What is it?
A community foundation is a tax-exempt, not-for-profit charitable organization that fulfills the requirements of Section 501(c)(3) of the Internal Revenue Code. Generally, a community foundation is established to meet the needs of the local community such as a particular town, county or state. A community foundation is made up of a collection of individual funds given by local donors to improve and sustain the quality of life in a given community. This collection of funds is then permitted to grow within the confines of the foundation. The funds are considered permanent endowment funds, the income from which (and sometimes the principal) is used to promote the purpose of the community foundation. A community foundation differs from a private foundation in that the IRS designates it as a public charity since it raises a significant portion of its resources from a broad cross-section of the public annually.
Generally, all community foundations share the following common elements:
- The foundation is a Section 501(c)(3) tax-exempt organization that is organized and operated for charitable
- The foundation has developed broad support in the form of contributions from separate and unrelated donors who have diverse charitable interests in the community that the foundation serves.
- The foundation has an independent governing body that broadly represents the public
- The foundation mainly operates as an organization that makes grants to other However, there are some charitable services that it may be appropriate for a community foundation to provide.
- The foundation focuses its grants and charitable services within a particular geographic area such as a county or
- The foundation provides grants to multiple grantees and the grants are not limited to a particular field of interest such as health or education.
- The foundation is made up of permanent endowment funds that carry out the charitable purposes of either the donor or the foundation's governing body.
Why should you establish a community foundation instead of a private foundation?
While a private foundation offers donors greater control over the assets they contribute to the foundation, there are numerous restrictions. As a result, administration of the private foundation can be costly. One of the major benefits of a community foundation is that it can accomplish the same charitable objectives as a private foundation, but without such restrictions.
How does a community foundation operate?
A community foundation is an organization that is made up of an aggregation of individual funds. The funds are usually named after the donor (for example, if Mr. Bill Smith donated funds to a community foundation, the funds might be named the Bill Smith Fund). The foundation then follows the instructions of either the governing body or the donor regarding the use of the funds. A typical community foundation might support specific local organizations like the ballet or a youth club. However, a community foundation can also support a widely recognizable institution such as a national university.
Types of funds
A community foundation usually allows a donor to impose various restrictions on a fund. Based on these restrictions, the foundation will classify each fund as an unrestricted fund, designated fund, field-of-interest fund, or advised fund.
An unrestricted fund is one in which the community foundation has full discretion over how to use the funds to carry out the foundation's charitable purpose.
A designated fund is one in which distributions from the fund are limited to a particular public charity, named by the donor at the time the contribution was made to the foundation; an endowment fund for the upkeep of a park, for example.
A field-of-interest fund is one from which distributions are limited to a particular charitable purpose specified by the donor; for example, to improve education.
An advised fund is one in which the donor advises the community foundation on charitable distributions to be made from the fund.
Caution: For the IRS to view a gift to charity as a tax-deductible charitable contribution, it must be complete. That is, the ultimate decision concerning grants must be vested with the community foundation. The donor must only serve in an advisory capacity when making recommendations to the foundation on how to distribute assets. If control is retained by the donor over his or her fund, the IRS will determine that the gift was not complete and the donor would not be entitled to a charitable deduction.
Advantages of establishing a community foundation
The community fund is exempt from the excise taxes and administrative requirements that are applicable to private foundations.
Easy to establish
You can establish a community fund fairly quickly and you do not have to apply to the IRS for tax-exempt status.
Less expensive than a private foundation
Generally, a community foundation is less expensive to establish and administer than a private foundation. Start-up costs are minimal since a community foundation does not need to establish a trust or corporation, which saves the accompanying legal fees. In addition, there is no requirement that you apply to the IRS for tax-exempt status.
As a donor, you will have access to the staff of the community foundation. This staff will have knowledge of the needs of the surrounding community. By utilizing the knowledge of the community foundation's staff, you can ensure your funds are used where they are needed most.
