Field of Interest Funds: Legal Considerations
Adapted from an article originally published in the North Carolina Bar Association’s newsletter, The Will & The Way.
While philanthropic giving through Donor Advised Funds (DAFs) has proliferated in recent years, there are other lesser-known vehicles that can be used for charitable giving. This article examines the benefits of Field of Interest Funds, to help you assist your clients in selecting the right vehicle(s) to meet their philanthropic objectives for both lifetime and planned giving.
How are Field of Interest Funds different from Donor Advised Funds?
As a threshold matter, Field of Interest Funds must fail the Donor Advised Fund test as articulated in the Pension Protection Act of 2006 (PPA). Section 4966(d)(2)(A) of the Internal Revenue Code (Code) defines a “donor advised fund” as “a fund or account (in) which is separately identified by reference to contributions of a donor or donors, (ii) which is owned and controlled by a sponsoring organization, and (iii) with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reasons of the donor’s status as a donor.” All three prongs of the definition must be met for a fund to be classified as a DAF. As detailed below, the definition excludes Field of Interest Funds.
What is a Field of Interest Fund?
Field of Interest Funds benefit organizations that fall within a specific charitable field or category rather than a particular charitable organization. Donors may describe the Field of Interest Funds broadly or narrowly. For example, the Fund could benefit the environment and emphasize air quality. Additionally, it may benefit an entire geographic area such as Charlotte-Mecklenburg or a smaller community, such as the Town of Matthews.
Field of Interest Funds are useful for lifetime and, more frequently, planned gifts. The fund can be opened with a single fund agreement and contributions during life should qualify for an immediate public charity income tax deduction. They are also eligible for qualified charitable distributions from an IRA. Again, for planned gifts, a variety of sources may be used to fund a Field of Interest Fund.
A distinguishing feature of Field of Interest Funds is that the advisory privileges are typically given to the sponsoring organization when the fund is created. As a result, Field of Interest Funds typically fail the third prong of the DAF test, which states “with respect to which a donor (or any person appointed or designated by such donor) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in such fund or account by reasons of the donor’s status as a donor.” However, the donor may be able to recommend that a committee, often with subject matter expertise, be appointed (perhaps by the sponsoring organization) to assist in overseeing grantmaking within the established field, so long as the sponsoring organization retains advisory privileges for the grantmaking.
It is worth briefly mentioning that Field of Interest Funds constitute the backbone of the community foundation movement and pre-date DAFs, which were not established until the 1930s. Frederick Harris Goff, founder of The Cleveland Foundation, the first community foundation, was concerned about how often provisions for the charitable uses of trust income became obsolete or counterproductive, a phenomenon he observed in his work as an attorney. He established The Cleveland Foundation in 1914 to pool the charitable resources of Clevelanders from all walks of life, both living and deceased, into a single permanent trust administered for the betterment of the community. Ultimately, many other communities followed suit with donors setting up unrestricted or broad Field of Interest Funds, primarily through bequests, entrusting future leaders to evaluate changing community needs and make grants accordingly. Currently, there are more than 800 community foundations across the United States, including Foundation For The Carolinas (FFTC), with each serving a unique geographic region. Field of Interest Funds continue to play a crucial role in empowering community foundations to respond to evolving needs and provide civic leadership within their communities. The COVID-19 pandemic starkly illustrated the importance of flexible funds that enable a timely response to critical and unexpected community needs.
Considerations for Field of Interest Funds for Planned Giving
The benefits of Field of Interest Funds as part of an overall strategy to meet a client’s philanthropic goals are perhaps best illustrated in the context of planned giving. While planned giving is a broad category and is not limited to charitable gifts taking effect at a donor’s death, for purposes of this article, references to planned giving refer to gifts that take effect at a donor’s death.
Given the unique structure of a Field of Interest Fund, this philanthropic tool is perhaps most beneficial in the planned giving context. Before addressing the distinctive features of these funds, it is worth noting that a Field of Interest Fund may be endowed or non-endowed, as directed by the client.
