The following excerpts have been taken from Legal Compendium for Community Foundations, Christopher R. Hoyt, Professor of Law, University of Missouri, 1996 Council on Foundations.

Community Foundation Definition

Community foundation is a 501(c)(3) organization which meets the public support test under 170(b)(1)(A)(vi). It has a governing body which broadly represents the general public and operates primarily as a grantmaking and charitable services organization within a defined geographic area.

In order for multiple trusts, not-for-profit corporations or unincorporated associations to be treated as a single entity for tax purposes rather than separate organizations, the community foundation must comply with six requirements.

1. Must be commonly known as a community foundation

2. All funds must be subject to a common governing instrument.

3. Must have a common governing body which directs the distribution of all funds exclusively for charitable purposes.

4. The governing body must have and must commit itself toward exercising the following: a: Variance Power over charitable purpose exercised when the purpose can no longer be achieved because it is impossible, impracticable or illegal. b. Power to replace a Trustee for either breach of fiduciary duty or inadequate investment performance.

5. Reasonable return on investments

6. Prepare periodic financial reports.

Completed Gift

In order to claim an income tax deduction for a contribution, the donor must make a completed gift and the completed gift must be made for charitable purposes. The courts have adopted a six-part test to determine whether a donor has made a completed gift.

1. The donor is competent to make the gift.

2. A qualifying donee is capable of taking the gift.

3. A clear and unmistakable intention on the part of the donor to absolutely and irrevocably divest himself of title, dominion, and control of property.

4. The irrevocable transfer of the present legal title and dominion and control of the entire gift to the donee, so that the donor can exercise no further act of dominion and control over it.

5. A delivery by the donor to the donee of the subject of the gift or the most effective  means of commanding dominion over it

6. The acceptance of the gift by the donee

The income tax regulations provide that a gift is generally made at the time of delivery. If the donor retains possession of the property or fails to deliver title to the property, then there has been an incomplete gift. If the charity refuses to accept the property, then the donor has made an incomplete gift. If the donor imposes a condition or contingency on a gift, then the charitable deduction is deferred until the condition or contingency is satisfied. Gifts that are earmarked, directly or indirectly for specific individuals or foreign charities do not qualify as gifts for charitable purposes.

Component Fund

There are five requirements for a fund to be treated as a component fund of a community foundation rather than a separate trust, not-for-profit corporation or association.

1. The donor must have made a complete gift. If the donor retains too much control over the property, or fails to deliver the property, then the donor has made an incomplete gift and is not entitled to a charitable deduction. In addition, the charity must accept the gift.

2. The gift must be for charitable purposes.

3. If the fund is a separate legal entity (such as a trust or corporation), then the organizational legal documents of the community foundation must meet the single entity requirements contained in the tax regulations for community trusts.

4. If the fund is a separate legal entity, it must subject itself to the common governing instrument of the community foundation.

5. The fund may not be directly or indirectly subjected by the donor to any "material restriction" or condition with respect to transferred assets.

Material Restrictions

A material restriction is a restriction or condition that prevents a community foundation from "freely and effectively employing the transferred assets, or the income derived therefrom in furtherance of its exempted purposes."  The definition is from the regulations that govern private foundation terminations. It is designed to determine whether a private foundation has transferred "all of its right, title, and interest in and to all of its net assets" to a public charity. It is the legal standard to determine whether a private foundation has made a complete charitable gift or not.

Indirect control which may create a material restriction:

1. If the only criterion considered by the community foundation in making a distribution from a fund is advice from the donor.

2. If the community foundation could be legally compelled to follow a donor's designation.

3. Retaining the "power of appointment."

4. Solicitations imply that the foundation will follow the donor's advice.

5. Advice of the donor is limited to the fund the donor established and the independent investigation and guidelines for specific charitable needs are not present.

6. Only the advice of the donor is considered with respect to that fund.

7. Follows the donor's advice substantially all of the time.

Material Restrictions (continued)

1. Restrictions concerning distribution

a. A donor (or person or committee designated by the donor) may not, directly or indirectly, reserve the right to name the charitable beneficiaries of the fund.

b. A donor may not reserve the right, directly or indirectly to direct the timing of distributions from the fund.

2. A failure to comply with the single entity regulations.

3. Payments to individuals and for non-charitable purposes. Therefore quid pro quo contributions are a material restriction.

