A Look At Alternatives To Private Foundations

A Look At Alternatives To Private Foundations

Article posted in Foundations on 22 September 1999| comments
audience: National Publication | last updated: 15 September 2012


Thinking about a private foundation? Maybe you should consider an alternative. In this article, Los Angeles attorneys David Wheeler Newman and Jose Silva examine the roles that public charities, common funds, and supporting organizations can play accomplishing donors' philanthropic goals.

by David Wheeler Newman & Jose Silva

The private foundation is a unique breed of charitable organization. While it is recognized as charitable, it is usually controlled and supported by a single source, such as one individual, a family or a corporation. In contrast the general public supports a public charity. There are certain features of the private foundation that make it an attractive vehicle for achieving charitable objectives: the donor retains maximum control over the use of charitable dollars; the donor is better able to control the timing of benefits since contributions to a private foundation do not need to be precisely matched to expenditures for charitable purpose; and a private foundation provides public recognition for the donor linking the donor's name to community involvement and philanthropy.

There are, however, a number of disadvantages to the use of the private foundation as a vehicle for charitable giving. In general, it is vastly preferable under relevant tax rules for an organization to qualify as a public charity if such status is available. Substantial excise reporting requirements, and other restrictions and limitations are applicable to private foundations. Foremost among them is the limitation on charitable contribution income tax deductions. For public charities, the limitation is usually 50% of the contribution base of an individual donor, but for private foundations, the limitation is generally only 30%.

The contribution base is defined as a taxpayer's adjusted gross income. Furthermore, with the exception of gifts of qualified stock, which are deductible at fair market value, the charitable contribution deduction for gifts by individuals to private foundations of appreciated property is generally limited to the lesser of fair market value or the donor's tax basis in that property.1 There is also an excise tax of 2% levied on the net investment income of private foundations, which can be reduced to 1% if certain minimum distribution standards are met. Additional private foundation excise taxes are imposed on self-dealing transactions, failure to make minimum exempt purpose distributions, excess business holdings, investments that jeopardize exempt purpose, and expenditures for lobbying and political activity.

Finally, private foundations must comply with burdensome record keeping and reporting requirements. Given these restrictions and limitations on private foundations, donors and their advisors should be aware of alternative vehicles for charitable giving to which many of these limitations and restrictions do not apply. This article addresses the significant tax and certain other characteristics of three such alternatives, known as common funds, donor advised funds and supporting organizations. All three types of organizations provide some or all of the advantages of a private foundation--control timing of tax benefits and donor name identification--while avoiding many of the restrictions and limitations to which private foundations are subject.

Public Charities

Charitable organizations exempt from tax under Internal Revenue Code (IRC) §501(c)(3) are generally characterized as either "private foundations" or "public charities." Under IRC §501(c)(3), a charitable organization is generally one organized and operated exclusively for charitable, religious, scientific, testing for public safety, literary or educational purposes, to foster international or national amateur sports competition, or to prevent cruelty to children or animals.

A private foundation is defined to mean an organization described in IRC § 501(c)(3) other than one described in IRC §501(a)(1), (2), (3), or (4).2 Under IRC §509(a)(1), certain organizations described in IRC §170(b)(1)(A) are automatically classified as public charities. These include churches, certain educational organizations, hospitals and certain medical research organizations, and organizations supported by governmental units or the general public. Section 509(a)(2) describes the support tests that must be met in order for an organization to be publicly supported, and therefore within this group of public charities. "Supporting organizations" are formed pursuant to IRC §509(a)(3), the third class of statutorily defined public charities. This type of organization, in general, is one that supports a public charity. The fourth class, set forth in IRC §509(a)(4), is entities organized and operated exclusively for public safety testing. However, common funds and donor advised funds would be classified as private foundations in the absence of the special rules discussed below because they are not organizations otherwise specifically described in these provisions. Nonetheless, both types of organizations may qualify for public charity treatment--at least for purposes of the 50% contribution base limitation because of special provisions in the Code and regulations.

Common Funds

Section 170(b)(1)(A) provides that contributions to specified organizations are deductible to the extent that the aggregate of such contributions for any taxable year does not exceed 50% of the taxpayer's contribution base. Included within this classification are private foundations described in subparagraph (E) of IRC §170(b)(1).3 One category of private foundation described in that provision is the common fund, also known as a donor directed fund. Contributions to common funds are therefore subject to the 50% contribution base limitation rather than the 30% contribution base limitation generally applicable to garden-variety private foundations.

