Tax Update
Sean P. Callan
John Christopher

Set-asides

Fraternity Foundation Grants – “The Players”

Fraternity Foundation Grants – What Can be Funded?

Fraternity Foundation Grants – Papering the Deal

Fraternity Top 10 List


What is the set aside procedure?
Under the Internal Revenue Code, college
fraternities and sororities pay federal income
tax on their investment income of over
$1,000 per year - e.g., dividends on stock,
interest on bank accounts, rents, royalties,
net capital gains and the like - unless such
funds are set aside to be used for charitable
and educational purposes. If such funds are
properly set aside and used, no federal
income tax is then payable.

The set aside procedure should be instituted by first determining the amount of net investment
income that would otherwise be subject to tax. The organization should then adopt a
resolution like that below, setting aside the amount of such net investment income (or the
desired amount, if less) in a separate bank account, which is identified as a "set aside fund". It
is very important that this exact procedure be followed.
SUGGESTED RESOLUTION
At a meeting of the (governing body) of ______________ Fraternity, on the _____ day of
___________, 200__, after discussion of the net investment income for the organization's fiscal
year ending __________________, 200__, the following motion was duly made, seconded, and
unanimously resolved as follows:
RESOLVED, that the amount of $__________ be set aside from the general assets of the
__________________ Fraternity in a separate bank account to be known as set aside account no.
______ of ________________ Fraternity.
RESOLVED, FURTHER, that said amount of $______________ may be used only for the following
purposes: Religious, charitable, scientific, literary or educational purposes, loans on local
chapter housing, or for the prevention of cruelty to children or animals; and for scholarships,
student loans, leadership and citizenship schools and services, and similar purposes.
_____________________________
President




All amounts set aside should first be deposited in a set aside
account before being disbursed for qualifying purposes. The
account should clearly be labeled as set aside funds and
preferably each year's set aside should also be separately
designated--e.g., set aside 1-2005; set aside 2-2006, etc.
It must not be commingled with an organization's general funds.
While set aside funds need not be used in the same year set
aside, in general, money in a set aside account should not
accumulate for more than two or three years after it was set
aside. Therefore, when an organization needs funds for any
qualifying purpose, the amount should first be taken from set
aside funds and earlier years' set aside funds should be depleted
before later years.
If the amount is large, it may also be invested in other ways--for
example, money market or mutual fund--as long as it is
properly segregated and labeled as a set aside fund. However,
long term investments that are not readily available should be
avoided as set aside funds are supposed to be used within a
"reasonable" time.

Set aside accounts cannot be loaned for
general fraternal purposes. In addition, an
organization may not pledge the set aside
monies or otherwise use them as collateral
for a third party loan. If such a transaction
occurs, the set aside funds immediately
become taxable.


Q. Is the set aside procedure available for
investment income that has been debt-financed-for example, rent received on real estate that
has a mortgage on it?
A. It has been the IRS' position since the set
aside procedure first came into the Internal
Revenue Code in 1969 that debt-financed
income, such as is described in this question,
would not qualify for the set aside procedure and
that unrelated business income tax is due
thereon under the rules of Code Section 514
relating to debt-financed income of exempt
organizations generally.


Q. What is the relationship between the set aside rules
and the 35% test under which a fraternal organization
may lose its exempt status if it receives more than 35%
of its gross receipts from non-member income?
A. Since investment income is by far the most common
type of non-member receipts for Greek organizations,
the investment income which is set aside counts
towards the 35% requirement, even though it is set
aside and no tax is paid thereon. It is important to
note, however, that if the 35% level is exceeded, then
even though tax is paid on the non-member investment
income, the organization still has exposure with regard
to the possible loss of its exemption--in other words,
paying tax does not resolve the 35% test issue.


Q. Can capital loss carryover deductions be
applied against an organization's current year's
investment income in determining the amount of
net investment income to be set aside?
A. Since the federal income tax law generally
allows deductions for capital losses to offset
capital gains, and allows capital losses in excess
of capital gains for a particular year to be carried
back three years and forward five years, it seems
reasonable to conclude that capital loss
carryovers are allowed as deductions from capital
gains for purposes of the set aside calculation.


Q. Is the set aside procedure a one time election
or can it be made every year? Also, does the set
aside procedure have to be used in its entirety or
can a partial election be made?
A. There is considerable flexibility for fraternal
organizations in the use of the set aside
procedure. An organization can use the set aside
procedure one year and elect not to use it in the
next year and so on, and vice versa. Also, the set
aside procedure can be used for a specific
amount of investment income and the
organization can elect to pay tax on the
remainder, thus freeing up such funds for
general fraternal uses.


Q. What can a fraternal organization do if its governing body is
ready to approve the set aside resolution and the amount of
investment income has not yet been computed?
A. This is a scenario that is encountered quite frequently. The
set aside election, in order to be effective, must be made by the
date that the organization's Forms 990 and 990-T are due to be
filed, including any extensions. The amount of set aside income
must be computed with accuracy and should be identical on the
organization's audited financial statements, tax returns and set
aside resolution. Therefore, the proper method is to wait to file
the election on the organization's tax return until this amount
has been computed with accuracy, even if that means that an
extension must be secured to file the return. In other words,
filing the organization's tax return too soon with the wrong
amount leaves any excess investment income subject to tax, so it
is much better to postpone adoption of the resolution and the
filing of the tax return until the organization is certain that the
set aside amount is accurately computed.

