(a) Constitutional Law Background

Legitimate charitable organizations and their fundraising professionals generally do not object to reasonable registration and reporting obligations in connection with their charitable solicitations. Few like government regulation, but it has come to be accepted within appropriate bounds. Even if charities and fundraisers do complain (and they have been known to vociferously do so), it is irrelevant, because the law is clear that these and other forms of government regulation of fundraising may be imposed. Each state inherently possesses and exercises the police power, and this authority enables it to look out for the interests of its citizens (who are actual or potential contributors) and strive to protect its populace from unscrupulous charitable solicitations.⁷

The problem, as seen through the regulatory prism, is well reflected in the “legislative declaration” preceding the fundraising regulation statute in Colorado. That state's legislature concluded that “fraudulent charitable solicitations are a widespread practice in this state which results in millions of dollars of losses to contributors and legitimate charities each year.” This sweeping declaration continues with the observation that “[l]egitimate charities are harmed by such fraud because the money available for contributions continually is being siphoned off by fraudulent charities, and the goodwill and confidence of contributors continually is being undermined by the practices of unscrupulous solicitors.” This legislature thus found that the law it enacted was “necessary to protect the public's interest in making informed choices as to which charitable causes should be supported.” (It is hard to believe that fundraising rapaciousness can be so replete in a state; it can be surmised that this declaration was made on the basis of little, if any, evidence.)

Still, when undertaken for charitable ends, the fundraising process is, as noted, an act of free speech. Indeed, charitable fundraising is among the highest forms of free speech, fully protected by the First and Fourteenth Amendments to the U.S. Constitution, meaning that governmental enforcement of it must be confined to the narrowest of means.⁸ These distinctions cause great tension and conflict in the writing and enforcement of the state charitable solicitation acts. The law requires that the police power be exercised in a manner that includes the appropriate restraints on enforcement of these laws as called for in the preservation of free speech rights. Regrettably, state legislators repeatedly violate these principles, writing laws that are overbroad, unduly burdensome, imprecise, and content-based. For example, as discussed later, states not so long ago were trying to regulate charities' solicitations by means of fundraising cost percentages, in the face of repeated declarations by the U.S. Supreme Court and other courts that they may not do so.⁹

The Supreme Court made it clear, in a trilogy of opinions issued during the 1980s, that the regulation of the process of fundraising for charitable purposes must be undertaken only by the most restrictive means because the solicitation of these gifts is a free speech right of the charities and those who raise funds for them.¹⁰ Two of these cases were launched by fundraisers for charities, rather than the charitable organizations themselves.¹¹ The Court held that free speech and charitable fundraising are inextricably intertwined, so that the fundraiser, as well as the charity, can assert the constitutional law protection.

In the first of these cases, the Court laid down the fundamental principle that a state government may constitutionally limit speech in serving a legitimate state interest as long as it does so “by narrowly drawn regulations designed to serve those interests without unnecessarily interfering with First Amendment freedoms.”¹² That is, a state government may regulate the content of constitutionally protected speech to promote a compelling interest it has, if the government confines itself to the least restrictive means of furthering the articulated interest. Otherwise, a form of regulation of charitable fundraising is to be voided as being unconstitutionally overbroad, as a transgression of free speech or other protected rights.

In one of the federal court cases decided in the aftermath of this trilogy, an appellate court held that a state law requirement that a professional solicitor must submit the script of an oral solicitation to the state for its examination at least 10 days before the commencement of the solicitation was unconstitutional.¹³ The court found that the requirement was an inappropriate prior restraint on free speech, being overly broad in its scope. The state contended that the law was the most effective means of monitoring telephone solicitations, but the court dismissed that argument with an observation that resonates throughout the entirety of the law on this subject: The First Amendment “does not permit the State to sacrifice speech for efficiency.”¹⁴

Thus, the posture of the law today, regarding the validity of a state charitable solicitation act, is that any provision of the law that impedes the charitable fundraising process is unconstitutional unless it is the most narrow form of regulation; however—and some in the fundraising profession remain in denial about this—in general, the basic components of a charitable solicitation act, such as those requiring registration, fees, bonds, reporting, disclosure, record-keeping, and prescribed contracts, are constitutional. This is the case irrespective of whether the entity being regulated is the charitable organization, a professional fundraiser, a professional solicitor, or a commercial coventurer.