Common funds are private foundations that are established to support one or more pubic charities. Local community foundations usually operate common funds. In essence, this type of private foundation serves as a "pooling" vehicle for the contributions of many donors who retain certain rights to subsequently direct distributions from the common fund to specified public charities. In addition to the higher contribution base limitation on the donor's charitable contribution income tax deduction, there are two significant tax advantages of the common fund. First, donors retain control since they may determine the ultimate recipients of their philanthropy without establishing a separate private foundation to accomplish their purposes. Second, as with private foundations, donors may "bank" their contributions by contributing a specific amount to a common fund, obtaining a current income tax deduction for their entire gift, and later selecting the ultimate recipients of the income and principal of the gift over a subsequent period of time.

Technical requirements. To qualify as a common fund, several technical requirements must be satisfied.4 These requirements are summarized below:

  • Affiliation. The common fund generally must be structured as an affiliate of one or more public charities such that, but for the donor control elements, it would qualify as a "supporting organization" described below.
  • Distribution. The common fund's income must be distributed on or before the 15th day of the third month following the close of the taxable year in which such income is realized. Thus, if the common fund has a December 31st taxable year, all income distributions must be made on, or before, March 15th of the following year.
  • Designation of recipients. The donor may designate annually the recipients of the income attributable to the donor's gift. The donor may reserve to his or her spouse the right to make such annual designations. No person other than the donor or his/her spouse may have the right to designate recipients.
  • Qualified recipients. Each income recipient must be a public charity.
  • Distributions of principal. The donor must have the authority to direct, either during life or through his or her will, the payment of corpus attributable to the donor's contribution to one or more public charities. Again, the donor may reserve this right to his or her spouse. No person other than the donor and his or her spouse may have such right to designate recipients.
  • Final distributions. The principal attributable to the donor's gift must be distributed by the common fund to one or more public charities no later than one year following the death of the donor, or the death of his/her surviving spouse, if the donor has reserved to that spouse the right to designate recipients.

If the donor fails to designate recipients of income or principal attributable to his or her contribution, the fund's directors may choose the recipients.5

While common funds have many substantial tax advantages, most prominently the entitlement to a 50% rather than a 30% contribution base for individual charitable contributions, and the ability to "bank" current charitable contributions for use in subsequent periods, the common fund itself is a private foundation, and thus is subject to all applicable private foundation rules, including the 2% tax on net investment income and the reporting requirements that apply to the fund as a whole.

Donor Advised Funds

Unlike common funds described above, the Internal Revenue Code does not contain any specific statutory definition of donor advised funds. Instead, donor advised funds, also known as "community trusts," are products of historical practice that have been given regulatory blessing. The original concept for the community trust was the establishment by charitably motivated individuals of vehicles for collecting contributions for the betterment of a community in general. As noted in the Treasury Regulations, "community trusts have often been established to attract large contributions of a partial or endowment nature for the benefit of a particular community or area, and often such contributions have come initially from a small number of donors."6 Donor advised funds are occasionally operated by public charities and by community foundations.

In general, a community trust is treated as a public charity if it meets a public support test, which may be satisfied by a fund if it meets the "33 1/3% of support test," or the "10% facts and circumstances test." The 10% facts and circumstances test will usually be satisfied if the community trust seeks gifts and bequests from a wide range of potential donors in the community or area served, through banks or trust companies, through attorneys or other professional persons, or in other appropriate ways that call attention to the community trust as a potential recipient of gifts and bequests made for the benefit of the community or areas served, and if the organization in fact receives at least 10% of its support from these sources.7 The 33 1/3% of support test will be satisfied if the community trust normally receives at least one-third of its total support from the government or the general public. If either the 10% facts and circumstances test or the 33 1/3% of support test is met, the donor may make deductible contributions up to 50% of his or her contribution base and the other adverse rules imposed on private foundations, such as the excise tax and reporting requirements, do not apply. If neither the 33 1/3% of support test nor the 10% facts and circumstances test is satisfied, then the organization will be treated as a private foundation and a donor's contributions will be limited to 30% of his or her contribution base, excise taxes may apply, and the more extensive reporting requirements will be imposed.

Technical requirements. Community trusts are almost exclusively creatures of regulation. Accordingly, the provisions of the applicable regulations8 must be strictly complied with to obtain the benefits of community trust status. The regulations generally prescribe two sets of requirements for community trusts--entry-level requirements and component fund level requirements.

