"Fund” or “Foundation”

Structural Considerations for Congregational Endowments
Dan C. Mohn
Assistant Vice President, Program Development
with editorial assistance by
Carolyn Allen
Assistant General Counsel
Presbyterian Church (U.S.A.) Foundation
1999

This paper is presented as a Foundation resource for the exposition of various legal and technical issues related to endowments, but is not intended as legal advice. Readers are cautioned to seek the guidance of professional advisors in the areas of nonprofit law and taxation as appropriate.


“Fund” or “Foundation”:

Structural Considerations for Congregational Endowments

Throughout the history of the Christian church the accumulation of wealth in the hands of religious institutions – and particularly, in the hands of congregations as the localized bodies for worship and administration – has been a controversial topic. And yet, in the face of occasional theological opposition, and both political and legal constraints, thousands of faithful church members have chosen to make charitable gifts to further their religious beliefs through perpetual endowments of Church mission. Today, the endowment of congregations is a significant component of the financing of congregational mission and outreach.

Tensions can emerge as a congregation wrestles with the economic, administrative, and philosophical or theological issues of endowments. To a considerable extent, these tensions can be tied to structure – the “who” and “how” of endowment administration. It has been reported that,
“In one conversation a trustee said, ‘We are the savers. You can’t trust the Session – all they want to do is spend.’ That may exaggerate the issue, but it does dramatically point to the tension we found in each congregation... We sensed that this may well be a built-in tension that needs to be managed, not solved.”

The Book of Order provides that all assets held by or for a particular Presbyterian church, Presbytery, Synod, the General Assembly or the Presbyterian Church (U.S.A.) are truly held in trust for the use and benefit of the denomination. Within this framework, several structural alternatives for the administration of church endowments are available to local churches, including:

  • Establishment of a segregated endowment fund (or pool of funds) within the existing governance and control of the church’s board
  • Creation of a separate legal entity (usually a trust or corporation) to operate as a “foundation” or “supporting organization” within the meaning of IRC 509(a)(3), benefitting the congregation
  • Creation of a “supporting organization” within the meaning of IRC 509(a)(3) by one, or a few, donors
  • Use of a the Presbyterian Church (U.S.A.) Foundation or a local “community foundation” to receive, hold, and administer earmarked component funds designated for the benefit of the congregation.

In the sections that follow, each structural option will be discussed in light of some of the legal and tax-related considerations for those church leaders charged with planning and administration.

Internally-administered endowment fund

The most commonly-used mechanism for holding and administering an endowment (defined here to include all funds held for long-term purposes, whether restricted or unrestricted, is to create a segregated fund, or group of funds, within the existing governance structure of a church. Such an endowment fund will be accounted for separately from other church funds and administered in accordance with policies and guidelines set by the governing board. While day- to-day administration and oversight may be delegated to a committee, final authority all matters related to an endowment remains clearly in the hands of the governing board.

Development of an internal endowment fund presents the following attractive features for a church:

  • Creation of available operating subsidies for the church
  • Creation of independence from economic and political forces
  • Improvement of church balance sheets.

Additionally, “an endowment can serve the present generation as a means of insuring that its values will be passed on to the next generation.”

In the perspective of these reasons for developing endowments, the advantages of an endowment structure which is internal to the existing church governing body become obvious. First, there is organizational simplicity – no new corporate entity is necessary; authority is consolidated under existing elected or appointed leadership; assets are accounted for in the broader context of the church’s total asset base.

Second, as a component activity within the overall structure and operations of the church, the endowment fund is exempted from the requirement file an application (Form 1023) for recognition of exemption from income taxation and is generally not required to file annual information returns (Forms 990) with the Internal Revenue Service, unless they have income from unrelated trade or businesses. “Passive” sources of income such as interest and dividends on invested endowments are not “unrelated business income”. variations and exceptions, see “Uniform Management of Institutional Funds Act: 1972 Act.” (1994) Uniform Laws Annotated, Volume 7A: Business and Financial Laws. (pp. 705-727). St. Paul, MN: West Publishing Company.