(b) Fundraising Cost Percentages

The most frequent application of this aspect of constitutional law concerns the attempts of the states to bar charitable fundraising where the expense of the solicitation, stated as a percentage of receipts, of the charitable organization involved is deemed to be excessive or unreasonable. Another variant is an attempt to prohibit compensation paid to a professional fundraiser or professional solicitor where the amount involved exceeds a particular percentage. Both of these types of laws have uniformly been struck down as being facially unconstitutional, overbroad, and not serving a legitimate governmental interest.

This subject is addressed elsewhere in the book in greater detail.¹⁵ The point to be made here is that a charitable organization's fundraising is, for these purposes, held up by the state legislators and regulators as the sole means for determining the charity's worth or validity in the eyes of a prospective donor. “High” fundraising costs are perceived to be an indicia of fraud.¹⁶ The fallacy of this underlying premise seems so obvious as to not merit analysis.

Yet it must be said: the thought that the merits of a charity can be distilled to nothing more than a percentage of fundraising costs is a conception that is based on a wholly invalid premise. That is the case because many variables account for the fundraising expense of a charity in a particular year, and some of these variables have little or nothing to do with the merits of the charity or its cause.¹⁷

The trilogy of cases referenced previously, and subsequent lower-court opinions, proclaim the principle that the touchstone of a charitable organization is not its fundraising expense; they stand for the principle that high solicitation costs are not an accurate measure of the presence of fraud. Laws that focus so intently on fundraising expenses are rules that attempt to limit access to fully protected speech based solely on dollar “efficiency”; the cost of speech has never been found to be a constitutionally appropriate measure of regulation.

Some fundraising methods are inherently more expensive than others. There are organizations whose programs are so controversial as to impede fundraising and thus increase costs. Usually, fundraising costs are higher in the early years of an organization's existence. An organization may have higher costs at the outset of fundraising, then reduce them over the years. A charitable organization with a well-developed constituency is likely to have much lower fundraising costs than one that does not. Legitimate charitable organizations do not deliberately strive to have “high” fundraising costs. There is no uniform way to measure these expenses. Indeed, there is disagreement about what is embraced by the term fundraising and controversy about when and how to allocate costs between program and fundraising activities.

Several variables account for fundraising expenses in any particular instance. A practical aspect of analysis of these variables shows that it is unfair to focus on the charity's costs or the fundraiser's fee. The success or failure of a campaign in a financial sense is likely to depend on such a multitude of factors as to be incalculable until completion of the campaign. Thus, the fundraising costs or the solicitor's fee (stated as a percentage) may not be known until the fundraising effort is completed—with a risk of violation of a law of this nature arising only after the fact.

Many factors, other than fundraising costs, should be taken into account in judging the efficacy of a charitable organization. Fundraising costs may be a factor in evaluation, but they should be judged in context, rather than as an isolated element inflated as to importance and distorted as to meaning.

It is a measure of the states' zeal to regulate charitable solicitations on the basis of fundraising costs that they have been driven—again and again—to enact blatantly unconstitutional laws. Two examples have been those enacted in California and Kentucky. The Kentucky law was struck down as unconstitutional in 1994;¹⁸ the California law was restrained by a permanent injunction issued in 1995.¹⁹ One must ask: Why do the state regulators continue to press for these laws, why do legislatures enact them, and why do governors sign them into law instead of vetoing them—even when advised by the state's attorney general that they are unconstitutional?²⁰ These misguided, all-too-frequent forays into this morass of lawmaking fly directly in the face of well-settled constitutional law and represent gross misapplications of state resources.

The element of fundraising costs remains a wholly arbitrary and ineffective means of evaluating a charitable organization's efficiency or program worth. It is a factor that only superficially appears to have any connection with a charity's “value.” Those (too frequently, politicians) who point to it as an indicator of the merits of a charity often know better and thus are guilty of pandering. Over the decades, governors, attorneys general, and legislators (federal and state) have shamelessly postured on the issue of charities' fundraising costs.²¹

(c) Fundraisers and Solicitors: Defining the Difference

Another major problem with the state charitable solicitation acts is the failure of the legislators and regulators to divine an adequate definition of the terms professional fundraiser and professional solicitor (or equivalent terminology).²² In the past, the definitions and distinctions written into the various state acts sufficed; today, they are so out-of-date, unrealistic, and inconsistent as to be nearly worthless.

