A recent CPA Journal article “Assisting Individuals with Charitable Legacies” (Sidney Kess and Edward Mendlowitz, April 2016, http://bit.ly/2nmSxfx) describes different ways donors may structure bequests. The authors state that CPAs can assist in helping the donors determine the best vehicle for the bequest; however, one factor not discussed is consideration of gifts that include donor restrictions. While care should be exercised when establishing the trust or other vehicle for the bequest, additional consideration is necessary for protecting a restricted bequest, as the person most interested in maintaining the restriction is usually no longer alive to monitor that provision.
In 2014, estate tax returns in the United States listed almost $18.8 billion of bequests; New York residents accounted for approximately $1.5 billion of that (Estate Tax Returns Study, IRS Statistics of Income Division, October 2015). These bequests were for estates large enough to require a federal estate tax filing; most estates are smaller, and bequests come from smaller donors as well. Many bequests are restricted, as evidenced by the large amount of permanently restricted net assets held by not-for-profit (NFP) organizations. Unfortunately, there are numerous examples of restricted bequests used in ways the donors had not intended. One example in New York City is the $138 million bequest to Long Island College Hospital (LICH) in Brooklyn by Donald and Mildred Othmer. The endowment was to be held in perpetuity with only the interest available for general funds, but with cy pres filings and the approval of the Attorney General’s Charities Bureau of New York, the bequest has instead been significantly spent, while the hospital was taken over by SUNY Downstate Medical Center and eventually closed in 2014. Thus, a well-established bequest can be undone when there is a lack of monitoring protections in the gift.
This article discusses items CPAs and their clients should consider to better protect donor-restricted bequests. It uses the experiences from the restricted bequest made by the Othmers to LICH as an example of what can happen to restricted bequests without strong protections.
Discuss Potential Bequest with the Organization
Some donors have a long-standing relationship with their chosen recipients, while others have had little contact. A potential donor should consider meeting with the organization to determine whether the restrictions are reasonable. This conversation also can allow the NFP to suggest other possible uses that may better meet the goals of the donor and the mission of the organization. Donors may be reluctant to do this if they wish to remain off the radar of the organization during their life, but CPAs can have this conversation directly with the organization on behalf of the anonymous donor as part of the due diligence for future bequests. Proactive and early discussions can ensure a better-crafted and therefore better-followed bequest restriction.
Monitor Recipient Organization
A decision to provide for a particular organization should not be static. This decision should be reviewed, perhaps even annually, to determine both the health of the organization and its ability to abide by the restriction. Audited financial statements and IRS Form 990 provide information about the financial health of the organization. The new ASU 2016-14 provides new classification and information that may make monitoring more transparent. The changes include classifying net assets as either with or without donor restrictions. New disclosures include quantitative and qualitative information about the liquidity and financial flexibility of the organization and cash needs for one year from the balance sheet date. These changes may help potential donors in their assessment.
Bequests often come from older clients, and their declining health can make monitoring an organization difficult. The donor’s will should provide for executors to review the intended organizations and to reallocate bequests if the review uncovers concerns. For the Othmers’ bequests, this task fell to Mildred as surviving spouse. By the time of her death, LICH had received a going concern opinion from its external auditors, a red flag indicating potential difficulty in honoring the gift’s restriction. But because Mildred had developed Alzheimer’s disease, she was incapable of performing any review. (The Othmers’ wills did provide for executors’ review of the organizations and permitted a change in allocation, but the bequests were made as stated in the will.)
Provide for Change of Organization
Occasionally, NFPs cease to exist or merge with another organization; a bequest made to one organization can then become the property of another. Donors of restricted gifts should specify the focus of the restriction so that the endowment can live beyond the original recipient organization. When organizations merge, the missions of the two institutions may be the same, but the location and recipients may not be. An endowment given to an institution geographically distant from the first could undermine the intent of the gift. Specific language in the gift instrument should make clear the parameters of the gift, for example, whether it is organization, location, or mission specific.
The Othmers’ will did not specify the motives for the bequest; however, it appears the bequest was institution- and geographic-specific. Donald Othmer served on LICH’s board, and Mildred volunteered there. Their wills did not provide for other medical institutions, while they did provide for many other organizations located in Brooklyn. With the sale of LICH, the court ordered that the Othmer endowment assets fund the Long Island College Hospital Medical Malpractice Trust to pay for malpractice claims against LICH. Better documentation about the reason for the Othmer bequest would have provided the courts with important information when determining the disposition of the bequest.
Structure Bequests to Tighten Restriction Provisions
Protecting a restriction on a bequest to an NFP can be difficult when the bequest is made directly to an organization, as NFPs have legal means available to remove restrictions from bequests.