Entry-level requirements. While community trusts usually are composed of numerous separately endowed component funds, there must be some central organization. Very generally, the community trust must bear a name that conveys the concept of a capital or endowment fund designed to support charitable activities in a relevant community.9 In addition, all funds of the organization must be subject to a common governing instrument such as a master trust, internal policy statement or uniform instruments of transfer.10 The community trust must also prepare and disseminate periodic financial reports concerning the funds that it holds.11

The community trust also must have a common governing body that directs that distribution of funds contributed to it for charitable purposes, and this governing body must have the ultimate fiduciary responsibility for distributions and investments.12 Among the powers that must be reserved to the governing body are the powers to modify and restriction or condition on the distribution of funds if, in its sole judgment, such restriction or condition becomes unnecessary, incapable of fulfillment, or inconsistent with charitable needs of the community; replace any participating trustee for breach of fiduciary duty; and replace any participating trustee for failure to produce a reasonable return of net income over a reasonable period of time.13

Component fund level requirements. If a contribution by a donor is to be held as a separate donor advised fund, favorable tax consequences would result only if the fund qualifies as a component fund of the community trust. Failure to qualify will cause the donor's fund to constitute a separate private foundation subject to the disadvantages discussed above. A fund will qualify only if the governing body is not subject to any "material restriction or condition" on transferred assets.14 The general rule of the material restriction or condition standard is that the community trust must be able to "freely and effectively" employ the transferred assets or their income in furtherance of the community trust's (rather than the donor's) exempt purposes.15 If this "free and effective" employment test is met, then the community trust will not be subject to a material condition or restriction.16

The Regulations specify, in great detail, the significant facts and circumstances that may be considered in determining whether a transfer is subject to a "material restriction or condition."17 The principal factors include whether the community trust is the owner of the contributed assets, whether it holds and administers these assets in a manner consistent with its exempt purposes, whether its governing body has the ultimate authority and control over the assets and their income, and whether and to what extent its governing body is organized and operated as to be independent from the donor.18

The Regulations further provide that the presence or absence of certain non-adverse factors will not cause a gift to be treated as being subject to a material restriction or condition. These non-adverse factors include the provision of a name or designation that memorializes the donor and his/her family; the specification that the fund's income and assets are to be used for a designated charitable purpose, or for one or more public charities (provided that such use is consistent with the community trust's exempt purpose); the administration of the assets in an identifiable or separate fund where some, or all, of the principal does not have to be distributed for a specified period (again, provided that the governing body must exercise ultimate and direct authority and control over the fund); and the fact that the donor requires the foundation to retain the property if such retention is important to achieve its exempt purposes (for example, the retention of a woodland preserve by a community trust organized for ecological purposes).19

The Regulations also specify certain adverse factors, the presence of which may indicate the existence of a material restriction. For example, if the donor reserves the right, directly or indirectly, to name the organizations to which the community trust must distribute the donor's gift (other than by designation in the instrument of transfer), or directs the timing of the distributions, then a material restriction or condition may exist.20 The Regulations make it clear that the Internal Revenue Service will examine carefully whether the seeking of advice by the community trust from, or the giving of advice by, any donor after the assets have been transferred constitutes a reservation of an indirect right to direct distributions, which would in turn constitute a material restriction or condition.21

The Regulations include a list of circumstances under which the seeking of advice may amount to the reservation of an unacceptable right of control. An independent investigation by the community trust to determine whether the donor's advice is consistent with the community trust's specific charitable objectives indicates that a reserved right does not exist. Similarly, if the community trust's guidelines are consistent with the donor's advice, it has instituted an educational program enumerating specific charitable needs, it distributes funds exceeding those distributed from the donor's fund to the same or similar organizations, and it provides in its written and oral solicitations that it is not bound by the donor's advice, then there is probably no improper reserved right.22

On the other hand, the presence of certain other factors suggests that of improper reservation of rights may exist. For example, if the written or oral solicitation of funds implies a pattern of conduct, or creates an expectation that advice will be followed; the donor's advice is limited to distributions from the donor's fund; the trust has not independently evaluated the donor's advice or published guidelines describing its purposes; the community trust solicits only the donor's advice concerning his or her fund and there is no procedure to considering advice from others; or the community trust follows only the advice of donors as to their funds substantially all of the time, then a reserved right may be deemed to exist.23 The Regulations further specify other adverse factors that may be easily avoided in most community trust situations.24

It seems reasonably clear from the applicable Regulations that a donor advised fund may be formed by a donor in accordance with any of the following three scenarios: 1) The donor's fund is distributed to other organizations falling within the exempt purposes of the community trust, even if the donor's advice is considered in part in making distribution decisions; 2) the donor's fund is distributed as the donor designates in the instrument of transfer; or 3) the donor's fund is distributed among a subset of organizations within "fields of interest" designated in the instrument of transfer, and as to which the donor provides advice.