4. Restrictions concerning contributed property.

a. The community foundation is required by any restriction or agreement, expressed or implied, to retain any securities or other investment assets transferred to it by the donor.

b. Right of first refusal. If the owner has a right of first refusal with respect to transferred securities of other property when and if disposed of by the community foundation.

5. Assumption of leases contracts and pledges. A material restriction exists if a community foundation assumes leases, contractual obligations, or liabilities of the donor, or takes the assets subject to such liabilities (including obligations under commitments or pledges to donees of the donor), for purposes inconsistent with the purposes or best interests of the community foundation.

6. Relationship with investment advisors. A material restriction exists if an agreement is entered into between the donor and the community foundation which establishes irrevocable relationships with respect to the maintenance or management of contributed assets.

7. Actions that would trigger a private foundation excise tax.

8. Other material restrictions if "any other condition is imposed on action by the community foundation which prevents it from exercising ultimate control over the assets received from the donor for purposes consistent with its exempt purposes.

a. A grant from a donor advised fund to a donor directed fund.

b. Trustee has the legal power to remove fund from the community foundation.

c. Contribution of a short-term property interest.

Pension Protection Act (PPA) of 2006 - Donor Advised and

Scholarship Funds

The PPA includes the first comprehensive regulation of donor-advised funds, and it directly affects scholarship funds with donor involvement. Community foundations that have the following funds will need to review the operations of these funds to determine whether they will be considered donor-advised funds under the new law:

• Donor-advised scholarship funds
• Alumni group scholarship funds
• Memorial scholarship funds
• Company scholarship funds
• Professional group scholarship funds
• Scholarship funds established by churches or other charities

Grants and distributions to individuals now prohibited for donor-advised funds

Beginning at the start of the first tax year following the August 17, 2006, enactment of the law (January 1, 2007, for foundations on a calendar year), scholarship funds that are deemed to be donor-advised are prohibited from making grants to individuals. Only scholarship funds that meet certain requirements may continue to make these grants. At the very least, you need to make any necessary changes to your scholarship procedures before you begin your selection process.

What is considered a donor-advised fund?

The PPA bars distributions from donor-advised funds to individuals. For a fund to be a donor-advised fund the following must be true:

• The fund must be separately identified with reference to the contribution of a donor or donors.
• The fund must be owned and controlled by a sponsoring organization (the community foundation).
• The donor or a person appointed by the donor must have, or must reasonably expect to have, the privilege of providing advice with respect to the fund's investments or distributions.

Distributions from a donor-advised fund to an individual will be deemed "taxable expenditures" and subject the community foundation to a 20 percent tax on the amount of the expenditure. In addition, foundation managers who knowingly approve the distribution could be subject to a 5 percent tax on the grant, not to exceed $10,000 per taxable expenditure. A grant to an individual includes a grant to a university for the benefit of a designated student, so this penalty may not be avoided by making a scholarship check payable to a school rather an individual.

It's clear that donor-advised funds established by a family and advised by members of that family would be considered donor-advised funds. The legislative history of the PPA suggests that memorial funds to which family members of the deceased provide advice on distributions may also be considered donor-advised funds. Similarly, funds established by professional or alumni groups for which members of the group serve as the advisory board will also be considered donor-advised funds. Funds established by corporations with advisory boards consisting of corporate employees may also be deemed donor-advised funds.

Does this mean that none of these kinds of funds can make scholarship grants? Fortunately, the law includes a provision under which these groups may award scholarships, but they will most likely have to alter their procedures to take advantage of the rule.

How to continue to award scholarships

The PPA does not consider a scholarship fund to be a donor-advised fund, even if a donor or fund advisor is a member of the selection committee, if all of the following are true:

• The sponsoring organization (the community foundation) appoints all of the members of the committee and the donor's advice is given solely as a member of the committee
• Neither the donor nor the parties related to the donor control the committee directly or indirectly
• All grants are awarded on an objective and nondiscriminatory basis using a procedure that has been approved in advance by the board of directors of the sponsoring organization and that has been designed to ensure that all such grants meet the requirements of paragraphs (1), (2), or (3) of section 4945(g).

Let's take these requirements in order and see how they will affect some of the most common scholarship fund arrangements. Remember that a donor can be a living, breathing person, a deceased person, a charity or other nonprofit, or a corporation or other type of business.

Community foundation appointment of selection committee members
The community foundation must appoint the members of the selection committee. While an advisor may certainly suggest some members of the committee, the community foundation must have the power to accept or reject any suggestions. Community foundations will probably have to review and approve annually the members of all selection committees subject to this rule.

