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Estate planning's best kept secret: community foundations.

Many estate planners are responsible for developing charitable giving strategies for their clients. They should consider the many donor options that community foundations offer. A client, with guidance from an advisor, can make a gift to a community foundation that enables the donor to enjoy significant tax savings while fulfilling a wide variety of charitable objectives. Community foundations are one way to serve clients better and also to strengthen communities. This article provides a basic introduction to community foundations.

An Estate Planning Challenge

Michael and Michelle Smith want to update their estate plans. Their goals are similar to those of many clients: ensure a comfortable retirement, provide for their children and minimize transfer taxes. The Smiths have an additional goal, however, they want to help their community. They have come to you because they are unsure of how best to achieve all their goals.

Although community service is important to them, the Smiths do not know the community's greatest needs or which agency or group will best address them. They are not sure they can give enough to "make a difference," but they would like their gift to be flexible enough that the beneficiaries could change as community needs change. As an estate planner, your challenge is to meet their goals in a simple and cost-effective way.

To do so, you might suggest the Smiths consider making a gift to their local community foundation. The Council on Foundations, a national association of more than 1,300 private foundations, corporate giving programs and community foundations, notes that more than 400 community foundations with assets of more than $6 billion(1) now operate across the country. A community foundation provides a unique means of philanthropy for many charitably minded individuals(2) because it can provide donors with choice, permanence, flexibility and tax benefits.

A community foundation is a public charity(3) that manages funds and distributes the fund income (or in some cases, the funds themselves) to benefit the community. It may be organized either in trust or corporate form. A foundation's governing body, the board of trustees or directors, represents a cross-section of a community(4) and is informed about and sensitive to the community's issues and needs, which it matches with its donor's wishes. The community benefits from the foundation's organized effort to collect and distribute funds. The donor benefits because the gift is maximized by that collective effort.

The Efficient Charitable Gift

There are several reasons why a community foundation is an excellent choice for charitable giving. First, giving to a foundation provides donors with the efficiency and flexibility that they may not acquire individually, especially those who are making smaller gifts. A community foundation donation can be pooled with other funds to implement the donor's charitable intent even when the gift by itself would have been too small.

Second, the investment management fees incurred by a community foundation can often be lower than those incurred by a small private foundation or a charitable trust. Thus, more income will be available for charitable purposes. The larger pool of investments allows for diversity and efficiencies of scale similar to those achieved by mutual funds.

Third, a community foundation can provide expert advice to enable the donor to direct the gift to meet the community's most pressing charitable needs. Donors can use the collective expertise of a community foundation's staff, attorneys, accountants and board members when they know the kind of charitable result intended but not the specific charity best to achieve that result. Donors often have an area of interest, such as the environment or homelessness, but are unsure how to make a gift effectively on their own. The foundation's staff is familiar with current community needs and can advise donors how best to achieve their philanthropic objectives.

Because a community foundation qualifies as a public charity under the Tax Code,(5) for income tax purposes a cash contribution to it is deductible up to 50% of the donor's "contribution base," which is basically the donor's annual adjusted gross income.(6) In contrast, a cash contribution to a private foundation is deductible only up to 30% of that base.(7) Donors can use this income tax savings to increase the charitable gift amount without decreasing their remaining assets.

A community foundation's operating efficiencies can make more income available for annual distribution to charities. Clients who establish their own private foundations may find administrative costs consume a large percentage of the annual income. In addition to administrative costs, private foundations are subject to several complex rules(8) and excise taxes(9) that do not apply to community foundations. A donor, by contributing to a community foundation rather than establishing a private foundation, may see more dollars used directly for charitable purposes because of the administrative and tax savings.

Flexibility for Donors

Donors who contribute to a community foundation can tailor the gift to meet their charitable goals. For instance, they can contribute to a donor-advised fund, enabling them to suggest to the foundation's board how to the funds will be distributed.(10) Or, the donor can designate a contribution's income go to a particular nonprofit agency, such as the little league or a children's hospital.(11)

Another type of contribution is a field-of-interest fund. Here, the donor indicates a certain area of interest -- the arts, education, health and human services, or elderly or youth. The foundation's board makes grant decisions based on the community's needs in that interest area. A donor may also elect to make an unrestricted contribution. This type of contribution gives the board the greatest flexibility to identify community needs and distribute the funds accordingly. An unrestricted fund can still be named for the donor.