In contrast to the requirements of the common fund described above, the donor advised fund is not limited in whom it may seek advice from concerning the distribution of funds. Only the donor and his or her spouse may direct the distribution of income and principal of a common fund, and no other person may give such directions. A donor to a community trust, however, may delegate his or her advisory function to any person or entity, either during the donor's lifetime or following his or her death, depending on the policies established by the community trust for these purposes and subject to the applicable Regulations discussed above. Advice may be solicited by the community trust from any person, including those whom the donor wishes to provide advice. In fact, advice is often received on an "unsolicited" basis because the general community at large (donors, recipients, and the pubic served by the organization) has an interest in the affairs of a community trust.

Supporting Organizations

Another type of charitable entity that may serve as an alternative to a private foundation is a supporting organization.25 A supporting organization is an entity organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of one or more public charities.26 A supporting organization is not treated as a private foundation because it does not itself qualify as a pubic charity or charities so that the requisite degree of public control and involvement is considered present.27 Furthermore, a supporting organization must be operated, supervised, or controlled by, or in connection with, one or more public charities.28 Donations to a qualified supporting organization are subject to the 50% contribution base limitation and supporting organizations are not subject to the onerous excise tax and reporting requirements applicable to a private foundation.

Technical requirements. To qualify as a supporting organization, a charitable organization must meet an organization test, an operational test, and a relationship test.

Organizational test. A supporting organization must be organized exclusively for the benefit of, to perform the functions or, or to carry out the purposes of one or more specified public charities.29 The articles of incorporation of a supporting organization must contain s specific provision limiting its purposes, and may not empower the organization to engage in activities that do not further these purposes.30 The articles of incorporation must also state the specific public charity or charities on behalf of which the supporting organization is to be operated, and may not empower the organization to support or benefit any other organization.31 An organization will fail to meet the organization test if its articles of incorporation expressly permit it to support or benefit any organization other than the specified public charities, regardless of the fact that actual operations of the organization have been exclusively for the benefit of the specified charities.32

Operational test. A supporting organization also must be operated exclusively to support or benefit one or more specified public charities and must engage solely in activities that support or benefit the specified public charities.33 Such activities may include making payments to members of the class benefited by the specified public charities, or providing services or facilities to them.

Note that it is possible for a supporting organization to ultimately support or benefit a public charity by benefiting another supporting organization that in turn supports the same charity. However, an organization will not be deemed operated exclusively for the support or benefit of specified charities if any part of its activities furthers a purpose other than supporting or benefiting such specified public charities.34

Relationship test. A supporting organization must stand in a defined relationship with one or more public charities.35 Due to the available variations, this is the most complex of the three tests for qualification as a supporting organization. The test may be met with one of three types of relationships.

A supporting organization may be operated, supervised, or controlled by its supported public charity. This relationship is comparable to that of a parent and subsidiary in the for-profit world. Typically, the trustees of the supporting organization are composed of, or appointed by, the trustees of the supported public charity.36

The supporting organization may also be supervised or controlled in connection with the supported public charity. This relationship is most comparable to that of brother-sister subsidiaries in the for-profit world, with the entities under common supervision or control.37

The third alternative relationship, which is the most flexible while at the same time the most complex, is that the supporting organization be operated in connection with the supported public charity. To come within this relationship, the supporting organization must meet both the integral part test and the responsiveness test, both of which are described in detail in the Regulations.38

The Two Tests

In general, the integral part test will be met if the supporting organization actually performs functions that the supported public charity would otherwise perform. Alternatively, the integral part test may be met if the supporting organization distributes substantially all of its income to the supported public charities, and the amount of these distributions are sufficient to ensure the attentiveness of the supported public charities to the operations of the supporting organization.39

The responsiveness test is satisfied if one or more of the trustees of the supporting organization are appointed by the trustees or membership of the supported public charity; if the two organizations have one or more trustees in common; or if the trustees of the supporting organization maintain a close and continuous working relationship with the trustees of the supported public charity. Alternatively, the responsiveness test is satisfied if the supporting organization is a charitable trust under state law and each supported public charity is named beneficiary with the power under state law to enforce the terms of the trust.40

Disqualified persons. A supporting organization may not be controlled directly or indirectly by one or more disqualified persons (a concept adopted from the private foundation rules), other than foundation mangers and one or more public charities.41 In general, a disqualified person is a person who contributes more than $5,000 to the organization and his or her contribution exceeds more than 2% of the organization's total contributions for the year, certain relatives of the donor, and entities in which the donor owns more than a 35% interest.