In earlier, simpler times, the law viewed the fundraising professional as a consultant, one who assisted charitable organizations in planning a solicitation program or campaign, although the charity actually sought the gifts. The professional solicitor, by contrast, was a person who, in lieu of but on behalf of a charity, solicited gifts. At best, the latter had a poor reputation as one who begged door-to-door or on a street corner, or—worse—solicited by telephone from the proverbial boiler room.

Those distinctions have been blurred and sometimes erased by the advent of developments such as direct-mail solicitations, telemarketing, and Internet communications. The bright line of distinction between consultants and solicitors has evaporated. The dichotomy started to fade with the massive use of direct-mail fundraising, where those who consulted on the design of the literature also physically introduced it into the mails, thereby arguably becoming part of the solicitation process. Soliciting by telephone in recent years has come out of hiding and into respectability, with the callers regarded as solicitors. Some of those who previously were solely solicitors began adding fundraising planning to their services. The demarcation line was irreversibly crossed when telemarketing came into vogue as a fundraising medium, causing the easy distinction between fundraising executives and solicitors to be lost forever.

Under contemporary legal precepts, many of those who are, generically, professional fundraising consultants are considered professional solicitors. This results in two problems. First, despite recent changes in practice, professional solicitors still suffer from the stigma of the past—the image of being the underbelly of philanthropy. Consequently, professional fundraising executives are loath to be viewed—by charities or their colleagues—as professional solicitors.

Second, the state charitable solicitation acts nearly uniformly treat professional solicitors more harshly than is the case with professional fundraisers. Registration fees and bond requirements are higher, and more disclosure and reporting are required. Fundraisers are forced to go through great legalistic contortions and acrobatics to avoid being classified under the law as solicitors, even though their services often partake of the functions of both. But the law does not accommodate this hybrid form, except to treat consultants and solicitors the same—as solicitors—which only compounds the problem and magnifies inherent unfairnesses. Indeed, some state charitable solicitation acts have essentially abandoned the distinction, regarding just about everyone who assists charities in the fundraising process as a solicitor.

Even if the assumption is granted that the professional solicitor is the bane of the field, reasonable individuals should somehow be able to conjure up a definition of the two categories. The distinction between those who have some role in the solicitation process and those who do not is, for the most part, obsolete. It makes little or no sense to regard a consultant as a solicitor simply because among the bundle of services performed is the function of helping to place fundraising literature in the mail. A more appropriate differentiation would be between those who first receive the donated funds and remit a net amount (if any) to the charities and those whose services are paid for by charitable organizations that received the contributions directly. What is needed is a definitional distinction that allows the states to monitor and prosecute the weekend bandits without unduly and unnecessarily regulating the legitimate fundraising executives and consultants.

(d) Bond Requirements

Typically, state charitable solicitation acts impose on professional fundraisers and professional solicitors the requirement that they procure a bond before commencing with their services.²³ The purpose of the bond is to offer some protection to the citizens of the particular state who have donated to charity, or what they thought was charity, under circumstances in which they may have been bilked.

The problem with bond requirements in this setting stems from the aforementioned failure of the law to make a meaningful distinction between fundraising consultants and solicitors, in that bonding only makes sense when it pertains to those who have direct and initial access to the donated funds.

Although today's definitions are at best vague on the point, one of the basic generic distinctions between a professional fundraiser and a professional solicitor is the handling of contributions. Basically, where the services of a professional fundraiser are provided to a charitable organization, the charity—not the fundraiser—is the solicitor and the recipient of the gifts. Usually, where a professional solicitor is involved, the gifts are made to the solicitor; the solicitor is reimbursed for expenses and paid a fee; and the net amount is paid to the charity involved. Therefore, a bond (or similar form of security) has some logic when required of a professional solicitor; it is of no utility when applied to a professional fundraiser.