Normally – 2 Parties
◦ The Fraternity – 501(c)(7)
◦ The Foundation – 501(c)(3)
Fraternity is not a charity!
1. Tax exempt? Yes, but not
charitable….
2. Member based – not formed to
benefit
others
3. Few limits on spending for
members
4. Donations not tax deductible
Foundation – charity!
1. organized and operated exclusively for
religious, charitable, scientific, . . .
literary, or educational purposes,
2. IRS limits spending to these purposes!
3. Donations – Tax deductible by donor
 Penalty
for violation
◦ loss of exemption;
◦ loss of deduction by donors
◦ AG action against trustees; and
◦ IRS scrutiny of industry
The Service has indicated that funding for
chapter consultants, graduate consultants and
similar leadership trainers can be made available
by a foundation to its related fraternity, provided
that the percentage of fundability is derived from
time sheets kept by these persons on a
contemporaneous, 40 hour per work week basis
(similar to the requirement for in-office
employees discussed below). When this
percentage has been obtained, it may be
multiplied by the overall expenses for the activity
for the year in question, to obtain the fundable
amount.
The Service has also ruled that a foundation may fund its related
fraternity's sponsored conventions, leadership conferences and
similar meetings, provided that the basis for fundability is
determined by a careful and reasoned analysis of the official
program and other materials with respect to the conference or
meeting in question. At least for large expenditures of this nature,
the organization should obtain a written opinion setting forth the
appropriate percentage. Also, organizations should bear in mind
that workshops of this type which are 100% educational by IRS
standards, although they do exist, are extremely rare; thus, if it is
determined that a particular meeting does qualify for 100% funding,
that decision needs to be carefully reviewed.
Also, in this connection, it is important to note that a foundation
may fund fraternity educational programs only on a "net" rather than
"gross" basis. For example, if a fraternity sponsors a leadership
conference which is 50% educational by IRS standards, the expenses
are $100,000 and attendees pay $50,000 in admission fees, the
maximum amount that a foundation should fund is $25,000. Also,
there should be no "doubling up" as between the fraternity's set
aside funds and the foundation - in other words, if the fraternity's
set aside funds fully or partially fund an activity, then the
Foundation cannot provide the same funding and vice versa.
With regard to written materials, videos and similar
publications separate and apart from meetings of the type
described above, the holding in the Phi Delta Theta case,
requires that such items be 100% educational in content to be
funded by a foundation for its related fraternity. In other
words, no allocation of the type describe above is allowed for
written materials, videos and similar publications. Therefore,
scholarship manuals, publications or videos concerning date
rape, alcoholism, health and safety issues and similar topics
are fundable but new member manuals and the like are
generally not so fundable. Again, at least for large
expenditures, the organization should obtain a written
opinion based upon a review of the text or viewing of the
item in question.
A foundation may also make administrative
grants to its related fraternity, based upon
the Phi Gamma Delta Excerpts, for the
educational and charitable percentage of the
fraternity's operations, provided that such
grants are based upon contemporaneously
kept, written time sheets of the fraternity's
employees, again on a 40 hour work week
basis. These grants can cover the
appropriate percentage of headquarters
expenses, salaries of employees and the like.
The Service has also indicated that a
foundation may fund museum space and
archival work of its related fraternity,
provided that these items are not confined to
the history of the particular fraternity alone
but also cover the fraternity's relationship to
educational trends, the place of women in
society and similar, broader topics.
Grant Proposal




In writing!!!
Goal oriented – not $ oriented…….
Joint venture to find common ground
Sufficient detail for real Board review
Grant Agreement





Again, in WRITING!!!!
Articulate clearly the educational component of
program
IRS required
Monitoring and claw-back provisions
Impact evaluation
1. NO GRANT AGREEMENT AT ALL!!!!
◦
◦
◦
IRS required
Must be written
Benefits fraternity
 Assurance that it can keep $
 Assurance of continued existence of foundation
 Requires follow-up/evaluation
2. Too many grants covered by
same agreement
◦ Very common
◦ Best practice – one agreement per
grant
◦ Less room for error – one on one
3.
Fail to articulate
educational purpose
◦ Another common error
◦ Details are perfect; no idea what
purpose is
◦ IRS concern – purpose more than
logistics
4.
Board review and approval
◦ Very important!!!
◦ Must appear in minutes
◦ Board authorized officer must sign
◦ Keep originals for each organization
5.
Recoup unused funds
◦ Monitoring and claw-back
◦ Unused fund should be returned, not carried
over or applied to different grant
6.
Follow-up reports
◦ Again, very important and often overlooked
◦ Value to fraternity as well
◦ Is the expenditure working?
7.
Supporting Documentation
◦ Must be more than a budget and request
◦ Chapter consultants – time cards
◦ % content – how is this demonstrated?
◦ Even 100% - get program and follow-up
8.
Amendments
◦ Must follow same formalities
◦ Clearly articulate relationship and need to
alter relationship
◦ Why is the change needed?
9.
Using Industry Terms
◦ IRS agent will review – that is the audience
◦ Avoid acronyms – TIPS
◦ Avoid trade lingo
10. Using grant agreement
when you need reimbursement agreement
◦ Salaries and overhead paid to fraternity