Philanthropists have long been attracted to private foundations due to the ability to retain control over their charitable dollars, the ability to time tax benefits from charitable giving, and the name identification linking donors to their philanthropic endeavors. Alternatives are available to achieve some or all of these objectives while avoiding the substantial reporting requirements, excise tax, and other disadvantages of funding and maintaining a private foundation. Two of these alternatives, the common fund and the donor advised fund, allow the donor to shift administrative responsibility to professional nonprofit managers, while retaining control or input over eventual distributions to charitable recipients. Donations to the common fund and donor advised funds in a public charity community trust qualify for the 50% contribution base limitation. The third alternative, a supporting organization, retains much more control for the donor and qualifies donations for the 50% contribution base limitation, at the cost of the donor providing or organizing the administrative infrastructure. However, a supporting organization is not subject to the burdensome reporting requirements and excise taxes imposed on private foundations. Each alternative has individual characteristics that should be examined to determine whether it is, for a particular donor, a suitable alternative to a private foundation.


  1. Qualified stock is long-term capital gain stock for which market quotations are readily available on an established securities market. IRC §170(e)(5)back

  2. IRC §509(a)back

  3. IRC §170(b)(1)(A)(vii)back

  4. IRC §170(b)(1)(E)(iii)back

  5. Treas. Reg. §1.170A-9(h); Rev. Rul. 80-305, 1980-2 C.B. 71back

  6. Treas. Reg. §1.170A-9(e)(10)back

  7. Ibidback

  8. Treas. Reg. §1.170A-9(e)(10)-(13)back

  9. Treas. Reg. §1.170A-9(e)(11)(iii)back

  10. Treas. Reg. §1.170A-9(e)(11)(iv)back

  11. Treas. Reg. §1.170A-9(e)(11)(vi)back

  12. Treas. Reg. §1.170A-9(e)(11)(v)back

  13. Treas. Reg. §1.170A-9(e)(11)(v)(B)(1)-(3)back

  14. Treas. Reg. §1.170A-9(e)(11)(ii)(B)back

  15. Treas. Reg. §1.507-2(a)(B)(i)back

  16. Ibidback

  17. Treas. Reg. §1.507-2(a)(B)back

  18. Treas. Reg. §1.507-2(a)(B)(i)back

  19. Treas. Reg. §1.507-2(a)(B)(iii)(a)(D)back

  20. Treas. Reg. §1.507-2(a)(B)(iv)(A)back

  21. Ibidback

  22. Treas. Reg. §1.507-2(a)(B)(iv)(A)(2)(i)-(v)back

  23. Treas. Reg. §1.507-2(a)(B)(iv)(A)(3)(i)-(iv)back

  24. Treas. Reg. §1.507-2(a)(B)(iv)(B)-(G).back

  25. IRC § 509(a)(3)back

  26. IRC § 509(a)(3)(A); Treas. Reg. §1.509(a)-4(a)(2)back

  27. Treas. Reg. §1.509(a)-4(a)(5)back

  28. IRC §509(a)(3)(B)back

  29. IRC §509(a)(3)(A)back

  30. Treas. Reg. §1.509(a)4(c)(1)back

  31. Ibid.; See Trust Under the Will of Bella Mayberry v. Comm'r., 80 R.C. 718, 1983back

  32. Treas. Reg. §1.509(a)4(c)(B)back

  33. Treas. Reg. §1.509(a)4(c)(1), (2)back

  34. Treas. Reg. §1.509(a)4(c)(1)back

  35. Treas. Reg. §1.509(a)4(f)(1)back

  36. Treas. Reg. §1.509(a)4(g)(1)back

  37. Treas. Reg. §1.509(a)4(h)back

  38. Treas. Reg. §1.509(a)4(i)back

  39. Treas. Reg. §1.509(a)(a34)(iX3)back

  40. Treas. Reg. §1.509(a)4(iX2)back

  41. IRC §509(a)(3)(C)back

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