© 2011 Leaffer Law Donor-Advised Scholarship Funds: The Rhythm and Harmony of Donor Participation Karen Leaffer Becky Farr Seidel National Scholarship Providers Association October 19, 2011

© 2011 Leaffer Law Agenda 1.Overview / Background 2.Donor-Advised Funds (DAFs) – Key Characteristics 3.Scholarship Fund Exception - How to Qualify 4.Real Life Application 2

© 2011 Leaffer Law Overview 3

© 2011 Leaffer Law Donor-Advised Scholarship Funds: Past  Donor(s) established separate fund or account with charity  Donor(s) “advised” charity in selection process, but gave ultimate decision-making authority to charity  Benefits to Donor(s):  Current tax deduction  Avoid cost and complexity of separate scholarship entity  Participate in selection process  Avoid private foundation rules 4

© 2011 Leaffer Law Donor-Advised Scholarship Funds: Past  Typical examples included scholarship funds established by:  Individual donors or families  Companies and their employees  University alumni and faculty  Professional associations and their members  Civic/service organizations and their members  Members of faith based organizations 5

© 2011 Leaffer Law Donor-Advised Scholarship Funds: Past Abuse #1: de facto donor control over selection process Abuse #2: convert personal gift to charitable donation Abuse #3: impermissible private benefit 6

© 2011 Leaffer Law Donor-Advised Scholarship Funds: Present Pension Protection Act of 2006: DAFs are no longer permitted to make scholarships, unless the scholarship fund exception applies! 7

© 2011 Leaffer Law Donor-Advised Scholarship Funds: Present Penalties:  Sponsoring Charity – 20%  Fund managers – 5% (for knowing violation)  Donors – possible penalties for private benefit or denial of deduction 8

© 2011 Leaffer Law Donor-Advised Scholarship Funds: Present Key Questions: 1.Is the scholarship fund a DAF? 2.If so, does the “scholarship fund exception” apply? 3.If not, what are the options? 9

© 2011 Leaffer Law Is the Scholarship Fund a DAF? 10

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 1.Fund or account is owned or controlled by a sponsoring organization 2.Fund or account is separately identified by reference to contributions of donor(s) 3.Donor/advisor has or expects to have advisory privileges as to distribution or investment of funds by reason of donor’s status as a donor 11

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 1.Fund or account is owned or controlled by a sponsoring organization  Covered: 501(c)(3) public charities  Covered: war veteran organizations, fraternal organizations and cemetery companies  Not covered: private foundations  Not covered: non-501(c)(3) organizations  Not covered: custodial funds 12

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 2.Fund or account is separately identified by reference to contributions of donor(s)  Covered: fund bearing name of donor (or related party)  Covered: separate fund on books and records which tracks contributions of specific donor(s) (or related parties)  Not covered: “general” fund from which scholarships are made (multiple donors, contributions pooled anonymously)  Not covered: “field of interest” fund dedicated for scholarships (multiple donors, contributions pooled and not separately tracked) 13

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 2.Fund or account is separately identified by reference to contributions of donor(s) … continued  Other “multiple donor” donor funds? (more on this later)  IRS will look at substance over form 14

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 3.Donor/advisor has or expects to have advisory privileges as to distribution or investment of funds by reason of donor’s status as a donor  Covered: advisory privilege (donor has right to make recommendations and sponsor will consider them)  Not covered: gift restrictions (e.g., purpose of fund is for scholarships or selection criteria) 15

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 3.Donor/advisor has or expects to have advisory privileges as to distribution or investment of funds by reason of donor’s status as a donor … continued  Covered: donor participates in selection process because he/she is a donor  Not covered: donor participates in selection process because he/she holds certain position (e.g., officers, director or fund manager of sponsor, president of university) 16

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 3.Donor/advisor has or expects to have advisory privileges as to distribution or investment of funds by reason of donor’s status as a donor … continued  Covered: selection of scholarship recipients  Not covered: recommendation of selection committee, so long as based on objective criteria related to expertise (e.g., department heads, high school principal, etc.) 17

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 3.Donor/advisor has or expects to have advisory privileges as to distribution or investment of funds by reason of donor’s status as a donor … continued  Covered: privilege arises under written agreement  Covered: privilege arises by course of conduct  Covered: privilege exists even if not exercised  Covered: privileges later  Not covered: no mutual expectation of donor/advisor and sponsor 18

