CHARITABLE FOUNDATIONS: ANOTHER OPTION TO HELP FINANCE SCHOOL ACTIVITIES. Fall 1999

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1 CHARITABLE FOUNDATIONS: ANOTHER OPTION TO HELP FINANCE SCHOOL ACTIVITIES Fall 1999 Written for WASB's Legal Services Membership by Lathrop & Clark LLP School districts continue to be faced with the challenge of evaluating and balancing the many competing demands for funds in the budget and allocation process under the revenue cap limitations. One avenue available to school districts in the battle to generate additional funds for school activities and programs is to create a charitable foundation. A charitable foundation is a nonprofit, tax-exempt organization established for the purpose of raising money for use by the school district. Foundation money does not supplant state and local funds, but instead is generally used for projects that could not otherwise be funded. Charitable foundations are separate legal entities from school districts, governed by their own board of directors typically consisting of parents, community leaders, business people, and educators. This Legal Notes discusses the legal and practical aspects of creating a charitable foundation to provide additional funding for school activities through public contributions. Gifts and Grants Funds can be raised for school projects by the direct solicitation by school boards of gifts and grants to be used for school purposes. 1 There are some advantages to raising funds through foundations versus direct donations to school boards. For example, if donations are made directly to a school board, the school board must administer such gifts and grants itself. Some school boards may not have the time, resources or expertise to handle such matters. School boards may also be subject to more restrictions on how funds are invested and spent. Moreover, since a foundation is a separate distinct entity from the school district this may make it more appealing to possible donors and increase fundraising abilities. Also, as a separate entity a foundation will not be subject to the same political pressures as a school board with regard to how funds are allocated for various school projects. Planning for a Charitable Foundation The success of a charitable foundation will depend in large part upon the initial planning and decisions reached at the time of the formation of the foundation. Some of the items which must be considered by the organizers of the foundation include the overall mission of the WISCONSIN ASSOCIATION OF SCHOOL BOARDS, INC. 122 W. WASHINGTON AVENUE, MADISON, Wl PHONE: FAX:

2 foundation, methods of fund raising, how assets of the foundation will be invested, purposes for which funds of the foundation will be used, the size and composition of the board of directors, and whether the foundation will rely on volunteers or hire employees. Purpose of the Foundation The organizers of a foundation need to determine the foundation's general purpose and how its funds will be spent. The purpose of the foundation may be to raise funds for specific identified needs, or the foundation may be organized to build an endowment fund whereby the earnings on the endowment are used for various types of school district projects. Consideration should also be given to the types of projects which would be supported by the foundation. For example, the foundation could provide that its primary purpose is to fund projects related to foreign language, artistic, or musical pursuits; or the primary focus could be enhancing the computer and other technological capabilities of the educational system; or the funds could be used to provide for the general benefit of the school district. If the foundation's funds will be used for the "general benefit" of the school district, donors may feel there is no specific need for their contribution or that their contribution is simply lost amongst the general budget of the school, Therefore, specific uses for the funds may help in attracting contributions to the foundation, assuming that the community at large supports the specific uses of the funds. If the foundation is planning on building an endowment fund, due to the time involved in establishing such a fund this may result in little current tangible benefit to the public. Thus, the foundation should take steps to make sure that the public does not lose interest in the foundation. It may be beneficial for the foundation to balance the building of the endowment fund with the use of funds for current projects so that community members see an immediate impact from their contributions and the work of the foundation. Incorporation Under State Law A charitable foundation must be a legal entity which is separate and distinct from the school district. This separate legal entity will often be structured as a non-stock, non-profit corporation. Non-stock. non-profit corporations are governed by Chapter 181 of the Wisconsin Statutes and are created by filing Articles of Incorporation with the Wisconsin Department of Financial Institutions. 2 Articles of Incorporation typically include only general information regarding the basic structure of the corporation. The provisions which must be included in the Articles of Incorporation are specified by statute and include a corporate name, the mailing address of the office of the corporation, the name and address of the initial registered agent of the corporation, and the name of the incorporator) The Articles should also include provisions for purposes of qualifying for tax-exempt status.

