Community Foundations

Q1: What is a community foundation?

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This is part of "What Every Grantmaker Should Know & Frequently Asked Legal Questions."

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Community foundations come in many forms, but in general terms, they are collections of charitable funds administered by a single board that is representative of the general public. Most, but not all, community foundations focus on a particular geographic area. Community foundations are both fundraising and grantmaking organizations, and they avoid private foundation status by virtue of the fact that they receive broad public support. Each fund of a community foundation generally must be subject to a "variance power," which allows the governing board to modify fund restrictions under certain circumstances.

Q2: What is the "variance power"?

Most community foundations require that each fund be subject to a power of the governing board (usually found in the articles of incorporation or bylaws of the foundation) to modify any restriction that limits the fund to a particular purpose or for a particular organization if, in the sole judgment of the governing board, the restriction becomes unnecessary, incapable of fulfillment or inconsistent with the charitable needs of the community or area served. Donors should be made aware of this power, and it must be exercised judiciously.

Q3: How does a community foundation differ from a private foundation?

Because it is not classified as a private foundation, a community foundation is not subject to the tax on investment income that applies to private foundations, nor to the rules that apply to private foundations regarding self-dealing, required distributions, excess business holdings, risky investments or taxable expenditures.

Community foundations are permitted to engage in a limited amount of lobbying (see Lobbying Q6). Contributions to community foundations under certain circumstances receive more favorable tax deduction treatment than contributions to private foundations.

Q4: What is a "material restriction"?

A fund intended to be part of a community foundation may instead be treated as a separate entity (and therefore classified as a private foundation that must obtain its own tax-exempt status and file its own tax return) if it is subject to a "material restriction." A material restriction is a restriction imposed by the donor that allows the donor to have some continuing control over the fund.

Examples of material restrictions are the donor's right to designate the recipients of grants from the fund, to direct the investment of the fund assets, or to change the purposes of the fund. The donor's irrevocable designation of a particular beneficiary or purpose for the fund, however, is not a material restriction if it is done at the time of the gift.

Q5: What are the different kinds of funds that community foundations offer?

Most community foundations maintain both endowment and non-endowment funds. One very popular type of fund is the donor-advised fund, in which the donor or another designated person has the right to make recommendations to the community foundation regarding grants from the fund. These recommendations are not binding on the community foundation (if they were, the fund would be subject to a material restriction), but allow the donor to maintain involvement with the fund after his or her gift.

Other common fund types include funds that are designated for particular beneficiary organizations or particular charitable purposes, and so-called "agency funds," which are established when a charitable organization hands over its own assets to the community foundation, to be administered for the benefit of the organization.

Q6: Are donor-advised funds required to pay out a certain amount each year?

No, not at the time of publication of these Frequently Asked Questions; however, the Pension Protection Act of 2006 directs the Treasury Department to study this issue and make recommendations about a mandatory distribution requirement. From time to time, proposals have been circulated to amend the law to require a certain minimum distribution annually from donor-advised funds, but no such legal requirement currently exists. Some community foundations have voluntarily adopted a policy of distributing a specified percentage of a fund's assets each year.

Q7: Are there any special limits on grants or other payments from donor-advised funds?

Yes. Donor-advised funds are not permitted to make grants to individuals. Grants to private foundations and non-charitable organizations require "expenditure responsibility" (see Grantmaking Q7), as do grants to certain kinds of "supporting organizations" (see Private Foundations vs. Public Charities Q1).

Donor-advised funds also must not make grants that result in a benefit to the donor or a related party (such as a "thank-you gift") that is more than "incidental." Payment of compensation or loans to a donor or related party is prohibited.

Not all funds that involve an ongoing role for donors are "donor-advised funds" for purposes of these restrictions. For example, certain funds with multiple donors or a single beneficiary are excluded.