© 2011 Leaffer Law Donor-Advised Fund: Three Elements 1.Fund or account is owned or controlled by a sponsoring organization 2.Fund or account is separately identified by reference to contributions of donor(s) 3.Donor/advisor has or expects to have advisory privileges as to distribution or investment of funds by reason of donor’s status as a donor 19

© 2011 Leaffer Law Of Special Concern: Multiple Donor Funds  For example … scholarship funds established by:  Faculty and alumni groups  Service and social clubs  Company employees  Friends in memory of loved one  Giving circles  Caution! Lack of guidance … but penalties still apply! 20

© 2011 Leaffer Law Of Special Concern: Multiple Donor Funds  Key factors for your attorney to consider:  How large is the donor group?  How are the donors related?  Does anyone dominate or control the group?  How is the selection committee comprised and selected?  What is the nature of its advisory privilege?  Is there a scholarship plan that meets the private foundation rules?  To what extent does the sponsor oversee the scholarship activity?  How close does the fund come to meeting the scholarship fund exception? 21

© 2011 Leaffer Law Key Questions: 1.Is the scholarship fund a DAF? 2.If so, does the “scholarship fund exception” apply? 3.If not, what are the options? 22

© 2011 Leaffer Law Does the Scholarship Fund Exception Apply? 23

© 2011 Leaffer Law Scholarship Fund Exception: Five Requirements 1.Donor/advisor (or related party) has advisory privileges only as member of advisory committee 2.Entire advisory committee is appointed by sponsoring charity 3.Donor/advisor and related persons do not directly or indirectly control advisory committee 4.Scholarships are awarded pursuant to pre-approved plan of sponsoring charity’s governing board 5.Plan is designed to comply with private foundation rules for scholarship activity 24

© 2011 Leaffer Law Scholarship Fund Exception: Five Requirements 1.Donor/advisor (or related party) has advisory privileges only as member of advisory committee  Okay: donor is a member of a 5-member advisory committee, does not control the committee, and gets to vote on candidates as part of this committee  Not okay: assume the facts above, but donor also gets to pre-select individuals who will be considered by the full committee 25

© 2011 Leaffer Law Scholarship Fund Exception: Five Requirements 2.Entire advisory committee is appointed by sponsoring charity  Okay: donor and spouse serve on five-person advisory committee, all appointed by community foundation  Not okay: fund agreement designates donor and spouse as advisors 26

© 2011 Leaffer Law Scholarship Fund Exception: Five Requirements 3.Donor/advisor and related persons do not directly or indirectly control advisory committee  Okay: advisory committee consists of donor, spouse and three retired college presidents  Not okay: advisory committee consists of donor, spouse, their accountant and two retired college presidents 27

© 2011 Leaffer Law Scholarship Fund Exception: Five Requirements 4.Scholarships are awarded pursuant to pre-approved plan of sponsoring charity’s governing board  Okay: board adopts “master” procedures applicable to all scholarship funds of the organization  Not okay: staff determine procedures for each fund 28

© 2011 Leaffer Law Scholarship Fund Exception: Five Requirements 5.Plan is designed to comply with private foundation rules for scholarship activity  Nondiscriminatory criteria and publicity  Objective selection process  Adequate records as to recipients  Reasonable renewal criteria  Monitoring of recipients’ performance – reports from recipients  Investigate known diversion of funds  Special rules for employee scholarships 29

© 2011 Leaffer Law Scholarship Fund Exception: Five Requirements 1.Donor/advisor (or related party) has advisory privileges only as member of advisory committee 2.Entire advisory committee is appointed by sponsoring charity 3.Donor/advisor and related persons do not directly or indirectly control advisory committee 4.Scholarships are awarded pursuant to pre-approved plan of sponsoring charity’s governing board 5.Plan is designed to comply with private foundation rules for scholarship activity 30

© 2011 Leaffer Law Real Life Application 31

© 2011 Leaffer Law Conclusion 32

© 2011 Leaffer Law Remember...  Any scholarship fund with ongoing donor involvement should be reviewed to determine DAF status  If scholarship fund is a DAF and does not qualify for scholarship fund exception … consider your options! 33

© 2011 Leaffer Law Options: 1.Eventually … request Treasury Department exemption 2.Modify fund terms to avoid DAF status 3.Modify fund terms to qualify for scholarship fund exception 4.Reorganize fund as supporting organization or private foundation 5.Don’t allow scholarship activity 34

© 2011 Leaffer Law 35

Karen Leaffer, Esq Becky Seidel, Esq Wynkoop Street | Suite 275 | Denver, CO LeafferLaw.com 36