3 In addition to filing the Articles of Incorporation, it will be necessary to obtain a federal identification number and adopt bylaws. Bylaws provide a set of rules for the operation of a corporation. There are no specific requirements as to what must be contained in corporate bylaws. Bylaws will generally establish the time, place and manner of calling and conducting meetings; establish committees; and set the number, duties, compensation and time of election for directors. Board of Directors The Board of Directors is responsible for the overall supervision of the affairs of the foundation. It must be decided how many individuals will be on the Board of Directors and what qualifications, if any, an individual must have to be eligible to be a member of the Board of Directors. A large number of members of the Board of Directors may be advantageous in terms of getting community involvement and obtaining diverse skills which each member can bring to the Board. A large Board may, however, make it hard for the foundation to make decisions. If the Board of Directors consists of a large number of individuals, the foundation may want to consider establishing separate committees (such as a fund raising committee and a finance committee) which will have authority over certain issues. Regardless of how many directors there will be, the foundation must decide how directors will be chosen. It should be considered whether members of the school board, school administration and/or teachers should be targeted to be on the Board of Directors of the foundation or if these individuals should be excluded from the Board. If members of the school board, school administration and teachers are part of the Board, this may help foster cooperation and teamwork between the foundation and the school district. Conversely, excluding these individuals from the Board of Directors may increase the credibility of the foundation by reinforcing in the eyes of the public that the foundation is an independent entity apart from the school district. The organizers of the foundation should decide if a broad base of representation from the community is appropriate for the Board of Directors. Having a diverse representation on the Board of Directors from business leaders, parents, and community members from diverse occupations may increase community support and involvement in the foundation. Thus, it may be desirable to provide certain qualifications for some members of the Board of Directors and that other members of the Board of Directors are appointed from the community. For example, assume the foundation decided to have seven members on the Board of Directors. The foundation could specify that the superintendent of the school district is always a member of the Board of Directors, that one teacher is always a member of the Board of Directors, that one person from a local social service agency must also be a member of the Board of Directors and that the other four members of the Board of Directors be elected or appointed without any preference based upon occupation.

4 Tax-Exempt Status A charitable foundation must be structured carefully to ensure that it is not only subject to no (or reduced) federal and state taxes, but that contributions made to it are eligible for treatment as charitable deductions by donors under federal and state tax laws. Simply forming a corporation as a non-stock, non-profit corporation and operating the corporation for charitable purposes is not sufficient to obtain tax-exempt status. Rather, to accomplish this objective, the charitable foundation will need to file an application for tax-exempt status with the Internal Revenue Service (IRS). The Internal Revenue Code (IRC) provides tax-exempt status to a number of different types of non-profit entities, but a foundation should be classified as tax exempt under IRC 501(c)(3). The benefit of obtaining tax-exempt status under IRC 501(c)(3) is that donors who contribute money or property to the foundation will be entitled to take a charitable deduction for income tax purposes for the amount of the contribution. Tax-exempt status under IRC 501(c)(3) allows donors to receive the same income tax benefit from contributions to the charitable foundation that they receive when they make contributions to their church or to other charities such as the United Way, the Red Cross, or Wisconsin Public Television. The IRS grants tax exempt status to non-profit entities which are organized and operated to benefit the public. There are many requirements which must be met to obtain tax-exempt status. Some of these requirements include: 1) a prohibition against engaging in lobbying or participating in any political campaign; 2) the income and assets of the foundation must be used exclusively for the benefit of the public; and 3) if the foundation is ever dissolved, the assets of the foundation must be distributed to another entity which is tax exempt under IRC 501 (C)(3). 4 IRC 501(c)(3) status will facilitate fund raising because donors may be able to achieve income tax and/or estate tax savings by making gifts and contributions to the foundation through a charitable remainder trust. Estate tax savings may also be realized by making charitable gifts at death as part of the individual's estate plan. A charitable remainder trust is basically an irrevocable trust agreement which provides that the donor would place certain assets, such as shares of stock or cash, in a trust and the donor would receive the income from the assets in the trust during the donor's lifetime and upon the donor's death, the property would pass to the foundation. The donor may be able to take a current income tax deduction for the fair market value of the remainder interest in the property at the time the trust is funded. A charitable remainder trust or an outright gift to the foundation pursuant to the terms of a decedent's will may also reduce the donor's liability for federal estate taxes because contributions to charitable organizations at death are an allowable deduction from the federal estate tax. Thus, IRC 501(c)(3) status allows donors more options regarding the type or structure of a contribution to the foundation and donors still obtain the favorable tax benefits resulting from the contribution.

