Problems With Funds for Pre-Selected Individuals
In the community foundation world, donors often seek to create funds for the benefit of a designated individual or small group of people: for example, an individual with enormous medical bills, a family blessed with quintuplets, or a family that has lost its primary wage earner. Although distributions from such funds usually take the form of grants to individuals, a community foundation should generally not establish such a fund.
No income tax deduction is available to individuals or corporations that make a gift of money or property to a specified individual. This is true no matter how needy or worthy of aid the individual might be and remains true even if the donor channels the contribution through a charitable organization. If a contribution is earmarked for a particular individual or family, the IRS is free to disregard the existence of the charitable intermediary and to consider the gift as made directly by one individual to another. Earmarking is defined as any oral or written agreement or understanding that funds will be distributed in a specified fashion [See Reg 53.4945-5(a)(6); Reg. § 53.4945-4(a)(5)]. Thus, a community foundation that establishes a fund for a pre-identified person or small group would be accepting funds for which no charitable deduction is available to the donor.
Establishing such a fund could jeopardize a community foundation's tax-exempt 501(c)(3) status if it gets into a pattern of setting up funds for designated individuals, since such funds would be providing impermissible private benefit rather than serving a charitable purpose [See Reg. § 1.501(c)(3)-1(d)(1)(ii)].
There are many potential pitfalls. Arguably, a charity would be participating in tax fraud if it led donors to believe that they could take tax deductions for these contributions, and it would certainly run afoul of the law if it gave receipts to contributors of more than $250 stating that the contributors had made charitable contributions. Informing donors that contributions do not qualify as charitable deductions might be legally correct, but it would be a public relations nightmare.
Other potential problems include disputes with family members regarding how donated funds should be spent and even lawsuits filed by creditors of benefited individuals. Finally, a community foundation that agreed to create even one of these funds would open itself up to endless requests for the establishment of similar funds.
A practical response to donors who approach the community foundation with a proposed fund for a designated individual is to explain the law and provide a list of banks or other institutions that may be willing to establish such funds. The community foundation may also wish to consider establishing a general fund that provides assistance in cases of economic hardship.
A note on donor-advised funds: Grants to individuals may not be made from donor-advised funds. This includes scholarships or any other type of funds transferred to an individual, including reimbursements.
