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Using a 509(a)(3) Supporting Organization as a Private Foundation Alternative

Using A 509(a)(3) Supporting Organization As A Private Foundation Alternative

In our last post, we began our exploration of supporting organizations by answering the question, “What Is a 509(a)(3) Supporting Organization?”.  Now, we want to take a look at one way to take advantage of this unique structure.

A Common Use Case:  As An Alternative to a Private Foundation

Private foundations are excellent 501(c)(3) choices to establish for the purpose of donating into it, and using it to fund charitable activities over time.  A key benefit of a private foundation for many is the level of control it offers to the founders.  Unlike public charities, private foundations are not required to have an independent board of directors, nor are they required to have a broad base of donors.  That’s why you often see foundations established by high net worth families or companies wanting more control over their philanthropic endeavors.

For larger donors looking to primarily support a specific charity, however, who don’t want to personally give directly to that charity, private foundation rules may prove to be too burdensome.  For starters, there are strict rules governing self-dealing that limits compensation to directors and other disqualified persons.  Also, there are limits on the type of assets that can be donated to a private foundation and the timing of tax benefits to the donor.

For example, the tax-deductibility of cash gifts to private foundations is limited to 30% of adjusted gross income (AGI) in any given year, not the current 60% of AGI limit afforded donations to public charities.  Similarly, tax-deductibility of gifts of certain appreciated property is subject to a 20% AGI limit vs. 30% for public charities.

To make matters worse, donations of appreciated property are not deductible at full fair market value when given to private foundations, unlike those given to public charities.  The valuation can be reduced by the untaxed appreciation, effectively lowering even more the true tax benefit of giving appreciated property.

And finally, investment earnings of private foundations are subject to up to 2% excise tax.

For these reasons, a private foundation may not be the ideal choice when a single public charity is meant to be the ultimate beneficiary.  Enter the 509(a)(3) supporting organization.

One of the biggest advantages of a supporting organization over a private foundation is the fact that the former is considered a public charity.  As such, the tax-deductibility of cash gifts and appreciated property is potentially higher.  Appreciated property valuations aren’t reduced by untaxed appreciation.  Supporting organizations, again because of being public charities, are not subject to the earnings excise tax.

There are some obvious tradeoffs to this choice, however.  First, unlike a private foundation, a supporting organization cannot have a closely controlled board of directors.  In addition, there will likely need to be overlap or even duplication of the board members from both the supporting organization and the supported public charity.  The degree of overlap depends on the choice of a Type I, Type II, or Type III supporting organization.

Also remember that a supporting organization is, by default, considered subordinate to and controlled by the charity it supports.  This lack of independence is often the reason the same large donor above may indeed choose a private foundation instead of a supporting organization.  The tax benefit might not outweigh the freedom factor.

As with most complex issues like this, the choice between a supporting organization and a private foundation in this unique situation is far from automatic.  It requires careful analysis to ensure that the balance of benefits falls the right direction and positively impacts both the funding organization and the ultimate recipient charity.

 

Greg McRay, EA

Greg McRay is the founder and CEO of The Foundation Group. He is registered with the IRS as an Enrolled Agent and specializes in 501(c)(3) and other tax exemption issues.

This Post Has 8 Comments
  1. I am a member of a 501c(5) organization with a separate 501c(3) that exists solely to fund us. Things are getting sticky with the relationship as the c(3) recently took over our event sponsorships. Aside from the fact that none of this was actually approved by the board, accounted for properly, and no one seems to understand the difference between a sponsorship and donation, I am worried about the basic legality of the c(3) collecting earned funds for the c(5). In addition, as i said before, the c(3) is acting like these are donations and not issuing he proper tax documents (in the lower levels the sponsors receive more in ‘substantial return benefit’ then they pay). They are also claiming that the funds are restricted as solicited donations. Is this legal? Could this be seen as a conduit by the IRS?

    1. This sounds like a really bad setup. A 501c3 cannot fund the activities of a 501c5 at all. 501c5 orgs are nonprofit (agricultural, labor, or horticultural), but they are not charitable. A 501c3’s activities and assets are restricted to exclusively charitable purposes. What you’re describing would actually be grounds for the IRS to revoke the 501c3’s status for cause.

  2. I have read that I nonprofit can’t have more than three years worth of operating expenses in the bank. Would a 509 a 3 be allowed to store enough funds that it could operate purely off interest?
    Suppose someone donated a $10 million lottery ticket, and the nonprofit’s operating expenses were only $200,000 per year. Would they be allowed to keep that $10 million in a savings account that gave them 2% interest annually, and therefore be able to operate perpetually without needing to raise funds ever again?

    1. Hi, Garrett. Actually, there are no fixed limitations on how much money can be saved. For example, some of your elite private colleges have hundreds of millions of dollars (some over $1b) in endowment. Private foundations are often seeded up front with all the money it will ever have to fund generations of philanthropy. In general, it’s not best practice for a operating charity (one with active programs) to squirrel away most of its financial resources and just drip out sustenance. But, even with that said, there is no rule about ratios. I hope that helps.

  3. My husband and i founded a 501c3 organization called Kids ‘n Kamp in 1982. (31-1052278) our mission is to provide programs and services for children who have cancer and their parents & siblings. we are currently serving over 400 families throughout Ohio. Tutoring, counseling, family camp, emergency funding (utilities, funeral expenses, clothing, etc.) retreats, holiday parties, family camp & much more.
    my husband passed away 2 years ago and i find myself at 76 with less energy and enthusiasm to keep up with the ever-growing needs of those we serve. i don’t want to close the doors all together and i don’t want to stop helping them. They have been my life’s work for 37 years and it has been my honor. Can you tell me how we can change our existing non-profit into a foundation that will raise funds for local childhood cancer research and support other childhood cancer charities (or individual families) in our community?

    1. Hi, Beverly. I am sorry for the delay in responding. Kudos on your many years of dedicated service!

      A change like this takes two steps. The first is buy-in from your board of directors, where your board would vote on this change. Make sure it’s well documented in meeting minutes. Next, you could seek change of status with the IRS to go from a public charity to a private foundation, but only if you want to. As long as the board can remain independent (not all related), shifting your charities activity from active programs to funding similar work can be a change you notate on your next IRS Form 990.

  4. Hi Greg, thanks for the detailed info on this alternative choice. I am in the midst of forming a non profit organization to “serve seniors” that are still in home residents. I am seeking to build/fund an organization that will provide much needed services (lawn care, house painting and light cleaning, basic repairs) that are currently way too high in cost for the majority of retired folks. Since I know that this need is huge and exists in every town, usa, its much too big to do myself. I’m wondering if this 509 (a) 3 isn’t the way to go??? I’m envisioning the need for lawn care and painting equipment, trailers to haul equipment etc., and while many of these things may be donated, I’m guessing many will not be.
    I’m also guessing that this will build to a multi city/state organization that will need to have many coordination points and officers more locally situated, which ultimately would report to a group of overseer’s on a higher level.
    Your thoughts on this undertaking and if this (590 a 3) is the best direction to move in?

    Thanks
    Jim

    1. I’m not sure that’s the right choice for you. Keep in mind that 509a3 nonprofits are 501c3, but they’re non-operating. You use a 501c3 structured as a 509a3 to financially support the work of an operating 501c3 charity. You need the latter, whether or not you ever need to utilize the former.

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