Third, keeping the endowment as a component entity of the church provides the church with the opportunity to minimize and manage structural tensions associated with endowment funds. An endowment committee which is part of and accountable to the church’s governing body should presumably share the larger body’s sense of mission and vision, perspectives and priorities for use of endowment funds.

Finally, most regulation of general endowments occurs at the level of state statutes; in the past two decades, a high degree of consistency in regulation has emerged as most states have adopted the Uniform Management of Institutional Funds Act (UMIFA) in substantially- unmodified forms. UMIFA, as well as many state non-profit corporation statutes, articulates a rather forgiving “normal business prudence” standard of fiduciary responsibility for church boards.

There are several perceived disadvantages to this model of endowment administration. First, the potential tension between the governing body and endowment committee is between spending and investing. Church governing boards have a tendency to optimize short-term results, while an endowment committee may take a more long-term view towards investment goals and use of endowment funds. Second, the governing board may not have sufficient expertise among its membership in the areas of investment management or fundraising. Third, the existing governing board may need to allay the concerns of potential or current donors regarding the responsible management and use of previous gifts. If perceptions of “breach of trust” are directed at the “institution” of the governing board (whether or not the incumbents are the perpetrators of such breaches), the suspicions can be mitigated through the creation of a new institution and power center. Finally, the governing board’s decision to treat a legally unencumbered gift as quasi-endowment cannot bind the fund in perpetuity; future board action can allow for the invasion of quasi-endowments.

Establishment of a separate foundation

Alternatively, a church may choose to establish a separate legal entity, a trust or an incorporated foundation, to receive and administer gifts that further the congregation’s mission. The foundation presents the following attractive features:

  • An organization which utilizes the legal and professional skills of trustees with investments, accounting, and planned giving
  • A clear accounting “firewall” which minimizes the likelihood of commingling of endowed or restricted funds with current operating accounts
  • A system of audit checks and balances and external oversight to assure the integrity of gift restrictions
  • An alternative fundraising program not in conflict with other church solicitations
  • An element of status or institutional “cachet”

The separation of endowment activity into a distinct receiving entity, however, creates numerous legal and regulatory concerns that will require management at the outset and on an ongoing basis.

First, the new legal entity must be recognized by the IRS as a tax-exempt organization and be qualified to receive tax-deductible gifts under IRC 501(c)(3). Obtaining IRS recognition of tax-exempt status can be difficult. A foundation with the primary purpose of holding, investing and distributing endowment funds will most likely not qualify as a ”church” under IRS regulations in order to claim the automatic tax-exemption available to churches. Form 1023 must be filed with the IRS, including a user’s fee, to establish alternative reasons for recognition as a tax-exempt organization.

The endowment-holding foundation may be able to obtain recognition vicariously, or by association, through one of two methods. First, the foundation may seek recognition as a subordinate organization under the “blanket exemption” provisions, requiring a “parent” exempt organization to certify that the “subordinate” operates on an ongoing basis for purposes that are consistent with the mission and rationale for exemption of the parent, that the “subordinate” remains under the control of the “parent”, and that the “subordinate” operates on the same fiscal year as the “parent”. Since many congregations obtain their own tax exemptions under the blanket exemptions of their denomination, then the congregation’s foundation exemption would necessarily be derivative only from the denomination, which could permit omissions and failures of accountability from year to year.

Additionally, the foundation may be able to gain recognition as an “integrated auxiliary” of a church. To qualify as an integrated auxiliary, the organization must be:

  1. Described both in sections 501(c)(3) and 509(a)(1), (2), or (3);
  2. Affiliated with a church or a convention or association of churches;
  3. Internally supported.

Affiliation is further defined in terms of coverage under a group exemption letter; operation, supervision, and control by a church or group or convention of churches; or relevant facts and circumstances. The “facts and circumstances” test delineates a number of indicia of affiliation, including governing instruments, power to appoint and remove trustees/officers, common names, and annual reporting to the parent.

