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H.R. 7 and Foundation Giving

Bill Is Passed with a Compromise on Section 105

One of the more divisive issues to face the philanthropic sector in recent years has been the proposal to amend the laws requiring private foundations to pay out at least 5 percent of their assets annually.

September's Question of the Month asked readers if they felt foundations should be legally required to pay out more money. Fifty-two percent of respondents answered yes, 38 percent said no, and 10 percent were not sure.

Most of the comments from respondents who answered "no" centered on the possibility that foundations would no longer be able to exist in perpetuity. "As I see it," wrote one anonymous reader, "foundations are set up by a donor to live on and carry giving on in their name even after they are gone. With perpetuity in mind, I cannot see the reasoning behind spending them down so that the ability to give in future years is minimized."

On the other end of the argument, respondents who answered "yes" were more focused on charities' immediate needs. "Sec. 105 of H.R. 7 will release money that charities need NOW for the important work that we do in our communities," commented another reader.

A Brief Overview

H.R. 7, also known as the Charitable Giving Act of 2003, was introduced into the House of Representatives by House majority whip Roy Blunt (R.-Mo.) and Harold Ford (D-Tenn.). Part of the president's faith-based initiative, the act's primary objective is to address the recent decline in giving and give charitable organizations, as well as the individuals that support them, a much needed boost.

The legislation encourages charitable giving by:

  • Giving individuals who don't itemize on their federal tax returns the ability to deduct a portion of their charitable contributions.
  • Allowing tax-free donations to qualified charities from Individual Retirement Accounts (IRAs).
  • Raising the corporate charitable deduction cap from 10 percent to 20 percent.
  • Reducing the excise tax on private foundation investment income from the current two-tiered system (1 percent to 2 percent) to a flat 1 percent of investment income.
  • Expanding the charitable deduction for scientific property used for research and for computer technology and equipment used for educational purposes.
  • Enhancing the deduction for donations of food.
The legislation also contains other provisions that are aimed at improving oversight and accountability:

  • Raising the foundation excise tax on self-dealing from 5 percent to 25 percent.
  • Simplifying lobbying expenditure requirements.
  • Authorizing the IRS to suspend the tax-exempt status of an organization that has been designated by the president or the secretary of state as a terrorist organization or as supporting terrorist activities.
The controversy surrounding the legislation, however, arises from the provisions in Section 105.

Foundations are currently required to spend at least 5 percent of their assets on an annual basis. Under current rules, foundations may include salaries, due diligence costs, grant monitoring costs, travel, excise tax payments and related administrative expenses as qualified expenditures satisfying the 5 percent payout requirement. Critics of current foundation practices point out that including these administrative costs as qualified expenditures actually lowers the amount of money that is granted to public charities.

Section 105 of the Charitable Giving Act was initially drafted to prevent foundations from including any administrative expenses as part of the required 5 percent payout. Many foundations and others were concerned about the impacts of disqualifying all administrative expenses at the same time the Department of Treasury's Voluntary Guidelines were raising the bar for heightened due diligence prior to making grants and heightened monitoring after grants are made in order to limit or prevent the diversion of charitable dollars to finance terrorism.

Passed, with a Compromise

On September 17, the House adopted the Charitable Giving Act of 2003 with a 408-13 vote. The Senate version of the bill, known as the CARE Act of 2003, had passed earlier this year with a 95-5 vote.

The final draft of the House bill, however, featured several important compromises on Section 105. Instead of completely removing administrative expenses from the 5 percent payout, Section 105 now disallows:

  • Any compensation to disqualified persons that exceeds $100,000 (i.e., if a foundation pays a disqualified person $150,000, only $100,000 of that amount can be counted toward the 5 percent payout).
  • Private and chartered air travel as well as commercial air travel above "coach" class.
  • Administrative expenses not directly attributable to direct charitable activities, grant selection, grant monitoring and administration, compliance with federal, state or local law, or furthering public accountability.
It remains to be seen if this compromise will last. The next step in the legislative process will be the formation of a conference committee to work out the differences in the Charitable Giving Act passed by the House and the CARE Act enacted by the Senate. The conference committee will focus on the funding necessary to pay for the bill.

Portions of the legislation are expected to go into effect as early as January 2004. The text of H.R. 7 as introduced in the House is available on the THOMAS World Wide Web system.

The preceding is a guest post by Patrick Ferraro, the Editor of the GuideStar Newsletter.
Topics: Charity Law and Regulations