No donor control of committee
The donor and related parties may sit on a selection committee, but they may not make up a majority of the committee. The majority of the committee must be made up of individuals who are not related parties and who are not designated or appointed by the donor. Related parties include relatives and employees of the donor. The donor's attorney will generally be considered a related party. The donor may recommend for membership on the committee someone who is not a related party. If the recommendation is based on objective criteria related to the expertise of the person recommended that person will not be considered designated or appointed by the donor. The legislative history of the PPA provides an example: if a donor recommends the heads of the science departments at local secondary schools to be on a committee to award grants for the advancement of sciences at those schools, the persons so recommended will not be considered to be designated or appointed by the donor.

This provision clearly bars the board of a professional or alumni group, church, or other public charity that has established a scholarship fund from serving as the entire selection committee. Members of the board may serve on the committee but the majority of the committee must be made up of other individuals who are not related parties (such as school officials, other educators, or community foundation representatives). Similarly, a fund donor's family cannot constitute the entire selection committee or even a majority of the group. This is also the case if the fund is a memorial fund. The legislative history of the PPA takes the position that since contributions to such a fund are identified with reference to the deceased, family members of the deceased will be considered related parties and may not make up the majority of the selection committee.

Where a scholarship fund is established by a corporation, corporate employees may be considered related parties and should not form a majority of the selection committee. Indeed, the Council recommends that no corporate employees serve on the selection committee. This will help ensure compliance with the rules for making employer-related scholarships.

Before appointing the members of a selection committee, the community foundation should be given basic information about why each individual being appointed is qualified to be on the committee-for example, he or she is a high school principal, a church leader, or a community representative. Donors should be asked to disclose any family or employment relationships they have with other committee members so that the community foundation can determine that the donor does not control the committee.

Procedures for awards
The PPA requires the community foundation board to approve in advance the procedures for making awards. These procedures must be objective and non-discriminatory and the grants must meet the requirements that are applicable to private foundations making grants to individuals for travel or study.

Board pre-approval of procedures
It's not clear from the text of the PPA how closely the community foundation board must review the procedures for each scholarship award. The Council believes that Congress intended community foundation boards to perform the role that the IRS plays in the pre-approval of private foundation scholarship procedures. According to the Internal Revenue Manual (the IRS's manual of procedures for its agents) the IRS's responsibility in these instances is to review a submission from the foundation that includes:

1. A statement describing the selection process
2. A description of the terms and conditions under which the foundation ordinarily makes such grants that is sufficient to enable the IRS to determine whether the grants awarded under such procedures would meet the requirements of IRC 4945(g)(1), (2), or (3)
3. A detailed description of the private foundation's procedure for exercising supervision over grants
4. A description of the foundation's procedures for review of grantee reports, for investigation in case diversion of grant funds from their proper purposes is indicated, and for recovery of diverted grant funds

The manual does not contemplate a series of separate approvals of particular grant programs. Once a private foundation's grant procedures are approved by the IRS, such grantmaking procedures apply to a new grant program as long as the procedures do not materially change. It is possible that the community foundation board could approve a general set of guidelines for committee selection, applicant processing and selection, follow-up, and investigation of misspent funds that would cover most scholarship funds.  This would not absolve the community foundation from appointing committee members as discussed above.  The Council will likely seek guidance on this issue shortly.

Objective and non-discriminatory procedures
Community foundations should already be familiar with the requirement that procedures relating to scholarship awards be "objective and non-discriminatory."

Compliance with paragraphs (1), (2), or (3) of section 4945(g)
Like private foundations, community foundations must now ensure that their grants to individuals for travel, study, or similar purposes fit into one of the three categories set out in these provisions of the Tax Code:

1. Paragraph (1) allows grants that are scholarships and fellowships. These are grants that pay for tuition, books and other expenses.
2. Paragraph (2) sanctions grants that are prizes or awards made primarily in recognition of religious, charitable, scientific, educational, artistic, literary, or civic achievement. If the recipient is chosen from the general public, he or she must be selected without any action on his or her part to enter a contest or proceeding, and the recipient must not be required to provide services as a consequence of receiving the award.
3. Paragraph (3) permits grants to achieve a specific objective, produce a report or other similar product, or improve or enhance a literary, artistic, musical, scientific or other similar capacity, skill, or talent of the grantee. This is the broadest category and covers, for example, awards to artists to create works of art and some scholarships that do not fit under paragraph (1).