The Uniform Prudent Management of Institutional Funds Act (UPMIFA), approved by all states except Pennsylvania, allows organizations to amend bequest restrictions when a restriction is “unlawful, impractical, impossible to achieve, or wasteful” [section 6(c)]. In these cases, the NFP will request court approval to modify the restriction. The organizations can also remove restrictions without court approval but with notification to the state’s attorney general for endowments that are less than $25,000 and more than 20 years old [section 6(d)]. New York has approved its own version of UPMIFA, which specifies a threshold of $100,000 [New York Not-for-Profit Corporation Law (NYNFPCL) Article 5-A, section 555(d)(1)]. New York law also requires that organizations seeking to modify donors’ restrictions contact the donors, who have a right to respond to the organization’s request for modification [NYNFPCL, Article 5-A, section 555(c)]. But many states do not permit descendants or their executors to be involved once a bequest is made. Often, the only parties to a cy pres action are the requesting organizations representing their interests, the attorney general representing the public’s interest, and the courts, with no organization specifically representing the deceased donors’ interests.
As stated above, the Othmers’ bequest went directly to LICH and required the funds to remain as a permanent endowment, with only the interest on the endowment available for general use by the hospital. LICH petitioned the court on three separate occasions to modify the restriction. The first petition occurred in 2000, just one year after receipt of the bequest, and the court allowed the endowment to be used as collateral on a loan. Subsequent cy pres filings in 2006 and 2011 permitted further invasion of the endowment fund. No entity (person or otherwise) argued on behalf of the Othmers’ interest in any of these hearings. While the invasion of the bequest was approved with court review, it is contrary to the original terms of the gift, an inherent risk for bequests made directly to the organization when no specific entity has donor standing to monitor the restrictions.
Donors may be unaware of laws governing organizations’ ability to challenge donor restrictions. CPAs should discuss with donors the current laws regarding restriction modification to allow donors to determine the actions they may want taken on their behalf. New York law states that when possible, modification should be consistent with probable donor intent [NYNFPCL, Article 5-A, section 555(c)]. To remove any uncertainty about intent, donors can leave detailed written information that adequately describes their wishes, including anticipating future changes in economic or social conditions that might require a petition for modification.
Donors also can designate another to act in their capacity, with language added specifically to the endowment agreement specifying that designated individuals have the right to enforce the restrictions. Article 5-A, section 551(a)(a-1) of the New York Not-For-Profit Corporate Law allows persons to act “in place of the donor,” although the persons cannot be executors or heirs of the estate. This provision provides a surrogate donor with additional rights that ordinarily would not exist for a bequest and could result in the donors’ right to monitor the bequest restriction in perpetuity. This use of a surrogate donor would allow for specific representation of donor interests in hypothetical cy pres proceedings.
Establish a Foundation
Establishing a private foundation that allocates the bequest over time can provide assurance that donations are spent in accordance with the donors’ wishes. By providing the organization with a yearly gift rather than the entire amount, foundation trustees can monitor the recipient’s use of the gifts. Even with this option, however, there is the potential for an unexpected change in the foundation’s priorities. To avoid mission creep over time, donors may consider limiting the life of the foundation. A limited-life foundation is less likely to experience a change in mission, as the trustees are more likely to know the benefactors and understand their perspective.
For bequests that are smaller, the cost of a separate private foundation may be impractical. In such cases, donating to an existing community foundation is a simple and cost-efficient way to ensure formal monitoring of the funds. Donors can choose to have their bequest join endowments already restricted for a particular purpose or to establish a new restricted endowment. The community foundation will monitor the use of the funds. Alternatively, donors can establish a separate donor-advised fund. Rather than the community foundation assuming complete funding and monitoring decisions, a second-generation or successor advisor can determine yearly fund distributions. In these cases, donors should provide the foundation with specific language about the donation’s intended use. This documentation can be used as additional evidence of donor intent.
Honoring Donors’ Wishes
When donors restrict their bequests, they have some expectation that the restriction will be honored long after they are gone. When creating the framework for the bequests, CPAs can add protections that will help ensure the bequests are used as the donors intended. For the Othmers’ restricted bequest, however, the outcome is uncertain. The most recent Form 990 of the LICH Malpractice Trust, funded using the Othmer bequest by court order, shows assets of approximately $83.5 million and an equal amount of liabilities to pay for malpractice claims. LICH has been closed and the real estate sold to a developer for $240 million, with the proceeds going not to pay for the malpractice claims nor to replenish the Othmer bequest but to SUNY Downstate Medical Center.