THE BLOG
12/05/2016 10:44 am ET Updated Dec 06, 2017

Some Legal Aspects of Donor Restricted Charitable Gifts

Donors to charities may typically restrict gifts with language in a deed (for example, land conveyed for a public school), a grant agreement contract or letter of understanding, or sometimes by notation on a check or financial instrument. This comment briefly provides an incomplete educational overview of donor restricted gifts. Always consult an experienced attorney and tax accountant in all charity and gifting matters.

All charities need a thoughtfully created gift solicitation, acceptance, and acknowledgment policy. The following several paragraphs briefly mention only a few of many possible concerns.

Is there any potential misrepresentation in the solicitation materials and stated purposes? When soliciting funds for specific purposes a charity must plan carefully before approaching a potential donor. Will the issue of redirecting or unrestricting the gift be discussed? Are the charity's fundraisers under pressure to achieve results so that they gloss over issues and avoid appropriate and candid conversations with potential donors? Avoid public relations problems and more serious claims of fraud.

What types of property will the charity never accept and what restrictions are unacceptable? Exotic forms of property and collections that the donor wants displayed or preserved may be of no value to the charity. How much will it cost the charity to manage and maintain the gift? Some donors have unrealistic estimates of the fair market value of their gifts or view gifting as a way to salvage a tax deduction from otherwise unsellable property.

Other potential donors may idealistically view their potential gifts as providing a transformative opportunity for the charity that financial due diligence and market research proves to be incorrect. For example, old and remote campgrounds or campuses may be costly to modernize and maintain and their isolation or marketplace competition will result in few new clients for the charity. These gifts may also be conditioned upon unacceptable restrictions. Some gifts may come with hidden potential liabilities. Especially exercise environmental due diligence if land is being donated to avoid liability for clean-up expenses.

Additionally, a charity must consider the possible issues related to a donor that provides stolen or embezzled funds, makes gifts from her or his corporation that were not properly authorized, or files for bankruptcy after making significant gifts. Unwinding gifts and addressing these events is difficult.

Once accepted, every gift, however small, should be processed in a uniform manner so that the donor will be acknowledged and thanked. Uncashed or cashed but unacknowledged checks display bad accounting and poor manners. Carelessness damages donor relations and confidence.

The basic rule is that gift restrictions are legally binding on the charity. Properly segregate restricted and unrestricted gifts. State law often views charities as "trusts" with a high duty of care and accountability. Interpreting gift restrictions involves determining the donor's intent from the actual language contained within the "four corners" of the document. Only when the document language is ambiguous will a court look to external sources such as conversations, etc. Contested interpretations may require a declaratory judgment action in court. Hence, donor restrictions should be carefully and thoughtfully written.

Another fundamental issue is if the donor's restrictions relate to the charity's funds generally or only to specific program related funds. Termination of a program may allow the charity to redirect program funds to other uses that resemble to original intention (cy pres doctrine). A related legal rule, equitable deviation, allows modifications to the administrative terms of gifts if those provisions become impossible, unlawful, or substantially impede the purposes of the donation.

Virtually all states have enacted the "Uniform Prudent Investor Act" and the "Uniform Prudent Management of Institutional Funds Act" that regulates investment and spending decisions related to trust funds and charitable and nonprofit endowments. Additionally, state property codes, trust codes, and nonprofit corporation legislation may contain relevant requirements. The details of these legislative acts are not discussed in this brief comment. Financial managers must be informed concerning these requirements and should obtain professional advice.

In general, in the absence of written consent from a donor, modifying donor restrictions may require court action based upon unanticipated changed circumstances, etc. Discuss at the time of the gift and document how possible modifications will be considered or made after the donor's death. A charity should lawfully and carefully undertake any restriction changes as sloppiness may impose personal civil and criminal liability on the board of directors of the charity. Allegations of breach of fiduciary duty or charity fraud, even if ultimately dismissed, are a public relations and legal nightmare. A variety of state and federal officials, especially the state Attorney General, may be authorized to take action.

Another source of restrictions are those found in the basic organizational documents of the charity such as Article of Incorporation, Bylaws, and the application for tax exempt status filed with the Internal Revenue Service. Does the donation and its restrictions fall within the stated purposes of the charity? Note, for example, that tax regulations generally restrict political action by a tax exempt nonprofit entity. The IRS has information on its Website. Again, this is a detailed topic beyond the scope of this brief comment.

Tax issues abound in all charitable giving and require detailed professional analysis. If the donor receives something in return for the gift, the charitable deduction is reduced accordingly and may be eliminated altogether. The basic rule is that a tax deduction is allowable as a "charitable contribution" if the gift is "to or for the use of" an IRS recognized tax exempt charity [26 U.S.C. Sec. 170(c)]. From this basic concept comes broad standards that prevent the taxpayer or a taxpayer designated individual from personally benefiting from the gift. For example, one might donate money to a college to pay the tuition of a grandchild. This form of earmarked gift with the donor seeking to make the charity or nonprofit a conduit is generally not tax deductible. In contrast, if the nonprofit, through the unimpeded exercise of discretion, selects the recipient of the donated funds, this may be allowable. The charity itself risks its tax exempt status if it operates for private benefit. Obtain expert advice.

Earmarking problems may also occur when the gift is to be transferred by the charity to a non-charitable entity. The charity must have complete discretion and control over the use of all donated funds for the donor to receive a charitable tax deduction. Best practice is for the charity to have a preexisting relationship with the non-charitable entity, perhaps, for example, providing funds for educational seminars.

In like manner, a variety of tax questions surround partial transfers of ownership or a contribution of property that a taxpayer retains a right to use. Additionally, without reversionary language in documents such as deeds or contracts, the gift may be irrevocable. In fact, simply returning an irrevocable gift may in itself create tax issues for both the charity and the original donor. Consult a tax expert.

Conditioning a gift upon a future event may prevent a charitable tax deduction unless the possibility that the gift transfer will not occur is "so remote as to be negligible" [26 C.F.R. Sec. 20.2055-2]. Restrictions generally may reduce the fair market value of the gifted property and hence the amount of the allowable charitable deduction.

Note that IRS rules address the deductibility of gifts to a U.S. charity that in turn provides funds to foreign grant recipients. Such actions may trigger both tax exemption and anti-terrorism legal issues. Violations of criminal law may occur. A properly structured "friends of" organization must not merely be a conduit for the foreign entity. Independent control and discretion by the U.S. charity are key factors. This area, as do all tax matters, requires expert consultation.

Private foundations must consider tax issues when making grants to individuals for travel, scholarship, and study. Does the granting process have objective standards that are followed in a nondiscriminatory manner? A variety of reporting is required.

A donor advised fund allowing a donor to make non-binding recommendations, or a provision in the granting document that specifies another charity to receive the gift under specified circumstances (a gift over provision) may allow some measure of donor control while preserving tax deductions.

Special tax considerations surround "deputized fundraising" under which a religious organization may make staff members responsible to raise support for their ministries. In broad and incomplete overview, the IRS requires that the religious body control the donated funds in a budget process and that salaries be paid without reference to amount of money that an individual raises. Be alert to conduit issues and obtain expert advice. Crowdfunding has similar issues and must be carefully structured if donors desire a charitable donation tax deduction.

This comment provides a brief and incomplete educational overview of a complex topic and is not intended to provide legal advice. Always consult experienced legal, tax, and accounting professionals in specific situations.