Why, then, do some state laws extend the bond requirements to professional fundraisers? It is because the writers of these laws often do not understand the distinction between a professional fundraising consultant and a professional solicitor. This is partially a function of the matter discussed earlier; it is also partially a misconception about the workings of the charitable solicitation process, in the sense of understanding who is receiving the charitable dollars.

Procuring and maintaining these bonds can be expensive and time-consuming. There are preferable alternatives, such as use of a certificate of deposit, letter of credit, or U.S. obligation, filed in lieu of a bond. This approach allows investment assets to be pledged while not disturbing the underlying investment. It eliminates the expense of premiums and reduces the time and costs associated with renewals of bonds. This is an idea all states should embrace, whether for professional fundraisers or professional solicitors.

(e) Other Features

Other features of the states' charitable solicitation acts also pose problems for charitable organizations and professional fundraising consultants.

Most of the state laws contain several types of prohibited acts that apply to charities and fundraisers.²⁴ These prohibitions often go far beyond the scope of fundraising regulation as such, and violations of these rules can bring heavy penalties.

Some laws require complex and onerous disclosures by professional solicitors.²⁵ Although these laws are designed to drive solicitors out of the states and keep them out, they often also apply to professional fundraisers, thereby causing many compliance problems. Some of the states require burdensome confirmations of donors' gifts.

These laws impose hefty registration, reporting, record-keeping, accounting, and other requirements on charitable organizations and professional fundraisers.²⁶ They often patronizingly dictate the content of contracts between charitable organizations and professional fundraisers and/or professional solicitors.²⁷ A growing practice is to require legends that are far from uniform and that clutter an otherwise carefully designed written charitable solicitation.²⁸ Some allow private lawsuits against fundraising consultants. The statutes are filled with injunctive, civil, and criminal penalties and carry sanctions of fines and/or imprisonment.²⁹ The attorneys general, secretaries of state, and other officials are given nearly unfettered authority to launch investigations, pursue injunctions, and prosecute those who (allegedly) have violated these laws.³⁰

A growing number of these laws contain requirements pertaining to what are termed either charitable sales promotions or commercial coventures.³¹ Many go so far as to have elaborate rules concerning the sale of tickets for charitable events.³² The list of limitations and prohibitions in some of these laws seems nearly limitless.

(f) Scope of Statutes

Every statutory law has its boundaries; a statute can reach only so far. What are the outer limits of a charitable solicitation act? Oddly, there is almost no law on the point. Given that the applicability of these acts almost always arises in the context of fundraising, which commonly entails the request for contributions,³³ and inasmuch as the other principal terms employed are charitable and solicitation,³⁴ it would not be unreasonable to assume that the state charitable solicitation acts do not extend beyond the realm of the solicitation of gifts (and perhaps grants). Yet, at least in some states, that assumption might be erroneous.

One of the most extreme—if not the most extreme—states on the point is Michigan. There, the state's attorney general asserts, the state's fundraising law also embraces the sale of goods or services by or on behalf of charitable organizations where it is advertised that some or all of the proceeds of the sale will be paid over for charitable purposes.³⁵ This position is manifested in an attorney general opinion, holding that a person who solicits funds for a charitable organization, representing that a portion of the proceeds will be used for charitable purposes, must be licensed as a professional fundraiser, even though the transaction embodying the “solicitation” is wholly a sale.³⁶ In the case, an individual solicited advertisements for a book to be published by a charitable organization, representing to prospective advertisers that part of the funds so earned would be used for charitable purposes.³⁷

In the analysis underlying this opinion, there is considerable discussion about circumstances in which a transaction is partly a gift and partly a purchase; there should be no question that transactions of this nature invoke the statute.³⁸ Yet, the opinion extends to transactions in which there is no element of a gift (nor solicitation of a gift in the context of the purchase). The state's statutory definition of a contribution excludes most dues; the attorney general read the exclusion to mean that all other forms of purchases of services (or goods) are to be treated as contributions.³⁹ Despite this opinion, it is hard to believe that a state's charitable solicitation act applies to sales transactions simply because some proceeds of the transactions will be devoted to charitable ends. This would mean that a charitable organization that generates revenue only through the sale of goods or services (such as a theater or home for the elderly or a charity raising money by means of a car wash or bake sale) would have to comply with one or more charitable solicitation acts. In actual practice, the laws are not being enforced in that manner.

