This is the third and last post we’ll publish on Georgetown Law’s 39th Annual Representing and Managing Tax-Exempt Organizations Conference featuring highlights from a number of sessions (mixed in some cases with my own thoughts). You can find our earlier posts here (IRS, Treasury, Capitol Hill) and here (Current Developments).

State AG Offices: Updates & The New Balance of IRS and State Oversight

  • National Association of State Charities Officials (NASCO)
    • Guidance from state regulators
    • Annual Report for 2020-21 will be released in May (Annual Report for 2019-20)
      • Case Reports – deceptive solicitations (including social media and crowdfunding solicitations), governance issues / breach of fiduciary duties, trust and estate issues
    • Top Trends & Issues
      • Transitional time for many nonprofits with financial strains and staff turnover
      • Increases in requests to borrow from restricted endowments and cy pres applications
      • Increase in online donations, “virtual” organizations, and viral charitable causes
      • Lack of or delinquent charitable solicitation registration continues to be an issue
  • Common law powers are important – note that AGs can replace all of the board members of a nonprofit as part of a remedy
  • Process is key in dealing with issues even if the outcome is less than ideal, but bad outcomes “9.9 times out of 10” are accompanied by (caused by) bad processes
  • California crowdfunding laws (AB 488) speak to insufficiencies of Charleston Principles as way to regulate charities – California if often a bellwether state, so pay attention even if you’re in another state
  • State charity regulators have partnerships with Treasury, IRS, FTC, and other state agencies

Diversity, Equity, and Inclusion: Legal and Practical Issues

  • Session focused on the Kellogg Foundation’s internal operations and ongoing racial equity journey
  • Driving a culture that is inclusive and diverse, so that every colleague feels valued, heard and respected is not only right, but makes business sense
  • Work of inclusion is very personal – including an authorizing environment (championed and modeled by the board), time and space, trust, willingness to understand, and openness to being understood
  • Racial healing is an active, intentional process that acknowledges truth about past wrongs created by individual and systemic racism and to address present-day consequences for people, communities and institutions; and facilitates trust and builds authentic relationships that bridge divides created by real and perceived differences
  • Talent and HR Strategies: Culture and work environment (includes leadership accountability); talent acquisition and workforce representation (includes behavioral-based racial equity questions); staff awareness and learning (including Intercultural Development Inventory and employee-led affinity groups that are relatively autonomous); evaluation and benchmarking

Tax and Legal Issues with Affiliated Exempt and Nonexempt Organizations

  • Both the Omidyar groups of organizations (including Humanity United) and the Chan-Zuckerberg groups of organizations (including CZI) were discussed as models and vehicles for flexibility
  • Why affiliate? necessity; access to capital, programs, markets; access to expertise; greater efficiencies; to find the missing pieces; testing ground/incubator for new ideas (before “institutionalizing” at the charity/program level); pursue aligned and impactful (but no necessarily charitable) goals; leverage and expend mission reach
  • Typical vehicles:
    • 501(c)(3) – private foundations, public charities, DAFs, supporting organizations
      • Must be careful about any assets put into a 501(c)(3) organization, particularly a private foundation, because may be difficult to pull them out without paying fair market value to the 501(c)(3) organization
      • Must be careful about unrelated activities, commerciality, Operational Test, excess business holdings (PFs only)
    • 501(c)(4) – social welfare organizations
    • Taxable entity (with a social/mission focus) – could be a nonprofit, for-profit corporation (including benefit corporations), or LLC (including L3Cs and PBLLCs)
      • For-profit: Must be careful about expectation and role of owner/investors; may have more difficulty raising money from philanthropic or social investors
  • Nonprofit: no tax, possible tax deductions for donors, halo effect
  • For-profit: greater flexibility in operations, in raising non-philanthropic dollars
  • Joint ventures, collaborations, contractual relationships, tandem structures
  • Affiliation models include: for-profit subsidiary; affiliated nonprofit; LLC model (e.g., CZI); impact (charitable?) investment fund; impact incubator; nonprofit/for-profit partnership; social impact operating company
  • Considerations and pressure points include: role and overlay of mission; who is driving the train; governance options; where is the money coming from; structuring the relationship; fiduciary considerations; maintaining and understanding appropriate boundaries (legal, perception); cultural issues; conflicts of interest (real and apparent); compensation issues; engaging with insiders / disqualified persons; disclosure issues; liability considerations; private benefit