Neither form of “derivative” recognition of tax-exempt status is automatic. Form 1023 must be filed and the church should also be aware that either status might impose an unanticipated risk of liability upon the church under state law.

Second, a foundation must file an information tax return annually with the IRS, either on Form 990 or 990PF. While churches, their integrated auxiliaries, and conventions or associations of churches are granted statutory exemption from the filing of annual returns, other organizations may be granted exception from the annual-filing requirements only at the discretion of the IRS, if the filing is not considered essential to the proper administration of the tax laws. This filing requirement will impose administrative and accounting burdens as an ongoing cost of doing business as a foundation.

Third, tax exemption does not automatically connote status as a “public charity”. An organization granted tax exemption under IRC 501(c)(3) will be considered a private foundation, subject to a variety of rules and restrictions, unless it can establish that it is established and operated as a “public charity”. Some public charities obtain their status by virtue of their primary function, including churches, educational institutions, endowments operated for certain state and municipal colleges, and governmental units. Other public charities, including those organized for the promotion of religion but not functioning as a church, obtain their status based upon a public support test.

There are two ways to fulfill the public support test: the one-third support test and the facts and circumstances test. The one-third support test requires that the organization normally receive at least one-third of its total support from government or public contributions. The implication of the one-third support test, in the context of a congregational foundation, is that the organization cannot be assured of obtaining and sustaining public charity status if it is not able to cultivate steady and significant gifts from the public.

The facts-and-circumstances test is a more forgiving means of attaining public charity status. As stated in Publication 557, “[to] qualify, an organization must meet the ten-percent-of-support requirement and the attraction of public support requirement.” The requirement that the organization must attract public support is defined as follows:

An organization must be organized and operated in a manner to attract new and additional public or governmental support on a continuous basis. An organization will meet this requirement if it maintains a continuous and bona fide program for solicitation of funds from the general public, community, or membership involved, or if it carries on activities designed to attract support from governmental units or other charitable organizations... Consideration also will be given to the fact that an organization may, in its early years of existence, limit the scope of its solicitation to persons who would be most likely to provide seed money sufficient to enable it to begin its charitable activities and expand its solicitation program.

For purposes of meeting either the one-third support or facts-and-circumstances tests, the congregational foundation can boost its support fraction by transferring funds from the church to the foundation.

The public support test must be met from year to year. The foundation may fail to meet the public-support test for a particular year and still retain its recognition as a public charity if it “normally” meets either support test. “Normally” is defined, by the IRS, in the following terms:

Both support tests are computed on the basis of the nature of the organization’s normal sources of support. An organization will be considered to have normally met both tests for its current year and the tax year immediately following, if it meets those tests on the basis of the total support received for the 4 tax years immediately before the current tax year.

Endowment foundation managers must assert some vigilance to assure that they are encouraging and developing gift revenues from a variety of sources, particularly if the majority of the foundation’s gross receipts are coming from investment income. And the primary sources of gift revenue should not be focused in the hands of “a person (or related person) who is in a position of authority, such as a foundation manager, or who otherwise has the ability to exercise control over the organization.”

There are several disadvantages to this endowment model. If a foundation is classified as a private foundation rather than as a public charity, the following disadvantages apply to the foundation:

  • charitable gifts of cash by donors could be deducted on income-tax returns subject to a ceiling of 30% of adjusted gross income rather than 50%; for capital-gain assets, the ceiling would be 20% rather than 30% of AGI
  • the value of gifts of appreciated assets would be deductible at adjusted cost basis rather than full fair market value
  • the foundation would become subject to a 2% excise tax on investment earnings each year (1% if the foundation expends at least 6% of its net assets)
  • the foundation must annually distribute an amount equal to 5% of the value of the noncharitable assets of the foundation
  • foundation managers and other “disqualified persons” (including major donors and their families) may be subject to stringent self-dealing rules.

Trustees of a congregational endowment should exercise great care to qualify the entity initially as a public charity, and to systematically monitor the conditions which would affect its continuing qualification as such. Two affirmative steps will be helpful: (1) establishment of a governing body which is widely representative of the congregation, not just those individuals who are (or are related to) principal donors; and (2) development, documentation, and active promotion of an ongoing solicitation effort to generate new additions to the endowment corpus.

