The Supporting Organization: The Next Charitable Scapegoat?

The Supporting Organization: The Next Charitable Scapegoat?

Article posted in Foundations on 17 March 1999| comments
audience: National Publication | last updated: 18 May 2011


The Planned Giving Design Center editors take issue with an article that appeared in the May 28, 1998 edition of the Wall Street Journal -- "How to Succeed in Philanthropy without Really Giving Anything."

This is America. All are entitled to an opinion.

But before a reader even gets beyond the title of the article by Monica Langley published in the Wall Street Journal on May 28, 1998 ("How to Succeed in Philanthropy Without Really Giving Anything"), the negative tone is apparent, and unfortunately, permeates the entire article. The downside of such authorship is that many people will read the article (including members of Congress and their tax writing staffs) and will reach a conclusion regarding supporting organizations that does not reflect reality in most cases. In addition and even more disconcerting, the WSJ article fails to "tell the whole story" from the legal, practical, and societal perspectives.


A supporting organization ("SO") under IRC Section 509(a)(3) is treated as a "public" charity. A gift to a public charity entitles the donor to the maximum tax benefits for income tax purposes. A gift to a "private" charity, such as a non-operating private foundation, is entitled to less favorable income tax benefits.

Notwithstanding this comparative economic detriment to a donor, a creator of a private foundation (and his or her family) may maintain absolute legal control over its investments, charitable disbursements, and administration. Because of this control and the potential for abuse, an excise tax regime was enacted in 1969 to combat self-dealing, to prohibit significant holdings in a closely-held business, and to require minimum annual distributions to charity, among other things. These excise taxes create a significant level of federal regulation and oversight, and accordingly, create additional administrative burdens for a private foundation.

Although most SOs are directly controlled by a public charity in a "Type-1" relationship (e.g., a Hospital Foundation, Community Foundation, or University), the "Type-3" SO provides greater latitude of control to its creator and is the primary target of the WSJ article. The Type-3 SO has been coined the "entrepreneurial supporting organization" ("ESO") because it should be naturally appealing to an entrepreneur. The ESO, however, should be equally appealing to any donor contemplating the creation of a private foundation or the institution of a charitable program for an existing public charity.


Here is a brief summary of the WSJ article for those who did not have an opportunity to read it. This article describes how large numbers of wealthy individuals and their advisors have discovered the ESO vehicle. It implies that they are using this vehicle for the immediate charitable income tax deductions it provides but are not using it to provide any immediate benefits to charity. The article indicates that donors can set up an ESO, contribute any type of property to it, retain control of the ESO and its assets, and take up-front charitable deductions based on the full fair market value of the assets contributed. It suggests there are no rules requiring that assets of an ESO be distributed to charity within any particular time frame and that ESOs are not subject to the kind of stringent requirements applicable to private foundations.

The article also highlights specific examples of some ESOs set up by well-known individuals and, through conversations with those individuals or their colleagues, notes that the ESOs have not done any actual charitable work so far. The article insinuates that all individuals who establish ESOs generally have little involvement with or knowledge about the functioning of their ESOs. However, the article does include comments from Marcus Owens, the IRS Director of Tax Exempt Organizations. Mr. Owens explains that SOs must be organized and operated for charity and must have valid charitable programs just like other public charities.


ESO creators tend to have significant wealth and a significant history of charitable giving. These donors are beginning to more critically review how charities are spending their contributed dollars and are developing their own clear and individualized philanthropic missions. These donors also think that public charities spend their contributed monies for charitable purposes more wisely than the government can spend their tax dollars for social programs.

The ESO is appealing to entrepreneurs, because they generally control closely-held companies. The number of such companies is increasing and many of them are growing rapidly in net worth, but are struggling to determine how to maintain business enterprise continuity. Some are selling out or going public, while others are attempting to restructure for the future. However, if business owners sell their enterprises, they will cause a significant income tax. And if they transfer their enterprises to family members or key employees during life or at death, they will cause an even greater wealth transfer tax.

Unlike a private foundation, an ESO may own closely-held business interests, and contributors to an ESO are entitled to the maximum income, gift, and estate tax charitable deductions. Thus, with the insertion of the ESO into the business succession plan, economically efficient and socially sensitive opportunities arise. In addition, the ESO provides the creator and family with a vehicle to organize their philanthropic giving and to dedicate their monies in perpetuity to the charities of their choice.