Primer on Fiscal Sponsorships and Intermediaries

  • Examples of use of Intermediaries:
    • Project incubation period (e.g., while waiting for IRS processing of exemption application)
    • Funding international programs (may avoid need for expenditure responsibility or equivalency determination)
    • Collaboratives (e.g., funders collaboratives)
  • Common types of intermediaries:
    • Fiscal Relationships (fiscal sponsorship – different models, fiscal agent)
    • U.S. “Friends Of” Organizations
    • Donor Advised Funds
  • Practical pointers for intermediaries and projects re: control, fundraising, lobbying, public relationship and communications
  • Practical pointers for funders re: due diligence, legal, common understandings, document agreement
  • Sample questions provided for asking about grants to intermediaries and selecting fiscal sponsors (including for donor collaboratives)

Legal, Tax, & Accounting Issues with Recoverable Grants and Forgivable Loans

  • Grants are defined in Treas. Reg. 53.4945-4(a)(2)
    • Recoverable grants are not defined in the regs, but Mission Investors Exchange defines them as “an agreement under which a grantee commits to repay a grant under certain circumstances, generally, if the project financed by the grantor is financially successful. If the conditions that trigger the repayments obligation are not met, the grantee is under no obligation to repay and no default is triggered.”
  • Recoverable grant useful – may be used to find charitable activities where revenue generation and ability to repay are less certain than anticipated for loans; may help grantee’s financial statements and credit rating; less pressure for grantee to repay; may be more familiar to grantor and grantee (e.g., with respect to compliance)
  • Program related investments (PRIs) are defined in IRC 4944(c) – include loans, equity
  • Loan useful – may build borrower’s credit history and market discipline; may better protect lender from private benefit concerns
    • Loan factors: promissory note (or other evidence of indebtedness), interest, security/collateral, fixed maturity date, demands for repayment, actual repayments, ability of borrower to repay, consistent records and reporting
    • Factors distinguishing a loan from a grant: expectation setting with the funding recipient, transaction document, transaction reporting, accounting treatment
    • Documentation of PRI loan: typically, but not necessarily, more intense than documentation of grant
  • Expenditure responsibility: ER for grants slightly different from PRIs (which require “full and complete financial reports of the type ordinarily required by commercial investors under similar circumstances”)
  • Is a recoverable grant an investment? If it is, may need to meet PRI requirements
  • If DAF, a grant seems clearly to be a distribution, but is a loan a distribution or investment? (this affects ER requirements and taxes on prohibited benefits)
  • Other considerations: state laws (e.g., CA) re: finance lenders (e.g., limiting numbers of loans or requiring a license); securities laws (loans covered, grants not, but recoverable grants – maybe if not carefully drafted)
  • Accounting rules – multi-year recoverable grant – PF may book it one way (grant) and recipient may book it another way (program income so not recognized all at once) and that may be okay

Role of Funders in Establishing Norms of Behavior for Grantees and Partners

  • Funders must be careful in terms of establishing norms that may be replicated by others (the consequences may be far-reaching)
  • Funders must be careful of being informed that another funder has established a different norm (may or may not be true, often lacks context)
  • Funders vary on whether they require receiving certain policies of grantee (e.g., DEI-related policies) unless it’s related to strict legal compliance (e.g., whistleblower), but they may not want to review grantee’s policies for multiple reasons, including those related to expertise, authority, capacity, ascending liability, and attorney-client privilege; provided, however, that some limited review for red flags may be helpful to grantee if, for example, funder provides access to an expert to help a grantee that values such help)
  • Funder concerns:
    • Grantee workplace complaints and violations, but may be challenging to ask questions and determine the propriety of questioning
    • Governance (e.g., whether grantee’s board is active and diligent in governance, whether there is an audit committee) – funders may signal norms or ‘best practices’ through their questions
    • DEI – be careful of race-based decisions and compliance with civil rights laws (see, e.g., Anti-Discrimination Laws – Section 1981)
    • Digital security
  • Funders may establish norms in charitability where the IRS has left a vacuum – e.g., what is work to eliminate prejudice and discrimination, how addressing environmental issues is treated as charitable
  • Funder actions after allegations of grantee misconduct: challenging area, dependent on facts and circumstances, follow-up may include: stopping future grants (but possibly with targeted support for legal counsel), checking on any jeopardy to grant funds, determining PR implications for funder, determining whether there was any misrepresentations by grantee