There is some risk of loss of governance control with a separate foundation, if its governing instrument may not require sufficient linkages, for instance by appointive power of trustees, by requirement of annual accountings and distributions, or by requirement that the foundation’s assets are held for the benefit of the congregation and default to the congregation in the event of dissolution of the foundation.

Additionally, there may be very real difficulties in the transfer of existing endowments to a separate foundation beyond the control of the church governing body. For instance, if a donative instrument created a true trust and the church is the designated trustee, court action may be required to appoint the foundation as a successor trustee. In light of the provision in the Book of Order that all funds held by or for a local Presbyterian church are really held in trust for the Presbyterian Church (U.S.A.), transfer of an endowment to a separate foundation could also be construed as a breach of the church’s fiduciary responsibility on behalf of the entire Presbyterian denomination.

The supporting organization

Occasionally a congregation will have an opportunity to establish a significant endowment through the initiative and generosity of one (or a few) donors. The donor may want to assure some external oversight and voice in the charitable utilization of the gift or its income, or may want the corpus of the gift to be designated for the benefit of more than one organization, including some whose mission may be incompatible with the congregation’s mission. Establishment of a private foundation would subject the funds to the regulatory provisions previously cited (mandatory minimum distributions, excise tax on investment earnings, self- dealing rules, etc.). A potential solution is to establish a “supporting organization” as described in IRC § 509(a)(3), meeting these requirements:

  1. The organization must be organized and at all times thereafter operated exclusively for the benefit of, or to perform the functions of, or to carry out the purposes of one or more specified organizations ... commonly called publicly supported organizations.
  2. The organization must be operated, supervised, or controlled by or in connection with one or more of the organizations described in section 509(a)(1) or (2).
  3. The organization must not be controlled directly or indirectly by disqualified persons... other than foundation managers and other than one or more organizations described in section 509(a)(1) or (2).

A supporting organization must fulfill an “operational test” demonstrating that it is serving the exclusive interests of the public charities named in its governing instrument.

A supporting organization

  • provides the same increased charitable deduction ceiling as a public charity
  • allows a single donor to “jump-start” an endowment for the congregation with a single large gift
  • is not subject to the potentially onerous “public support” test applicable to a public charity
  • provides for (in fact, requires) participation in governance by the congregation’s governing board
  • is not subject to the multiplicity of private foundation regulations
  • may accumulate earnings for a number of years in anticipation of achieving some future purpose. There are some pragmatic and policy disadvantages to a supporting organization, from the standpoint of the congregation’s governing body. A few of the potential disadvantages which must be considered are:
  • the governing instrument may be designed and dictated solely by the donor, without consultation and input by the congregation’s governing body
  • the governing instrument may skew control of the selection of the congregation’s representatives (on the supporting organization board) into the hand of the donor or his/her successors
  • the supporting organization may designate (or withhold) its distributions as a means of coercing certain actions/initiatives of the congregation or stifling legitimate activities.

Presbyterian Church (U.S.A.) Foundation

The Presbyterian Church (U.S.A.) Foundation offers other options for churches seeking to establish endowment funds but not wanting to keep daily administration, investment and management responsibilities internal to the church congregation. The Presbyterian Church (U.S.A.) Foundation is a qualified IRC 501(c)(3) organization offering traditional life income gift vehicles to donors, such as gift annuities, charitable remainder trust and pooled income funds. These types of funds will provide income for life to the donor and a remainder interest for the benefit of the church. The Foundation offers Donors the ability to establish a “donor advised fund” within the safe-harbor provisions issued by the IRS, which permits the Donor to give non- binding advice to the Foundation concerning the amount and suggested recipients of fund distributions. The Foundation also provides an opportunity for Donors to establish permanent funds to benefit a church or other organization, providing the opportunity for the Donor to restrict the use of the funds or leave the use of such an endowment to the sole discretion of the church governing board. Additionally, the Foundation offers investment management services for churches with their own endowment funds, allowing the church to delegate the day to day administrative and investment activities to the Foundation and providing the church with necessary information to track and monitor the performance of the Foundation in fulfillment of the ongoing fiduciary responsibilities of the church with respect to the endowed funds.