The variety of donor options provides great flexibility and such endowment funds represent a permanent community resource. The donor may name the fund to retain a separate identity even though it becomes a component fund of the community foundation.(12)

Treasury regulations must be followed to ensure donations become component funds rather than being considered as donations to a separate private foundation. In most cases, these rules can easily be met while still meeting the donor's objectives.(13) Donations to a community foundation cannot be "materially restricted" by the donor. A determination of whether a donation is materially restricted has to be based on all the facts and circumstances of the contribution.(14) For example, the Internal Revenue Service will consider whether the foundation's governing body has control and authority over the donated assets.(15)

Community foundations are not for everyone and some IRS requirements may not meet your clients' needs. For instance, a donor may not identify a particular individual to receive funds. Likewise, the community foundation may not consult only the donors to determine how to make distributions from their funds and the community foundation may not grant donors the final right to determine when distributions are made.(16)

Tax Benefits and Funding Options

Gifts of Cash

Once donors have determined their gift beneficiaries, they must next determine how to fund them. There are several alternatives, one being cash contributions. After donors have set up their funds, they can write one check for the donation's full amount or give cash over time as the donor can afford it. For gifts of cash, donors may deduct up to 50% of adjusted gross income in the year the gift is made (with a five-year carryover for excess contributions), so the tax savings are immediate.

Appreciated Property

A second way to fund a contribution is with a lifetime gift of appreciated long-term capital gain securities or real estate.(17) This option is an especially efficient funding method because the donor can deduct the property's current fair-market value without having to recognize the unrealized capital gain.(18) In contrast, contributions of real estate or stock in a closely held business to private foundations are deductible only to the extent of the donor's basis in the property.(19) The deduction is available to the donor only up to 30% of the adjusted gross income. If donors cannot use the full deduction in the year of the donation, they can use the excess over the succeeding five years.(20)

Closely Held Business Stock

Gifts of stock in a closely held business, followed by a redemption of stock by the corporation, can also reduce a company's accumulated cash. This approach can be useful especially when a long-term owner is considering selling the company.(21)

Tangible Property

Donors can give tangible personal property, including artwork, antiques or jewelry, to a community foundation. These gifts offset up to 30% of the donor's adjusted gross income, but the deductible amount is limited to the donor's cost basis if the use by the donee is unrelated to its purpose.(22) Any excess contributions may be carried over the succeeding five years.(23)

Planned Giving Options

By establishing a charitable lead trust,(24) donors can make current charitable contributions of income to a community foundation while reserving capital for family or other beneficiaries. Under the trust's terms, the foundation receives the income from the trust corpus for a specified time. At the end of that time, the trust either continues for the benefit of other beneficiaries or terminates to distribute the corpus. Through this vehicle, donors can make contributions, take an income tax deduction in the year the trust is established and still retain the corpus for other giving.

Several types of gifts provide a current tax deduction while deferring the actual gift to the foundation and the charities it supports. One method is the charitable remainder trust.(25) Here, the community foundation is the ultimate, rather than the immediate, trust beneficiary. The donors establish the trust, designate themselves or others as the income(26) beneficiary, and provide the trust will terminate at some future date with the assets given to the foundation. The donors benefit by keeping an interest for life while at the same time taking a current charitable donation; the foundation benefits when it receives the remainder of the trust. Donors can use part of the tax savings to purchase life insurance, the proceeds of which can go to children or other beneficiaries, thus replacing the corpus going to the foundation when the trust terminates.

Funding a charitable remainder trust with appreciated property might well fit a donor's retirement needs. The donor could donate appreciated property without paying any tax on the appreciation. The charitable remainder trust could then sell the assets and invest the full proceeds in property that could increase the income otherwise available to the donor. Upon the donor's death, the community would benefit through the remaining interest's transfer to the community foundation.

Life insurance is another means of future funding. By naming a community foundation as the owner and beneficiary of a life insurance policy, the donor can immediately deduct an amount approximately equal to the policy surrender value.(27) Donors who continue to pay the annual premiums after donating the policies can deduct these as well.


The simplest way to make a future gift is to name a community foundation as a beneficiary under a will or a living trust.

Permanence and Flexibility

All these methods of giving, whether they result in current or future gifts, have an advantage over a direct gift to an operating charity. Gifts to community foundations have permanence but are adaptable to changing community needs. In most cases, the community foundation's governing instrument gives the board the authority to modify a gift restriction if it determines the restriction or condition is unnecessary, incapable of fulfillment or inconsistent with community needs.(28) This variance power can assure donors their gifts will continue to address changing community needs even if a particular community problem has been solved.