However, the ESO structure is not without its control limitations.

  • Designation of Supported Public Charities. At the outset, the creator must specifically designate the public charities ("DPCs") to be supported by the ESO. Changes to the listed DPCs are only permitted in very limited circumstances, all of which are out of the ESO's control. Permitting a donor to specifically designate a wide variety of DPCs should be promoted, not prohibited. Disparate, yet valid, charitable interests all represent charitable interests. It is a uniquely worthwhile endeavor to poll the family prior to the creation of the ESO (including even the family members who are not at that time legally capable of voting on trust matters) to determine the family's collective and varying charitable interests.
  • Attentiveness. The legal standards underpinning the ESO, as fully described in several of the 14 pages of Treasury Regulations covering SOs, essentially require that at least one DPC be "attentive" to the ESO's activities. Since no DPC legally controls the ESO, accountability is derived from one DPC "looking over the ESO's shoulder." More accurately, the DPC can be "breathing down" the ESO's neck. For instance, the DPC must be given the right to enforce the trust and compel an accounting in court. In this regard, the ESO should deliver an annual report to the DPCs, which details its investments, assets, and charitable disbursements. In many instances, a Trustee of a DPC is even a Trustee of the ESO. Serving in such capacity provides a DPC with an insider's perspective on the ESO's operations.
  • Control. A level of control by the creator is permissible. For instance, the creator initially chooses the DPCs and should provide input on the ESO's vision and charitable disbursements. The creator will select the initial Trustees and may retain the right to appoint successor Trustees. The creator can also choose whether to make additional contributions to the ESO. However, the creator and persons related to the creator cannot legally control the ESO. Thus, unrelated persons must control a majority of the vote for all matters, including without limitation, the disbursement of dollars to DPCs and the investment and use of the ESO's assets. In addition, an ESO's founders will not live forever. Although they may attempt to control matters of the living after their demise, other individuals will need to take over the reigns and determine the direction of the assets being distributed to, and appreciating in value for, charitable causes.
  • State Law. State law also imposes responsibilities on the ESO Trustees. All Trustees, whether related or unrelated, will function as fiduciaries for the sole benefit of the DPCs. The DPCs will, at a minimum, receive the ESO's annual report. This fiduciary duty places a very high standard on the Trustees' conduct, and management decisions made by them will be scrutinized under this concept. A breach of a fiduciary duty will subject the ESO Trustees to personal liability.
  • Distribution Requirement. The ESO is required to either make an annual distribution of a specific portion of its net income to its DPCs or specifically perform a tax-exempt function that the DPC would otherwise perform. In many instances, the ESO will distribute to the DPCs an amount in excess of the required minimum amount, because the founder and his or her family become actively involved in the success of the specific DPC programs supported by the ESO.
  • Self-Dealing Tax. Under recently-enacted legislation, the ESO is subject to "intermediate sanctions" which impose an excise tax akin to the private foundation self-dealing excise tax.

Thus, in the big picture, the creator and his or her family may not legally control the ESO; all of the Trustees are subject to fiduciary liability for mismanagement; excise taxes for self-dealing may be imposed; the ESO must annually report to the DPCs who have the legal right to enforce the trust and compel an accounting; and annual distributions will be made to the DPCs or a particular DPC program will be actively promoted.


An ESO will in most cases be operated in a fashion which is consistent with the letter and the spirit of the law. However, as Marcus Owens aptly put it in the WSJ article, an ESO which fails to fulfill its legal requirements will have to "fish or cut bait." Despite the spectre of abuse reflected in the examples in the WSJ article, the IRS did not express concern, because it has the necessary enforcement tools in place to deal with any real abuse.

We have heard it all before - government services are being cut back; and societal ills and needs, and the corresponding demands on charities, are exploding. Enlisting the assistance of successful entrepreneurs, not just in giving their dollars but in creating, instituting, and administering specific charitable programs, may prove to be a boon to the future framework of the charitable world. Through the ESO, creators and their families can instill philanthropy in their children and their children's children, and institute a pattern of thoughtful giving for the benefit of all of our children.

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