The advantages of using the Presbyterian Church (U.S.A.) Foundation as a resource, for endowment administration services, or for investment management services include:

  • service in a fiduciary capacity for life income gifts
  • access to a wide variety of giving techniques
  • access to a higher degree of administrative, investment, and distributional expertise than the congregation may have internally
  • assistance with identification and cultivation of potential donors
  • consistent and widely-available policies and guidelines for acceptance and administration of gifts and funding objectives
  • a degree of external oversight of the uses of restricted gifts
  • professional gift-development resources, including deferred giving instruments, training and education of endowment committee members, and access to professional marketing and promotional materials
  • periodic reports of fund assets and performance
  • variance power, as delineated in the governing instrument, to modify restrictions of a specific gift when the charitable purpose or specified charitable organization no longer exists
  • elimination of the need to qualify the “component fund” (i.e., the fund earmarked for the benefit of the congregation) for recognition as a tax-exempt entity.
  • investment management services
  • contributions qualify for higher charitable deduction limitations granted to public charities

Churches choosing to utilize the services of the Foundation for the administration and investments of life income plans ultimately benefitting the church or for permanent funds benefitting the church need to recognize the potential for confusion among potential donors, as gifts need to be made directly to the Foundation for the benefit of the church, rather than to the church directly. The church, working with the Foundation’s Development Officers, needs to communicate clearly the mission of the Foundation and the role it plays in the charitable giving program of the local church. Another potential disadvantage for a church utilizing the administrative services of the Foundation is the loss of immediate control and decision making power available to a church that administers its endowment funds internally.

Community foundations

The final structural alternative commonly available to congregations seeking to establish endowments is to utilize a community foundation. A “community foundation” or “community trust” generally is described as one which is “established to attract large contributions of a capital or endowment nature for the benefit of a particular community or area”. A community foundation, while operating as a single entity under a single governing instrument, may receive and hold any number of separate funds or trusts, as long as those component funds are administered subject to the governing instruments of the community foundation. Component funds may be earmarked for the benefit of a particular public charity (such as the congregation), and they may bear purpose restrictions, as long as those restrictions do not constitute a material degree of retained control by the donor.

The advantages of utilizing a community foundation to administer an endowment for the benefit of a congregation are very similar to the advantages enumerated above in connection with utilizing the Presbyterian Church (U.S.A.) Foundation for endowment administration.

Once a community foundation is recognized as such, donors may rely on that recognition until public notice to the contrary from the IRS. That assures that an individual’s single endowment gift (and attendant restrictions) will not be treated as a contribution to a private foundation.

There are some disadvantages to the use of a community foundation for accumulation of the congregation’s endowment. As with use of the Presbyterian Church (U.S.A.) Foundation, donors may face some confusion as they must make their gift to the community foundation for the benefit of the church, rather than making the gift directly to the church.

Second, the congregation’s governing board cedes some control of the resources which are ultimately directed to its mission when it encourages donors to route their endowment gifts through a community foundation. The gift instruments used by the community foundation to receive donors’ restricted gifts must clearly indicate that the foundation has the power to modify any restriction or condition on the distribution of funds for any charitable purposes or to specified organizations if in the sole judgment of the governing body (without the necessity of the approval of any participating trustee, custodian, or agent, the restriction or condition becomes, in effect, unnecessary, incapable of fulfillment, or inconsistent with the charitable needs of the community or area served...

A third disadvantage to use of a community foundation for a congregation’s endowment is that the donor or beneficiary congregation may lose some flexibility in naming contingent or successor charitable beneficiaries. If the particular church entity ceases to exist, no longer has a presence within the defined geographical service area, or no longer meets the denominational or other common bond which defines the “community”, the trustees of the community foundation may exercise their variance power in ways the donor did not expect. This disadvantage may be mitigated by anticipating and negotiating clear contingency provisions that are mutually acceptable.