When a Field of Interest Fund is created, the donor identifies a specific area of charitable focus, as broadly or narrowly as the donor desires, and entrusts advisors to exercise discretion in awarding future grants within that identified area. Because there is no specified beneficiary, the role of the advisor is key. In selecting an advisor, clients typically look to the sponsoring organization and may recommend a committee of advisors to assist the sponsoring organization with grantmaking. Advisors on the Field of Interest Fund should have both experience with grantmaking and expertise in the selected subject matter. Particularly where the donor has strong ties to a particular place and desires to support that community or region, the local knowledge and connectivity offered by a community foundation may be a welcome resource, as each community foundation represents a specific geographic region. For example, a donor wanting to support broad charitable purposes in Cabarrus County might contribute to the Cabarrus County Community Foundation’s endowment, supporting annual grantmaking within that geographic region, as led by Foundation staff and a board of local civic leaders.
This ability to select a general area of interest and leverage the advisors’ expertise can be compelling for the donor who does not have specific organizations they wish to support or who lacks significant experience with grantmaking but is nonetheless passionate about the future impact of their gift. Even clients with a lengthy history of giving and existing relationships with nonprofits may find a Field of Interest Fund valuable given the forward-looking nature of planned giving. Planned giving frequently asks clients to predict their future charitable goals – how would I use these funds in 25 or 50 years? – a task that can be daunting given the changing needs within our communities. A Field of Interest Fund helps assuage this concern about an unknown, evolving future by entrusting future grantmaking to the advisors. Here, it is important to note that in addition to the experience and expertise that the advisors provide, they offer another benefit that is uniquely welcome for planned gifts clients – future relevance. That is, in awarding grants from the Field of Interest Fund, the advisor is able to evaluate the greatest current needs and opportunities within the client’s specific focus area. In 2020, for example, a Field of Interest Fund focused on early childhood literacy might well have awarded grants to increase access to remote learning. Certainly, no donor fifty years, or even five years ago, could have predicted the necessity of remote learning. However, in 2020 this was an important and timely way to support early childhood literacy. The discretion inherent in a Field of Interest Fund allows grantmaking to meet the needs of the day, even as those needs evolve.
Thus, a Field of Interest Fund can be a helpful planned giving tool for a variety of clients – those who may not have a strong connection to a specific nonprofit, but are generally passionate about a specific area of community need; those who desire a longer-term impact and are mindful of ever-evolving needs; and, as we increasingly see in our work, those who wish to give a portion of a planned gift to a Field of Interest Fund in an effort to diversify their giving and future charitable impact. For these clients, there is a desire to both provide for the organizations they know and love well, perhaps via a Designated Fund, and a recognition that there will be future needs and opportunities that we cannot predict. The opportunity to incorporate a Field of Interest Fund as part of a planned giving strategy can provide peace of mind regarding future, relevant impact. For example, the same donor might create a Designated Fund to benefit the local homeless shelter and also a Field of Interest Fund to support ongoing community efforts to address affordable housing.
Indeed, in addition to creating a standalone Field of Interest Fund that reflects a client’s specific, perhaps narrow charitable focus, a donor may consider contributing to an existing Field of Interest Fund, pooling the client’s funds with other like-minded community members for greater impact. Many community foundations have such funds that reflect broad community areas of need. FFTC, for example, offers eight Community Impact Funds that support broad, vital causes in our community: Health & Human Services, Education & Youth Development, Arts & Culture, Environment & Wildlife, Animal Welfare, Evolving Needs & Opportunities, Our Region and Your FFTC. In awarding grants from each of these endowed funds, FFTC leverages the respective experience and expertise of our grantmaking team and volunteer community leaders. For the donor who wishes to support broad community causes, the opportunity to be a part of a larger initiative, as with the Community Impact Funds, can be compelling.
As discussed, Field of Interest Funds can be an important tool to address evolving community needs and may also offer a way to contribute to a broader fund supported by the community. While the benefits of using Field of Interest Funds for planned giving are more widely known, they are also helpful tools for practitioners seeking to fulfill their clients’ charitable objectives during life.
Considerations in Using Interest Funds for Lifetime Giving
Recent legislation enhanced the benefits of using Field of Interest Funds, either as standalone charitable vehicles, or in concert with other charitable planning tools such as DAFs for lifetime giving. This article will address several pieces of relevant legislation with a more comprehensive discussion, including excess business holdings considerations, provided at the end of this section.