Navigating Complex PRI Investments

  • Program-Related Investments (IRS) – applicable to private foundations (PFs)
  • Prong 1. The primary purpose is to accomplish one or more of the foundation’s exempt purposes
    • Charitable purpose – Is the activity or approach to be funded “inherently” charitable? If not inherently or obviously charitable, does it serve a charitable purpose anyway? Document (purpose, metrics, covenants to achieve charitable purpose)
    • Two sub-prongs:
      • Significantly furthers the accomplishment of the private foundation’s exempt activities
      • Investment would not have been made but for such relationship between the investment and the accomplishment of the foundation’s exempt activities
    • Private benefit issue is the most vexing one – 501(c)(3) organization’s activities cannot benefit private interests more than incidentally
      • Facts and circumstances – public benefits, unique position of counterparty to carry out the project, funding directed to charitable aspects of project, counterparty would carry out the charitable aspects of the project without the 501(c)(3) organization, terms are reasonable and limited
  • Prong 2. Production of income or appreciation of property is not a significant purpose
    • What is the intent of the PF
    • Unlikely that any for-profit investor would be willing to make the investment on the same terms, but note that PRI examples recognize investors have motivations across the spectrum so terms may be similar for different reasons; See Proposed Treas. Reg. 53-4944-3(b)
    • Investment return is very uncertain/unlikely
  • Prong 3. Influencing legislation or taking part in political campaigns on behalf of candidates is not a purpose
  • General approach to working with for-profit partners: education and alignment (PRIs will be new to most; social impact is not the same as charitable); and protections (due diligence, building your internal case about charitability)
  • Direct equity investment PRIs vs. indirect equity investment PRIs (e.g., PRI in the equity of an investment fund for purpose of having that investment fund make investments into companies in furtherance of, and in compliance with, the parameters of a charitable purpose)
  • PRIs outside of the U.S.: compliance with local laws of country, cultural norms, currency fluctuations

Tax and Legal Issues with Scientific Research Grants and Contracts

  • See IRS Audit Technique Guide for background
  • Scientific research in the public interest: generally involves certain factors, including making results available to the public on a non-discriminatory basis, performing research for the government, directing research towards benefitting the public – may be okay even if sponsor of research obtains IP rights but only if any patents are made available to the public
  • Partnering with for-profits: private benefit must be incidental to furtherance of charitable purpose (e.g., promotion of health)
  • Medical Research Organizations (MROs): public charities that directly engage in the continuous active conduct of medical research in conjunction with a hospital – MRO asset and expenditure tests – see Treas. Reg §1.170A-9
  • Key considerations in a negotiation:
    • Charitable objective and what rights are needed to ensure intended result
    • Nature of project and stage of development
    • Who is the counterparty (nonprofit or for-profit)?
    • What is the nature of the transaction (e.g., grant, contract, PRI)?
  • IP rights in research: ownership follows inventorship (which is determined under patent law), but inventors generally assign all rights to employer (e.g., university, MRO) that can then allocate rights and other parties may have rights – e.g., other funders, NIH (march-in rights)

Recent Developments in Retirement Benefits and Deferred Compensation

  • ERISA class-action litigation has exploded recently
  • ESG: According to the presenters, the use of ESG factors in investment decision-making (with respect to plan assets) can collide with fiduciary duties; DOL has warned against violations of the duty of loyalty by subordinating the interests of the participants and beneficiaries in their retirement income or financial benefits under the plan; but, in October 2021, DOL issued Notice of Proposed Rulemaking on “Prudence and Loyalty in Selecting Plan Investments and Exercising Shareholder Rights” signaling acceptance of consideration of ESG factors
    • When the ESG factor is material to the risk-return analysis, fiduciaries must consider that factor
    • When the ESG factor is not necessarily material to the risk-return analysis, it is now easier to use it as the “tie breaker”
  • Cyber Theft: Increasing reports of retirement asset and data cyber theft and related lawsuits; see DOL guidance addressing cybersecurity practices of plan sponsors, service providers and plan participants
  • Crypto: Fidelity just announced it is going to allow its clients to add Bitcoin to their retirement accounts; this may impact what is expected of nonprofits
  • IRS Audits: Increase in IRS audits of 457(b) deferred compensation plans; two common foot faults relate to the timing/initiation of required minimum distributions and the timing/implementation of subsequent deferral elections