Transferring a Private Foundation

A donor who established a private foundation but for some reason, such as administrative costs, may want to terminate it, might consider transferring the private foundation's assets into a component fund of the community foundation. The assets then retain identity in a distinct fund, but take on the advantages of a public charity.

The Internal Revenue Code allows an organization to terminate its status as a separate private foundation if it distributes all of its net assets to a community foundation and satisfies certain specified requirements.(29) Terminating the private foundation releases it from the excise tax, administrative costs, reporting requirements and other restrictions placed on it by the Tax Code.(30) Once advised about a community foundation's advantages, your clients may decide to convert their private foundations into community foundation funds -- for convenience, simplicity, efficiency and tax savings.

For more information about names and locations of community foundations, please write, Joanne Scanlan, Vice President, Council on Foundations, Suite 300, 1828 L Street, NW, Washington, DC 20036, (202) 466-6512.


1 The Council's source is Foundation Giving, 1991 edition, (New York; The Foundation Center), p. 32.

2 Although this article refers to individual donors, donors may be businesses, corporations, or private foundations.

3 Most community foundations are described in I.R.C. Sections 170(b)(1)(a)(iv) and 509(a)(1).

4 Treas. Reg. 1.170A-((3)(10); Treas. Reg. 1.170A-9(13)(iii). Donors and advisors should review the qualifications of any organization's governing board and staff before making a gift. This is true for community foundations and any other charitable organization. The Internal Revenue Service Regulations may provide some confidence but certainly do not substitute for a careful investigation of a charity.

5 See supra note 3.

6 I.R.C. 170(b)(1)(A); I.R.C. 170(b)(1)(F).

7 I.R.C. 170(b)(1)(B).

8 See, i.e., I.R.C. 4941 (restricting and taxing "self-dealing" transactions); 4942 (requiring an annual payout or an additional tax); 4943 (taxing excessive holdings); and 4944 (taxing profits from investments that jeopardize the carrying out of a foundation's exempt purposes).

9 I.R.C. 4940 (subjecting most private foundations to a 2% excise tax on their net investment income).

10 A foundation's board of governors must retain the distribution decision making power to maintain its status as a community foundation. See infra notes 14-17 and accompanying text.

11 An advantage of this type of contribution is that, if the donor's designated agency dissolves, the foundation directors can determine an appropriate charitable substitute to carry out the donor's intent.

12 A foundation may require a donation of a particular size to establish a named fund, but contributions of any size may be made to already established funds.

13 Treas. Reg. 1.507-2(a)(98) (made pertinent to community foundation donations by Treas. Reg. 1.170A-9(e)(11)(ii)).

14 Ibid.

15 Ibid.

16 Treas. Reg. 1.507-2(a)(8)(iv). The regulation also limits other restrictions that the donor might impose.

17 Gifts of property with a claimed value in excess of $5,000 must be supported by a qualified appraisal unless the gift property consists of money or publicly traded securities. Treas. Reg. 1-170A-13(c).

18 However, the unrealized appreciation might trigger an alternative minimum tax under I.R.C. section 55.

19 I.R.C. 170(e)(1). There is an exception from this rule for stock for which market quotations are readily available. I.R.C. 170(e)(5).

20 I.R.C. 170(b)(1)(C).

21 See Rev. Rul. 78-197, 1978 CB83.

22 I.R.C. 170(e)(1)(B)(i).

23 I.R.C. 170(d).

24 I.R.C. 2055(e)(2)(B).

25 I.R.C. 664(d); 2055(e)(2).

26 The required distributions will vary depending on whether the trust is an annuity trust under I.R.C. section 664(d)(1) or a unitrust under I.R.C. section 664(d)(2).

27 But see, Private Letter Ruling 9110016 (Nov. 30, 1990), and Private Letter Ruling 9147040 (Aug. 20, 1991).

28 Treas. Reg. 1.170A-9(e)(11)(v)(B)(1).

29 I.R.C. 507(b)(1)(A).

30 Treas. Reg. 1.1507-2(a)(5).

Howard A. Sweet, JD, is a partner in LaFollette & Sinykin in Madison, Wisconsin, where his practice includes estate planning and representation of nonprofit charitable organizations. He received his JD from the Harvard School of Law, and is a founding member of the Madison Planned Giving Council.

Joanne R. Whiting is an associate with LaFollette & Sinykin, Madison, Wisconsin. She is a 1991 graduate of the University of Wisconsin Law School, where she was a Law Review member and a note and comment editor.
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Author:Sweet, Howard A.; Whiting, Joanne R.
Publication:The National Public Accountant
Date:Dec 1, 1992
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