Entering into "commercial co-ventures" and/or making contributions to a donor advised fund (DAF) allows a family business to carry out its charitable goals without the need for forming a stand-alone family business private foundation. While there are several reasons why a family business may opt to create its own private foundation (which will be the topic of a subsequent post), "commercial co-venturing" and opening a DAF are simpler and less expensive means of engaging in philanthropy.
A "commercial co-venture" is a contractual arrangement between a for-profit entity (i.e., the family business) and a tax exempt charitable organization where a portion of the family business’s earning/profits/sales, depending on the venture, are paid to the charity. For example, a family business makes and sells specialty food items and wants to support local and/or national hunger relief organizations.
It may enter into an agreement so that a certain percentage of its sales proceeds goes to a specific relief organization. Currently, about 25 states regulate “commercial co-ventures” through registration or other requirements, in order to ensure that the charities are not taken advantage of by for-profit businesses. Consultation with legal counsel well-versed in commercial co-ventures is highly recommended.
Donor Advised Funds
A donor advised fund is a discrete fund opened by a donor (the family business) at a "sponsoring organization" which is a public charity. Sponsoring organizations include community foundations and national commercial charities.
The sponsoring organization owns the assets donated to a DAF. The donor may enter into an agreement regarding the use of funds prior to making contributions and/or may make recommendations as to distributions to charitable organizations. However, the DAF sponsor has authority under state law to vary the use of DAF funds despite any donor agreement, and may disregard a donor’s distribution recommendations.
The nature and type of distributions from DAFs vary depending on the sponsoring organization’s policies. Some sponsoring organizations will make distributions to foreign charities, some will make distributions to private foundations, and others will only make distributions to domestic public charities. Some sponsoring organizations require distributions to be made every certain number of years, whereas others have no such policies.
Some sponsoring organizations will engage in impact investing and cutting-edge use of DAF funds (such as PRIs, discussed below), others will not. It is important to interview DAF sponsors to ensure the sponsor is willing to carry out the philanthropic goals of the family business.
DAFs are not subject to most of the excise tax rules applicable to private foundations (such as self-dealing, jeopardy investments, minimum distributions, or taxable expenditures). DAFs are, however, subject to the excess business holdings rules (which limits the amount of closely held business interests which may be owned by the DAF), except in the case of a "program related investment" or "PRI".
Program Related Investments
Very generally (as PRIs are complex), a PRI is a specific statutory carve-out from the private foundation jeopardy investments rules that allows grants, loans, equity acquisitions, guarantees, and other uses of foundation assets to further the foundation’s charitable purposes, which:
- Qualify toward the foundation’s annual minimum distribution requirements;
- May allow a return of funds to the foundation under certain circumstances;
- Are not subject to the jeopardy investment rules so may be high risk, low return; and
- Are not subject to excess business holdings rules so may be large equity positions in closely held businesses.
In the DAF context, while DAFs have no current statutory minimum distribution requirements or concerns about jeopardy investments, a DAF distribution which is an equity investment that meets the statutory PRI requirements should not be subject to the excess business holdings rules.
The income tax benefit to a family business from commercial co-ventures and DAF contributions depend on the type of business entity and how the entity elects to be taxed for federal income tax purposes. Any charitable contribution deduction for an entity taxed as a partnership or S corporation flows through to the partners or S corporation shareholders. If the family business is taxed as a C corporation, the corporation, and not the shareholders, may take a charitable contribution deduction up to ten percent (10%) of the corporation’s taxable income.
Choosing the Right Charity for Your Family Business
Prior to embarking on commercial co-ventures or opening a DAF, we recommend consulting with experienced legal counsel.