Administration of funds
Accounts (directly held funds)
One method of administering the funds within a community foundation is by using the fund-accounting rules for nonprofit organizations. Under these rules, each fund within the foundation represents a separate account on the foundation's books. The individual funds are then administered according to the rules for nonprofit organizations.
Trusts and corporations (component funds)
Another method of administering funds within a community foundation is by placing each fund in a separate trust or corporation.
Even though the community foundation does not have legal title to the assets within the trust (legal title is held by the individual trust or corporation), the trust is considered part of the community foundation for tax purposes (sometimes referred to as a component fund). This means that a fund does not file a separate tax return even if it is a separate trust. Instead, the foundation files a consolidated tax return that includes the financial transactions surrounding all of its funds. In other words, the IRS allows community foundations to treat the multiple trusts and corporations of the foundation as part of the community foundation rather than as individual private foundations. In addition, a contribution to a component fund is treated as being made to the community foundation. As a result, the donor can claim a tax deduction at the rates applicable to contributions to a public charity. However, for a trust or a corporation to qualify as a component fund, the following IRS requirements must be met:
- The organizational documents of the community foundation must meet the single entity test (explanation to follow)
- The trust must be subject to the governing body of the community foundation
- The foundation must accept the contribution
- The donor must not place a material restriction on the fund with respect to transferred assets A community foundation qualifies as a single entity as long as the following requirements are met:
- The organization is commonly known as a community foundation, trust, or fund
- The organization prepares periodic financial reports that treat all the funds that it holds, either directly or in component parts, as funds of the organization
- All funds of the organization are subject to a common governing instrument
- The organization has a common governing body with the power to: modify any restriction or condition on the distribution of funds if such restriction or condition becomes unnecessary, incapable of fulfillment, or inconsistent with the needs of the surrounding community that is being served by the organization; to replace any participating trustee , custodian, or agent for breach of fiduciary duty under state law; and to replace any participating trustee, custodian, or agent for failure to produce a reasonable return of net income over a reasonable period of time
Tip: For more information see Section 501(c) (3) of the Internal Revenue Code and related regulations or IRS Publication 557, Tax-Exempt Status for Your Organization.
An alternative to establishing a fund within a community foundation is to form a separate charitable trust or corporation that qualifies as a grant-making Section 509(a)(3) supporting organization. However, a community foundation will normally require the supporting organization to have a large endowment to offset the costs of maintaining a separate organization. Section 509(a)(3) sets forth three tests that an organization must meet before qualifying as a supporting organization: the organizational and operational test, the control by non-disqualified persons test, and the relationship test.
Organizational and operational test
The organizational and operational test requires that the supporting organization be operated for the exclusive benefit of carrying out the purposes of a public charity. Generally, the organizational test is satisfied if the supporting organization's purpose is as broad as that of the community foundation. In other words, as long as the grants from the supporting organization further the community foundation's charitable purpose, the test is satisfied.
Control by non-disqualified persons test
The control by non-disqualified persons test requires that a supporting organization not be controlled by disqualified persons. A disqualified person is anyone who is a substantial contributor, meaning anyone who: contributes more than 2 percent of the total contributions that are received by the supporting organization, is related to the disqualified person, or could be influenced by a disqualified person such as an employee of the donor. In other words, a donor's family can only have a minority representation on the community foundation's governing body for it to qualify as a supporting organization.
The relationship test requires that the supporting organization be operated, supervised, or controlled by or in connection with the community foundation. A supporting organization is controlled by the community foundation if a majority of the governing body of the supporting organization is appointed by the community foundation. A supporting organization is supervised or controlled in connection with a supporting organization if both the supporting organization and the community foundation have common control. A supporting organization is operated in connection with the community foundation if the organization meets the responsiveness test and the integral part test.
The responsiveness test requires the supporting organization to be satisfactorily responsive to the needs or demands of the community foundation. This can be accomplished by the community foundation having at least one representative on the governing body of the supporting organization. The integral part test requires the supporting organization to maintain a significant involvement in the operations of one or more community foundations, which, in turn, depend on the supporting organization for the type of support it provides.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal professional.
LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.
This article was prepared by Broadridge.
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