conditions, including continuous display and a requirement that the works
always be exhibited together. The donor also required the proceeds from the sale of any
of the works to be used to purchase other works of art for the museum. The IRS ruled
that there was no reduction in the estate tax charitable deduction because there was no
way the museum could be divested of ownership (such as through reversion), and the
only restriction on the sale of the art by the museum was a requirement that it purchase
other works of art with the proceeds.
In Silverman, T.C. Memo 1968-216, a donor contributed a significant number of
pieces of art to various museums with the restriction that the property could not be sold
for three years. The Tax Court found that the three year restriction had an adverse
impact on the value and reduced the charitable deduction. Notwithstanding that
decision, in my experience, donors routinely make gifts and bequests of art to museums
with restrictions on deaccessioning.
Planned giving advisors should also consider the significantly different impact in
inter vivos and testamentary gift situations. While a donor’s income tax deduction may
be reduced for income tax purpose if a lifetime gift is deemed to have restrictions
affecting valuation, a particularly bad result arises if the donor owns fee simple title to
the property at death, but places restrictions in the testamentary charitable gift of the
property that reduces its fair market value. In that case, the estate tax charitable
deduction may equal the property’s value for estate tax purposes.
Rather than jeopardizing the full fair market value of a charitable deduction,
donors should consider whether precatory language expressing their wish that the
donated property not be sold is satisfactory.
Exempt organizations and their professional advisors must be aware of the new
breed of donors and their desire to control or restrict their charitable gifts.
opportunities and traps related to donor control so they can effectively design gifts in
this environment of increased donor control.