On March 1, The San Francisco Foundation presented, as part of its Professional Advisor Seminar Series, Donor Restrictions – What Will Your Clients Think of Next, featuring Erik Dryburgh, a highly respected attorney with Silk, Adler & Colvin.  Erik focused both on donor issues and charity issues with respect to restricted gifts.  Here are some of the key points from this excellent seminar:

Donor Issues

• Gifts or partial interests in property are generally not deductible (exceptions include a remainder interest in a CRT, a remainder interest in a personal residence or farm, and an undivided portion of a donor’ s entire interest in property).
• The charitable deduction rules from a gift tax perspective are slightly different than those from a federal income tax perspective.
• The charitable deduction rules from a state income tax perspective may be different than those from a federal income tax perspective.
• Incomplete gifts are not deductible.  A donor’s retention of control over a contemplated gift may cause the gift to be incomplete for purposes of the charitable deduction, particularly if there is the possibility of a reversion back to the donor.
• A gift with a condition subsequent may not be deductible if such condition subsequent may result in defeating the gift remaining with a charity.  If, on the date of the gift, the possibility of some act or the happening of some event that would defeat the gift remaining with a charity is not so remote as to be negligible, the gift is not deductible.
• Restrictions on the gift may affect its valuation (i.e., they may reduce the amount of the charitable deduction).  For example, a gift of a patent subject to a restriction that the recipient charity may not sell such patent for three years probably should lower its fair market value without such restriction (based on the willing buyer – willing seller test).
• A gift to a charity acting as a conduit to allow the gift to benefit specific individuals is not deductible.  The recipient charity must have dominion and control over the gift and its ultimate disposition.  Moreover, the gift must benefit a charitable class rather than specific individuals ("charity begins where certainty in beneficiaries ends").  However, there are grey areas.  For example, a donor might state in the gift instrument (will, deed, letter, etc.) that the donor recognizes that the charity has full dominion and control over the gift but expresses an interest in seeing the gift benefit X, a member of the charitable class served by the charity.
• A gift to a charity that results in a return benefit to the donor may not be entirely deductible.  If the return benefit is substantial, the gift may not be deductible at all.  If the return benefit is nominal, the transaction may be bifurcated into a gift component and purchase component.  The gift component is contingent upon the donor intending at the time of the transaction that he or she is making a gift (i.e., that he or she is intentionally giving to the charity more than the fair market value of the return benefit).  There is no deduction where the donor receives or anticipates receiving a substantial benefit in return.  See Ottawa Silica Co. v. U.S., 669 F.2d 1124 (Fed. Cir. 1983).

The charity also must deal with issues related to a donor’s restrictions …

Charity Issues

• The charity may find that the restrictions cause the gift to be unusable.  For example, a gift might be made restricted to the establishment of a scholarship endowment fund to provide scholarships to students who are orphans for enrollment in nursing or pharmacy school.  The intended charitable class eligible to receive such scholarships may be so small that the charity may find that the gift is unusable.  If the donor is no longer able to consent to modification of the gift, the inability to use the gift may require the charity to go to court to loosen the restrictions (e.g., cy pres action).
• The donor restrictions may become outdated.  This is particularly true in the case of an endowment gift (perpetuity is a long time).  The recipient charity should be given variance powers to modify any restrictions that become impracticable or would otherwise defeat the charitable intent of the donor (perhaps requiring a supermajority vote of the board authorizing use of the variance powers).
• The donor restrictions may create fiduciary duty problems for the charity’s board.  If the restrictions include certain requirements with respect to the investing of the gift, such requirements may be inconsistent with the board’s prudent investor duties (but see Cal. Corp. Code sec. 5240(c), which relieves a board of a nonprofit public benefit corporation of its prudent investor duties in such cases).  In substantiating a gift, what should be reflected on the written acknowledgment where the gift results in an indirect substantial benefit to the donor or is subject to restrictions that would lower its value?  The charity should remember not to value a non-cash contribution but to describe it fully, including all of the restrictions.
• A donor restriction requiring that a facility, program, award or other item be named after a certain individual may result in public relations damages if the named individual becomes associated with a scandal or a cause in opposition to the charity’s mission.  A charity would be wise to have a naming and unnaming policy in place.
• An endowment gift in California is subject to the Uniform Management of Institutional Funds Act (UMIFA).  The Act describes among other things what part of the endowment fund can be spent.  The spending limitation can cause a problem in a down market where any expenditures may be disallowed.  If the donor expects the endowment to provide consistent funding to a given project or program, a down market can quickly defeat this purpose.

In conclusion, Erik suggested that a donor might want to include the following provisions in a gift instrument to both (1) protect the donor’s interests, and (2) preserve the charity’s ability to make the best use of the gift:

• An introductory paragraph expressing the donor’s affection or appreciation of the charity and the donor’s intent to make the described gift to the charity.
• An acknowledgment of the charity’s practices, policies and fees, but allowing the charity the flexibility to change such practices, policies and fees.
• A provision requiring the charity to use the funds to do a specific thing.
• A provision stating that if the charity does not do the specific thing required that the charity grant the money to another charity that will.
• A provision giving standing to the donor to enforce the gift instrument.
• A provision granting variance powers to the charity which may be exercised if any of the donor restrictions causes furtherance of the donor’s charitable intent to become impossible or impracticable.

I would be remiss not to mention that prior to Erik’s discussion, San Francisco Foundation program officer Arlene Rodriguez delivered an eye-opening discussion of the Foundation’s Environment Program, including its Environmental Health and Justice Initiative.