Regarding the matter of the boundary, this opinion also asserted that, if “simply because the donor [note the term] was provided some benefit, such a payment could not be deemed a charitable contribution, then all of the safeguards established in [the act] could easily be circumscribed by an organization or fund-raiser.” In fact, the matter is precisely the opposite: if a payment is not a charitable contribution, the transaction would fall outside the reach of the statute. The “safeguards” of these laws would be “circumscribed,” but only because they simply do not apply.

In one instance, an attorney general's office attempted to apply the state's charitable solicitation act to the solicitation of corporate sponsors for a marathon conducted to generate proceeds for a charitable organization. The matter found its way into court, where it was held that the statute was inapplicable. The court concluded that the transaction was a “commercial” one and that it did not involve “gifts.” As the court succinctly stated, the solicitation had “nothing to do with philanthropy.”⁴⁰ That is the correct statement of the law generally: these statutes do not apply where the charitable “fundraising” does not entail the soliciting or making of any contributions.⁴¹

Thus, notwithstanding the state of the “law” in this one jurisdiction, the better view is that the state charitable solicitation acts apply only where the transaction involved entails, in whole or in part, a contribution. If a state legislature wanted to expand its charitable solicitation act to encompass all sales of goods and services by and for charities, presumably it could do so; such an expansion of the law, however, might prove impolitic.

(g) Conclusion

A considerable majority of the states have significant charitable solicitation acts.⁴² A fundraising charitable organization that is located in one of these states, and/or is soliciting in one or more of these states, faces (unless exempted) a formidable array of requirements. It is one of the many anomalies of the law that a person can engage in many forms of behavior that are potentially harmful to society—and face far less regulation. For example, in some states, regulation is far more stringent for solicitation of a charitable gift than for purchase of a firearm.

Why this mountain of law came into being is not clear. This circumstance is particularly mysterious when played off against the fact that the activity that is heavily regulated is an exercise of a constitutional right and the response to it is a voluntary act. As to the latter, charitable giving is, of course, not mandatory. If a person is uncertain about making a contribution to a charitable organization, the putative donor can simply defer the gift until the uncertainty is resolved (as, for example, by obtaining wanted information). (If a donor is giving at the last minute for tax purposes, a “safe” donee—perhaps a college, hospital, or the donor's own private foundation—can be selected.)

Not only is the rationale for all this law a mystery, so too is whether any of it is accomplishing anything of consequence. (This rationale is not to be confused with the purpose underlying these laws, which is to protect the public against unscrupulous fundraisers and unworthy charities.) Are there many fraudulent and other misrepresenting charitable solicitations? Are there many unscrupulous charities? Or ill-meaning fundraising efforts? Are individuals really being protected?—and, if so, from what?

The truth is that no one knows. Those who portray the charitable sector as riddled with abuse are those who have a vested interest in portraying the sector, or selected entities in it, in as negative a perspective as possible: the regulators, the watchdog agencies, and the media. Even in those quarters, it appears, an authentic case is not being made: grand extrapolations from a few bits of anecdotal evidence do not prove anything.

So, the charitable community watches and struggles with these charitable solicitation acts. While conceding a legitimate purpose for these laws (protection of the citizenry), one may ask just what task or tasks all these “apparatuses” are accomplishing. Might not the energy and public money (tax revenues) consumed by these apparatuses be better used elsewhere (in or out of government)?⁴³

(a) Definitions

Among the headaches is the threshold definitional one: What is a fundraising professional? At a simplistic level (the historical one), a fundraising professional is either an employee of a charitable organization or a consultant, the latter being one who assists charities in planning and implementing a solicitation campaign. Generally, only the latter type of fundraising professional is subject to state regulation. The actual asking for gifts is, according to this level of analysis, the province of the charities, who do this using volunteers.

