JUST WHAT ARE FRATERNAL EDUCATIONAL AND CHARITABLE PURPOSES ANYWAY?

Barbara Schwartz Bromberg

Introduction

One of the most common fraternal organization client inquiries has always been: “What kind of  activity sponsored by the fraternity will the Internal Revenue Service recognize as eligible for charitable foundation funding and/or set aside funding? Is there a difference between these two types of funding?” The frequency and importance of these inquiries has of course increased dramatically since the recent, well-publicized fraternity and fraternal foundation case with the Internal Revenue Service and the subsequent dissemination of certain excerpts of the closing agreements in that case.

In my practice I am often requested to provide a “list” of the types of programs that are considered “safe” by the Internal Revenue Service for this kind of funding. There are certain points that need to be made in this connection. First, there is no completely exhaustive list as such because in my experience, each organization’s educational and charitable programs are somewhat unique — the best way to determine qualifying programs for any particular organization is to review carefully the chart of accounts and other applicable records for that organization. Second, the funding of no program, even the most obviously charitable and educational, is “safe” if the Internal Revenue Service’s guidelines as to procedural matters are not followed — this would include the proper segregation of set aside funds in the case of set aside funding and appropriate grant agreements being executed in the case of foundation funding. With this preamble, there are, however, certain areas which the Internal Revenue Service has either approved in pronouncements in the past or which have been widely accepted by the Internal Revenue Service in the audit process. This column will discuss some of these areas and include some guidelines as to the types of supporting documentation which should be in place.

Qualifying Programs

1. Chapter Consultants — This is usually one of the largest programs sponsored by a fraternal organization, both in terms of expense and in time consumed in administering the program. The Service will usually allow both set aside and foundation funding of the educational portion of the expenses of this type of program, provided the chapter consultants keep contemporaneous written time records showing the portion of their time devoted to educational subjects such as leadership, scholarship, health and safety issues and the like. The format of the report used by the chapter consultants will be very important in eliciting responses which reflect the amount of educational time that we know these chapter consultants spend on these matters. Subjects such as ritual, rush, social pursuits and extension are not considered educational under these guidelines and should not be counted in determining the appropriate funding percentage. Some organizations tabulate these reports in-house and some have outside advisors help them with the tabulation process — in either case it is recommended that a written opinion be secured for all large set aside and foundation funding expenditures.
2. Conventions, Leadership Conferences and Similar Meetings — The Service has also traditionally allowed such funding of the educational portion of national conventions, leadership conferences and similar gatherings. However, it is important that the educational percentage of the particular meeting involved be established through a detailed analysis of the agenda and written materials used for each convention or conference. Again, since there is usually a very substantial expenditure involved in the case of conventions and other national and regional meetings, many organizations do ask their counsel to prepare a written allocation opinion; similar topics as described under Number 1 above are considered educational and noneducational, respectively, in nature. Under the recent closing agreement guidelines, the Service has indicated that no educational time shall be allocated for recreational events or events at which a meal is served. While the former rule is certainly understandable, the latter can pose problems in terms of achievement awards, leadership speeches and the like which often take place at these events — it is recommended, therefore, that the meal at which these events typically occur be separated from the speech, awards presentation or other educational event so that this “educational time” is not lost.
3. Loans on Local Chapter Housing — This is one of the areas where set aside and foundation funding rules differ. Loans on local chapter housing (not other types of loans) may be made from set aside funds as a qualifying program but are not considered a program expense if made from foundation funds (such loans would be considered investments by the foundation and thus subject to being tested by investment criteria). The good news is that such loans are an ideal way to use up set aside funds since they are usually large and the documentation there­ for is totally The bad news is that although the interest on such loans does not in itself have to be set aside because it is considered member income, principal repayments made on such loans must be recycled back into the set aside fund. Nevertheless, I would recommend that most fraternal organizations consider using housing loans as the first qualifying expenditure from set aside funds.
4. Written Materials, Videos and Similar Publications Separate and Apart from Meetings -­ Many fraternal organizations would like to fund publications, videos and the like from foundation or set aside Since the decision of the U.S. Tax Court as affirmed by the Sixth Circuit Court of Appeals in the Phi Delta Theta case many years ago, the rule of thumb has generally been that only such materials which qualify as 100% educational in content by Internal Revenue Service standards should be so funded. This should include such items as health and safety manuals, anti-alcohol materials, risk management videos and the like, and would definitely not include a typical pledge manual and similar publications. It is recommended that no educational allocation be attempted in this area such as is generally accepted under Numbers 1 and 2 above. When in doubt in this particular area, it is best to be conservative. This rule should not be confused with the fact that a fraternal foundation is allowed to reimburse its related fraternity for its pages in the fraternity magazine which are used to communicate with existing and potential donors: these are considered in the nature of fund raising and cultivation expenses for the foundation, not program expenses.
5.  Charitable Contributions, etc. — Of course, both set aside funding and foundation funding are available for very straightforward items such as charitable contributions to other recognized charities qualified under Code Section 501(c)(3), scholarships and student loans (both of which may be confined to members of the particular organization as long as they are awarded on an objective and nondiscriminatory basis according to an established procedure). It has been stated that the Service viewed these types of expenditures very favorably in recent audit situations.
6. Administrative Grants — Many fraternal organizations would like to fund various fraternity overhead and administrative expenses which are allocated to its charitable and educational activities — for example, the fraternity may employ a person who spends part of his or her time on scholarship matters and would like to seek foundation funding for this position. While this needs to be extremely carefully handled and documented, and the employee must keep contemporaneous written time records to establish the time spent on these matters, this too is usually a permissible qualified expenditure from foundation and set aside

Conclusion

These are just a few of the most common areas considered for foundation and set aside funding by most organizations. A future column will discuss some of the more unusual or less well-known funding areas. However, it is generally my recommendation that with respect to both set aside and foundation funding, an effort be made to fund as many larger and well-established programs as possible. This will enable the organizations to handle any possible Internal Revenue Service audit more successfully since they will have fewer programs and financial points of contact for the Service to investigate. Hopefully, the programs will all be of the type that are well-established and qualified within Internal Revenue Service guidelines. This is preferable, in this writer’s opinion, to having a myriad of smaller expenditures which require detailed allocation procedures and documentation. I also like to recommend that the boards of the foundation and fraternity consult with each other to develop a somewhat coordinated educational program and then determine whether foundation funding should be sought for a particular program or if that program will be funded from set aside funds- by doing this, the more conservative, well-established programs can be funded from the foundation, since an honest mistake in funding could conceivably endanger the foundation’s tax exempt status, whereas an error in judgment concerning set aside funds simply means some taxes might have to be paid. While the latter is not a pleasant alternative, it is certainly less serious for the organizations on a long-term basis.