A final disadvantage in the use of a community or denominational foundation is that the congregation is not assured of direct representation and voice in the governing board of the foundation. Thus, the congregation’s leadership will be wise to assure itself that the governing board of the foundation is representative of the wide diversity of views, philosophies, and commitments that define the “community” which the foundation seeks to serve.

Conclusion

For the congregation which seeks to establish and build an endowment, the task is not simply one of identifying and articulating the need, vision, and opportunity. Structure counts!

The organizational model chosen for the endowment will have immediate and long-term impact on the degree of regulation, as well as the potential achievements of the endowment. Further, structural considerations will be influenced by the expectations for and by initial donors. And the participation of donors in the long-term governance and administration of the endowment will be limited by the specific model chosen.

All organizations face structural tensions – especially when structures interface with money. Some of those structural tensions are unanticipated consequences of a history long-writ. The congregation that desires to have a healthy endowment – one that is both financially blessed and accepted as a positive force for long-term mission – would do well to understand the legal and regulatory aspects of their structural choices for the endowment fund, and to make proactive decisions that anticipate the future for the congregation and its most generous members.

References
Adler, Betsy Buchalter and Gregory L. Colvin. “Structuring charitable and philanthropic organizations,” in Fuerst, Rita A. ed., What fundraisers need to know about state and federal regulation: How it can influence all aspects of their work. New Directions for Philanthropic Fundraising, No. 13, Fall 1996. San Francisco: Jossey-Bass, Inc., 1996. 3- 16.

Hammar, Richard R. Pastor, church, and law - Second edition. Matthews, NC: Christian Ministry Resources, 1991.

Hansmann, Henry. “Why do universities have endowments?”. Journal of Legal Studies, vol xix. Chicago: The University of Chicago. 1990. 3-42.

Hoge, Dean R. and Loren Mead. Survey of Endowed Presbyterian Churches. Wilmington, DE: National Association of Endowed Presbyterian Churches, 1995.

Hopkins, Bruce R. The law of tax-exempt organizations, Seventh Edition. New York: John Wiley & Sons, 1998.

Internal Revenue Code of 1986.

Massy, William F. (1990). Endowments: Perspectives, policies & management. Washington, D.C.: Association of Governing Boards of Universities and Colleges.

Miller, Lisa. “Rev. Chesnut’s Lot: A Wealthy Church and Plenty of Critics.” Wall Street Journal, July 6, 1998.

“Uniform Management of Institutional Funds Act: 1972 Act.” Uniform Laws Annotated, Volume 7A: Business and Financial Laws. St. Paul, MN: West Publishing Company, 1994. 705-727.

United States. Dept. of Treasury. Internal Revenue Service. Regs. Sec. 1.507-2(a)(7),(8).

United States. Dept. of Treasury. Internal Revenue Service. Rev. Proc. 80-27, 1980-1 C.B. 677.

United States. Dept. of Treasury. Internal Revenue Service. Rev. Rul. 78-95, 1978-1 CB 71.

United States. Dept. of Treasury. Internal Revenue Service. Tax-Exempt Status for Your Organization (Publication 557). Washington: GPO. [Internet version, 1998].

United States. Dept. of Treasury. Internal Revenue Service. Tax guide for churches and other religious organizations (Publication 1828). Washington: GPO, 1994.

United States. Dept. of Treasury. Internal Revenue Service. T.D. 8640, 26 CFR Part 1.

Williams, Kenneth D. “Financial statements prove accountability.” In Fuerst, Rita A. ed., What fundraisers need to know about state and federal regulation: How it can influence all aspects of their work. New Directions for Philanthropic Fundraising, No. 13, Fall 1996. San Francisco: Jossey-Bass, Inc., 1996. 99-114.

Please note that these are all samples and should not be used without careful review.

This is not intended to be legal, financial or accounting guidance but as a guide for the church to write its own material according to your local needs and restrictions. Please refer to your own accountant or attorney for accounting and specific legal counsel.