With corporate profits rebounding, we are hearing from more corporations interested in starting a corporate foundation. Many companies support charity in an ad hoc way by purchasing tables at fundraising dinners, providing in-kind goods for raffles and silent auctions, making grants, or sponsoring employee volunteer efforts. Increasingly, companies are thinking more strategically about their philanthropy. To better coordinate their giving, many companies are choosing to create corporate foundations to organize, focus, track, and publicize their philanthropic efforts.
Benefits of Forming a Corporate Foundation
In addition to public goodwill attributable to corporate philanthropy, corporate foundations provide economic benefits to their corporate sponsors. For example, contributing to a corporate foundation permits a corporation to level out “peaks and valleys” in corporate giving by making more contributions to the foundation during profitable years and little if any when profits are down. The corporation can make the gift and receive the tax benefits in a profitable year and still have funds available to support philanthropy in lean years.
Foundation giving is also a smart way for a company to have more influence on how major gifts are used. Individuals and corporations have to be careful about attaching too many conditions to a gift. Gifts having more than a remote possibility of coming back to the donor are considered incomplete and therefore are not tax deductible. Corporate foundations do not need to worry about ensuring a gift is complete because the foundation does not pay income tax and does not need an income tax deduction. Accordingly, a corporate foundation has greater flexibility to make gifts subject to stronger terms to ensure its grants are used as intended.
A corporate foundation also allows the company to protect executives from fielding funding requests by permitting them to direct such requests to an external decision-maker.
Vehicles for Corporate Philanthropy
A. Donor Advised Funds. Some companies dip their toes into the corporate foundation model by starting a donor advised fund within an existing charity such as a community foundation. Donor advised funds may be named X Foundation to honor the corporation and are an inexpensive and relatively easy way to create and maintain a corporate foundation. However, a donor advised fund will always be subject to the internal policies and procedures of the sponsoring organization and has certain legal limits on its activities. For example, a foundation structured as a donor advised is limited in its ability to make scholarship grants or other grants to individuals. Further, a gift to a donor advised fund is legally a gift to the sponsoring charity. The donor retains a right to advise on grants from the fund but the sponsoring charity has the ultimate right to determine how funds are used. Some companies prefer a more direct and flexible approach such as a nonprofit corporation.
B. Nonprofit Corporations. Once a company has decided to form its corporate foundation as a separate nonprofit corporation, the next decision is how the foundation will be governed. Some company foundations are led by a board of directors made up entirely of company executives and employees. Others invite outside community leaders to serve on the board. The company may also set-up committees of employees to make grant-making recommendations or run volunteer efforts.
Once the decision to form a separate nonprofit corporation is made and the governance structure is determined, the company will have to determine whether the foundation will be a private foundation or a public charity for tax purposes. Both are exempt from federal income taxation under Internal Revenue Code Section 501 (c)(3) and both are typically required to file annual information returns with the Internal Revenue Service; however, private foundations and public charities are subject to very different tax rules.
1. Public Charities. Public charities receive favored treatment under the Internal Revenue Code. Very generally, for a corporate foundation to qualify as a public charity, it must receive at least one third of its support from the general public. Most corporate foundations that plan to raise significant funds through fundraising choose to organize as a public charity.
2. Private Foundations. The primary benefit of a private foundation is donor control. The IRS permits a private foundation to be controlled by a single donor or small group of donors. In addition, private foundations, unlike public charities, do not need to fundraise to meet the public support test. However, private foundations are subject to greater operational restrictions than public charities. For example, private foundations must meet minimum payout requirements of approximately 5% of its asset value annually. Further, private foundations must avoid the following or face penalty excise taxes:
(a) Self-dealing transactions with insiders.
(b) Ownership of “excess business holdings” which is basically greater than a 20% interest in any one business.
(c) Risky investments that jeopardize the accomplishment of the foundation’s charitable purposes.
(d) “Taxable expenditures” including contributions to individuals, other private foundations, or non-charitable organizations.
To comply with these rules and avoid penalty taxes, private corporate foundations may not buy tables at charity dinners and cannot make matching grants that fulfill the pledges made by the company or insiders connected to the company. The private foundation cannot rent space from the company. Also, private foundations often have to conduct more detailed grant-making due diligence than public charities. Finally, a private foundation has more restrictions than a public charity with respect to the types of organizations it can support.
Whether a company chooses to form a donor advised fund or create a separate foundation, forming a corporate foundation presents a terrific opportunity to better organize, focus, track, and publicize a company’s philanthropic efforts.