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Public Charities May Face Scrutiny If Too Frugal

Question of the Month: How much money can a public charity keep in the bank? Technical answer: As much as it wants, and there is no law saying otherwise, state or federal. Real world answer: It depends.

It defies most people's common sense, but public charities (the organizations exempt from federal tax under IRC 501(c)(3)) are under no legal obligation to spend any particular amount of their resources on charitable activities, as long as they spend some. In contrast, private foundations are required to spend at least 5 percent of their endowments every year. Many non-profit

board members, some of whom may have their own private foundations, assume they have some legal obligation to spend the money on their missions if only because they feel a moral obligation to do so.

But, as the Senate and Consumers Union found out this summer, some non-profit board members are very aware that they don't have to spend the money. When its federal funding was up for consideration earlier this year, the Boys & Girls Clubs of America was asked for its financial records by four senators, led by Chuck Grassley of Iowa. The charity was then asked to explain why it kept $107 million in investments while local clubs were being closed for lack of funding. The senators were also interested in why half of the charity's investments were in offshore funds designed to avoid the unrelated business income tax. Finally, the senators noted that in a recent five-year period the charity's payouts from its endowment funds never exceeded 2.98 percent a year, much less than the minimum required of private foundations.

Ordinarily the Boys & Girls Clubs wouldn't have to worry about the senators' questions, but the senators felt they had the right to ask. After all, the charity has received more than $650,000,000 in federal funds since 2000. The law may not require the Boys & Girls Clubs to spend more for charity, but the prospect of losing federal funding can open the purse just as well as a truly charitable impulse might.

Also this summer, non-profit health insurers attracted the attention of Consumers Union, which reported that seven of 10 Blue Cross Blue Shield affiliates it studied had surpluses more than three times the level needed to remain solvent, even as some of them raised premiums on their customers. The Arizona affiliate kept a surplus of $717 million (seven times the regulatory minimum) while its premiums went up between 8 and 18 percent. Health Care Service Corporation, an affiliate operating in Texas, Illinois, New Mexico and Oklahoma, had five times the regulatory minimum of surplus funds while also increasing its premiums over the last three years. In all, the Blue Cross Blue Shield plans nationwide held more than $32 billion in surplus funds on their balance sheets at the end of 2008. That number is a sharp increase in surplus amounts from just a few years earlier.

Clearly, sensible non-profit management demands that there be surpluses. Charities need reserves just as commercial entities do. In the charitable sector, however, the charities have missions to fulfill and the law gives them wide discretion in how to do that and how much of it to do. It also allows them to do almost nothing and still retain their tax exemption. The result is that unless the charity managers decide to spend enough of their resources on programs to pass a public "smell test" of a sort, they will continue to get questions from senators and studies from consumer groups.

If they persist in their frugality, they could even get a statutory minimum to spend, and that would be the worst outcome. The private foundation 5 percent minimum payout rule is a good example. It has, effectively, become a maximum standard--it is now a ceiling, rather than a floor. We would be better off with more charity than with a new rule.

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Bruce D. Collins

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