New Rules for Not-for-Profit General Partners of Low-Income Housing Tax Credit Partnerships

IRS updated its prior guidance for Not-for-Profit organizations that serve as general partners of low-income housing tax credit partnerships, and want to obtain IRS exempt status.  The guidance, in the form of a memorandum from the head of the Exempt Organizations Rulings and Agreements division of IRS, requires the following:

Applications for exemption must include a description of the proposed activities, and how they further the organization's exempt purpose:

Although exemption can be granted prior to completion of a final partnership for LLC agreement, the agreement should be sent to the IRS when it is completed.  The applicant for exempt status should have a conflict-of-interest policy, and the agreement should protect the not-for-profit's assets by limiting its liabilities through:

• reviewing an independent phase 1 environmental report,

• entering into a fixed-price contract that is bonded or has similar guarantees,

• limiting operating deficit guarantees to no more than five years from breakeven,

• limiting tax credit adjuster payments to the amount of developers' and similar fees,

• incorporating a right of first refusal that allows the not-for-profit to acquire the project at the end of the compliance period for a reasonable price,

• limiting the not-for-profit repurchase obligation to the amount of investor capital contributions, and assuring that the not-for-profit may not be removed as general partner, except for cause, and after written notice and a reasonable cure period have been provided.

New Rules for Donor Advised Funds
Donor Advised Funds (DAF) are very popular today, but the rules are becoming more complex.  A DAF is simply an account (usually named after the donor) created by a public charity, such as a community foundation, to which a donor makes a contribution.  The sponsoring organization thereafter has legal ownership of, and control over, the transferred property.  DAFs are popular because they allow donors to retain a say in the use of gifted property without incurring the expense and hassle associated with setting up and maintaining a private foundation.  In addition, its attraction also stems from the fact that a contribution to a DAF is deductible under the contribution rules applicable to a public charity rather than the less favorable contribution rules applicable to a private foundation.

Although not legally bound to follow advice or suggestions by the donor, the sponsoring organization will generally try to do so in order to maintain a positive relationship with the donor.  The sponsoring organization generally charges a fee for maintaining the DAF.  Upon termination, typically assets remaining in the DAF transfer into the sponsoring organization’s general fund.  Termination usually occurs at the end of a specified period of time or upon a specified event (such as the donor’s death).

Under the Pension Protection Act of 2006 (and the regulations soon to follow) tighten the rules governing DAFs. Under the new rules, a DAF must be separately identified by reference to contributions of a donor or donors, owned by a sponsoring organization and expected to provide a donor (or his or her designee) certain advisory privileges regarding the distribution or investment of fund assets by virtue of being the donor.  Let’s look at the two primary parts of this new definition through an example.  Suppose your organization creates a fund dedicated to fighting child abuse in your community.  Your fund attracts contributions from several donors but doesn’t separately identify or refer to contributions of a donor or donors.  Your fund, in this case, will not be considered a DAF even if donors are given advisory privileges.  However, even if your fund is separately identified, the mere provision of advice isn’t evidence of advisory privileges.  Just because a donor believes he or she has advisory privileges isn’t sufficient to create them.  There must be some reciprocity by your organization.  If your donor or donors regularly provide advice and your organization considers it, then advisory privileges is created.

The new rules go on to outline what is not allowed in regards to DAFs.  A DAF doesn’t include any fund or account:

• that makes distributions to only a single identified entity; or

• for which the donor or donor designee advises about which individuals receive grants for travel, study, or other similar purposes, provide (1) the privileges are exercised exclusively as a member of a committee all of whose members are appointed by the sponsoring organization; (2) no combination of donor and donor designee (or related persons) control the committee, directly or indirectly; and (3) all grants from the fund are awarded on an objective and nondiscriminatory basis under a procedure, approved in advance by the sponsoring organization’s board of directors, that is designed to ensure that all grants meet the requirements governing private foundation grants to individuals.

Under the single entity exception, a donor is permitted to have advisory privileges regarding the distribution or investment of amounts in a fund established at a college or university for exclusive support of its activities.

Taxes on Prohibited Benefits
If a DAF’s distribution results in “more than an incidental benefit” to certain persons, two taxes can be applied.  First, a tax equal to 125% of the amount of the benefit is imposed on the person who advised that the distribution be made or who received the benefit.  Second, a tax equal to 10% of the amount of the benefit is levied on any fund manager who agreed to the distribution knowing that it would confer a prohibited benefit.

Automatic Excess Benefit Transactions
Under Internal Revenue Code 4958, a tax is imposed on any excess benefit, which is the amount by which the value of any economic benefit provided by a public charity to certain “disqualified persons” exceeds the value of goods and services received by the charity.  Under the Act, any grant, loan, compensation, or “other similar payments” from a DAF to a donor or donor advisor, his or her family members, or certain entities in which any of the preceding specified persons has more than a 35% ownership interest is automatically an excess benefit.  Consequently, the entire amount paid to one of the specified persons is taxable, rather than just the excess if the value of the economic benefits provided over the benefits received by the sponsoring organization.

Tax Distributions
The Act imposes a tax on a sponsoring organization equal to 20% of any taxable distribution from a DAF.  A “taxable distribution” is any distribution from a DAF:

• to any natural person; or

• to any other person if (1) it is not for one of the religious, charitable, scientific, etc. purposes enumerated in Internal Revenue Code 170( C )(2)(B); or (2) the sponsoring organization doesn’t exercise expenditure responsibility over the distribution.

However, distributions to the sponsoring organization, other public charities, conduit foundations, private operating foundations, certain supporting organizations, and other DAFs aren’t subject to the taxable distribution rules.

Taxes on Excess Business Holdings
The Act also extends the excess business holdings tax rules, previously applicable only to private foundations, to DAFs.  Generally, these rules require a DAF to dispose of certain interests in business entities within five years from the date received. Several transitional rules govern the disposition of excess business holdings currently owned by a DAF.  

Reporting Requirements
On Forms 990 or 990-PF filed for tax years ending after August 17, 2006, a sponsoring organization must list the total number of DAFs it owns at the end of the year; state the aggregate value of assets held in such funds at the end of the year; and disclose the aggregate contributions to, and grants made from, such funds during the tax year.

The rules have changed and are complex.  If your organization has a Donor Advised Fund or are considering creating one, seek professional help from your tax advisor or call Dugan & Lopatka.