Tax Cuts and Jobs Act of 2017
The Tax Cuts and Jobs Act (TCJA) of 2017 was the largest overhaul of the tax code in three decades, with most provisions set to remain in place through 2025. In addition to a number of revisions to earlier tax law, the standard deduction was significantly raised. The Tax Foundation estimates the percentage of itemizing taxpayers dropped from 31.1% pre-TCJA to just 13.7% in 2019.
As a result of these changes, taxpayers adjusted their strategies for post-TCJA giving, which include using DAFs to bunch their donations (discussed in Selecting the Right Philanthropic Vehicle: Private Foundations vs. Donor Advised Funds) and using IRAs to make QCDs (effectively tax-free distributions from an IRA to qualified charities). QCDs count toward an IRA owner’s required minimum distribution (RMD) and are particularly advantageous for clients claiming the standard deduction. As detailed below, while the advantages of using QCDs are many, QCDs cannot be made to DAFs, Private Non-Operating Foundations, Supporting Organizations, or split-interest giving vehicles (i.e., charitable remainder trusts, charitable lead trusts, pooled income funds). For clients wishing to use QCDs for multi-year philanthropic planning, Field of Interest Funds can be beneficial planning vehicles.
After the passage of the SECURE Act, individuals who own IRAs are now required to take RMDs each year beginning at age 72 (an increase from age 70½). RMDs are treated as taxable income and, as the name implies, must be taken regardless of whether the funds are needed. In some instances, the income from the RMD may push the taxpayer into a higher income tax bracket or trigger phaseouts which limit tax deductions and may even trigger higher taxes on social security income (i.e., the Medicare high-income surcharge). Even though the SECURE Act raised the RMD age from 70½ to 72 years old, individuals may still take QCDs from their IRAs at age 70½. The maximum amount that can be transferred from a traditional IRA to a qualified charity each year as a QCD is $100,000 per individual. In this regard, for couples, each spouse with an IRA may make QCDs of up to $100,000 per year, enabling potential combined QCDs of $200,000. Although this applies to a limited age group, there are thousands of Baby Boomers reaching this age daily. Furthermore, as indicated by a study conducted by The Philanthropy Roundtable, this demographic is very philanthropic with 77% of households donating to charity.
The benefits of QCDs are significant for qualified individuals. As noted above, QCDs are do not constitute taxable income and satisfy RMDs. During the 18-month window between 70½ and 72, clients who make QCDs can provide support to charities while simultaneously reducing the remaining amount in their IRA (while preserving other assets), thus resulting in reduced future RMDs and taxes. As noted, while QCDs may not be made to DAFs or private foundations, they may be made directly to most public charities, as well as to community foundations and other organizations to support Field of Interest Funds, as well other funds such as Designated and Scholarship Funds. Thus, Field of Interest Funds may provide an attractive alternative for clients who wish to provide strategic support over a period of years rather than in one lump sum.
As an illustration of the impact of QCDs, an individual who elects to make a QCD of $100,000 to charity and is in the 22% marginal tax federal income bracket, can save $22,000 in federal income taxes. To expand, the same donor could contribute the $100,000 QCD into a Field of Interest Fund to benefit Animal Welfare with the sponsoring organization overseeing the distributions to non-profits within that focus area. If the sponsoring organization is a community foundation, the Field of Interest Fund provides the community foundation with discretionary grantmaking resources, and the donor can benefit from their subject matter expertise. In addition, the assets in the Field of Interest Fund could be invested and potentially grow tax-free during this time.
Coronavirus Aid, Relief, and Economic Security Act of 2020
Under the Coronavirus Aid, Relief and Economic Security Act (the CARES Act), donors who itemize their deductions may deduct cash contributions to public charities up to 100% of their Adjusted Gross Income (AGI) in 2020 and 2021. This represents an increase from the 60% AGI limit that ordinarily applies to cash gifts made to public charities. Excess contributions can be carried forward for up to five additional years. While the benefits of the CARES Act are set to expire at the end of the year, they are significant enough to warrant discussion. Similar to QCDs and other recent enhanced charitable provisions, this increased 100% AGI limit does not apply to cash gifts made to DAFs, Private Non-Operating Foundations, Supporting Organizations, or split-interest giving vehicles, but may be made to Field of Interest Funds (among others). The enhanced AGI limit also does not apply to charitable contributions carried forward from a prior tax year.