5 One potentially significant income tax savings which donors may be able to realize involves the gift of appreciated stock or securities to the charitable foundation. This alternative maybe particularly attractive to donors because the donor would receive a charitable contribution deduction equal to the fair market value of the stock or securities donated to the foundation and the donor would escape the income taxation on the appreciation of the stock which would have been realized had the stock been sold. 5 This allows a charitable contribution deduction to the donor for the full fair market value of the stock without causing any taxable income to the donor as would result if the donor sold the stock and then contributed the cash to the foundation. The foundation could then sell the stock after the contribution and the foundation would not recognize taxable income on the sale of the stock because the foundation is a tax-exempt entity. Fund Raising Organizers will need to consider the types of fund raising methods that will be used. The foundation could employ professional fund raisers or fund raising could be done through volunteers. The types of fund raising activities could include solicitation of gifts through telephone calls, direct mail or personal visits with potential donors. Funds can also be raised through the sale of items, various fund raising events or by seeking grants from private grantgiving foundations. The appropriate fund raising strategy will vary depending on the unique characteristics of the community involved. The types of fund raising in which the foundation is willing to engage may have a substantial impact on the amount of funds which the foundation is able to raise and this will in turn directly affect the results which can be realized by the foundation. Investment Strategy The foundation should also develop an investment strategy. If the foundation is raising funds which will be spent relatively quickly, the investments should most likely be made in short term low-risk types of investments. If the foundation is building an endowment fund, the funds will be invested for a significant period of time and an investment strategy consistent with this longer term investment outlook would be appropriate. A foundation should attempt to reach some consensus on the investment policy which will be pursued and the foundation may wish to take steps to address various public concerns regarding investing in companies such as tobacco companies, companies that manufacture or distribute alcohol, companies which claim to be environmentally friendly or companies which do not exploit child labor in foreign countries. Addressing these issues initially may help avoid public criticism over the types of investments made. Other Requirements If the foundation is soliciting charitable contributions, the foundation may have to register with the Wisconsin Department of Regulation and Licensing. 6 If the foundation normally receives more than $25,000 per year in gross receipts, the foundation will have to file an informational income tax return with the IRS. In general, the foundation will not pay any income

6 tax but a return must be filed which shows the receipts and expenses of the foundation. It should be noted that a foundation will pay income tax if it engages in certain business activities which are unrelated to its exempt purpose. For example, if the foundation engages in significant levels of fund raising through sales of items, the foundation may have to pay income tax on the income generated from this business activity. For these reasons, it is advisable for foundations to implement appropriate accounting procedures which accurately track receipts and expenditures. Conclusion A charitable foundation can be an effective way to raise money to help finance school activities. Creating the non-stock, non-profit corporation under state law and obtaining taxexempt status from the IRS is a significant undertaking and considerable effort is required to keep a foundation operating and to make it successful. Therefore, careful thought should be given to the planning of a foundation and the methods which may encourage public support prior to committing the resources necessary to establish this type of charitable foundation. wasb\ 15\legal note(charitablefound) doc ENDNOTES 1 For a discussion of this topic see "School Board Solicitation and Administration of Gifts and Grants" Wisconsin School News (December 1985). 2 Wis. Stat Wis. Star (I). 4 IRC 501(c)(3) and Treasury Regulation 1.501(c)(3)-1(B)(4). s IRE 170(e)(1). 6 Wis. Star

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