The CARES Act does not change the AGI limit for charitable gifts of non-cash assets or for gifts to DAFs. If a donor wishes to make charitable gifts exceeding the respective AGI limits, they might consider “stacking” charitable gifts of cash and non-cash assets and leveraging Field of Interest Funds to fully meet their tax and charitable goals.
Excess Business Holdings
The rules related to excess business holdings (Section 4943 of the Code) can also make Field of Interest Funds attractive planning tools for charitably minded clients. Congress enacted the excess business holdings rules to limit the ability of individuals to retain control of business enterprises after transferring ownership to a private foundation. For purposes of the taxes under Section 4943, DAFs and supporting organizations are treated as private foundations.
Generally, under Section 4943, the combined holdings of a private foundation and its disqualified persons are limited to 20 percent of the voting stock in a business enterprise that is a corporation, partnership, joint venture, or other unincorporated enterprise. In the case of a partnership or joint venture, voting stock is replaced by a beneficial interest in the profits of the partnership/joint interest.
A private foundation that has excess business holdings may become liable for an excise tax based on the amount of the excess holdings. Typically, an initial tax of 10% of the value of the excess holdings is imposed on the foundation. The tax is imposed on the last day of each year that ends during the taxable period. The initial tax may be abated if the foundation can show that the excess holdings were due to reasonable cause and not to willful neglect, and that the excess holdings were disposed of within the correction period. Note, the correction period begins on the first day that the foundation has excess business holdings and ends 90 days after a notice of deficiency for the additional tax is mailed.
After the initial tax has been imposed, an excise tax of 200% of the excess holdings will be imposed on the foundation if it has not disposed of the remaining excess business holdings by the end of the taxable period. However, the additional tax will not be assessed, or, if assessed, will be abated if the excess business holdings are reduced to zero during the “correction period.”
There are several exceptions to the excess business holdings rule; however, a detailed discussion of these exceptions falls outside the scope of this article. That said, it is important to highlight a few exceptions. Under Section 4943(d)(3)(B), a business enterprise does not include a trade or business at least 95% of the gross income of which is derived from passive sources. In addition, under Section 4943(c)(2)(C), there is a de minimis exception for a private foundation (or DAF) holding no more than two percent of the voting stock and not more than two percent of the value of all outstanding shares. Perhaps most importantly in the area of charitable gifts, Section 4943(c)(6) provides five years to dispose of holdings in a business enterprise acquired by gift or bequest that would otherwise be considered excess business holdings. There is also the potential to seek an extension of five additional years under Section 4943(c)(7) for unusually large gifts and bequests if certain requirements are met.
In light of the draconian penalties noted above, it is important that clients take care before transferring holdings in a closely held business to a private foundation or DAF; however, most public charities are exempt from the excess business holdings rules. Because Field of Interest funds are not considered DAFs, they are not subject to the excess business holdings rules and can be important vehicles for gifts of closely held business interests.
While there are many tax considerations that make Field of Interest Funds attractive for lifetime and charitable planning, clients are often motivated to give for other reasons. In fact, studies have shown that individuals are inclined to give back to make an impact and that often leads to personal satisfaction, known in philanthropy as the “warm glow” effect. Therefore, even without the tax benefits, your clients may wish to explore Field of Interest Funds to fully achieve their philanthropic goals. In particular, for clients contemplating gifting a portion of their estate to a Field of Interest Fund, it can be rewarding to establish a relationship with the sponsoring organization during life. This provides an opportunity to better understand the sponsoring organization’s approach to grantmaking and perhaps create a deeper relationship with key staff that may provide peace of mind.
In helping your clients fulfill their philanthropic objectives, there are a variety of charitable vehicles to consider. Field of Interest Funds, while perhaps less well known, present unique and important opportunities for charitable planning, both during lifetime, and particularly for planned gifts.
Disclaimer: The information provided in this article is general and educational in nature. It is not intended to be, and should not be construed as, legal or tax advice. Foundation For The Carolinas does not provide legal or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Please consult an attorney or tax advisor regarding your specific circumstances.