To continue this line of analysis, there are exceptions, of course, and sometimes charities obtain contributions through paid solicitors. This practice has been generally frowned on by fundraising professionals. Indeed, it was once thought throughout the world of philanthropy that “self-respecting” charities did not use paid solicitors and “proper” professional fundraisers did not associate with them.⁴⁵

The laws among the states were written with this dichotomy in mind: the consultant and the solicitor. Thus, today, the predominant definition of a professional fundraiser is this:

Any person who for a flat fixed fee under a written agreement plans, conducts, manages, carries on, advises or acts as a consultant, whether directly or indirectly, in connection with soliciting contributions for, or on behalf of, any charitable organization, but who actually solicits no contributions as a part of such services.⁴⁶

As can be seen, there are two principal elements of this definition: the professional fundraiser does not solicit gifts and is paid for the service provided (the definition thus excludes volunteers). This definition (or a similar version of it) of the term professional fundraiser is used in most of the states,⁴⁷ with some of these states using the term professional fundraising counsel. Other states use the term fundraising counsel.

The usual definition of the term professional solicitor—that found in the law in most of the states⁴⁸—is this:

[A] person who, for financial or other consideration, solicits contributions for, or on behalf of, a charitable organization, whether such solicitation is performed personally or through his [or her] agents, servants, or employees or through agents, servants, or employees specially employed by, or for a charitable organization, who are engaged in the solicitation of contributions under the direction of such person, or any person who, for a financial or other consideration, plans, conducts, manages, carries on, advises, or acts as a consultant to a charitable organization in connection with the solicitation of contributions but does not qualify as a professional fundraising counsel.⁴⁹

This definition has three principal elements: the solicitor asks for contributions, is paid for the service, and is anyone in the solicitation process (excepting volunteers) other than a professional fundraiser. A few states use the term paid solicitor.

Some states excuse from the status of either a professional fundraiser or professional solicitor those who are employees or officers of the soliciting charity, as well as lawyers, investment counselors, and bankers.

Over the years, there have been two problems with these definitions:

1. They increasingly do not work.
2. The derogation associated with being a professional solicitor has continued, with the law often being far more stringent with respect to solicitors than fundraisers.

As to the latter point, this aspect has been somewhat ameliorated, in that courts have struck down some of the harsher provisions as being unconstitutional.

Before discussing why these definitions do not work very well, it is important to note that there are other definitions of these terms. Consequently, considerable confusion exists in this area of the law at present. Some states so broadly define professional fundraiser that the definition includes a professional solicitor. For example, one state⁵⁰ defines a professional fundraiser as “any person who for financial compensation or profit participates in public solicitation in this state of contributions for, or on behalf of any charitable organization.” In another state,⁵¹ the term professional fundraising firm is used to describe what is usually defined, in other states, as a professional solicitor; two other state statutes⁵² contain the same anomaly. In one state,⁵³ the term professional solicitor is so broadly defined that it encompasses what is normally defined as a professional fundraiser. Another state uses the term professional commercial fundraiser to describe what most states define as a professional solicitor.⁵⁴

Some states define a professional solicitor as “any person who is employed or retained for compensation by a professional fundraiser to solicit contributions for charitable purposes in this state.”⁵⁵

The relatively easy-to-define dichotomy between professional fundraisers (i.e., as consultants) and professional solicitors has evaporated. This phenomenon started with direct mail fundraising, where those who consulted about the design of the literature began physically introducing it into the U.S. mails, thereby becoming part of the solicitation process. Soliciting by telephone has come out of the boiler room and become respectable, with the callers regarded as solicitors. The lines of demarcation were further blurred when telemarketing became a staple of fundraising.⁵⁶ The distinctions between consultants and solicitors are, today, all too antiquated.

(b) Defining Solicit

Part of the problem lies in the definition of the term solicit. (A search of case law on this subject yielded only cases concerning barratry—lawyers illegally soliciting business—or prostitution.) The state charitable solicitation acts define the term broadly. For example, the statute in one state⁵⁷ defines the term solicit as meaning “to request, directly or indirectly, money, credit, property, or other financial assistance in any form on the plea or representation that the money, credit, property, or other financial assistance will be used for a charitable purpose.” This is, obviously, a most encompassing definition of the word, although it is typical.

In part, this becomes a line-drawing exercise, with the question being: At what point does a consulting service become a solicitation service? As referenced earlier, direct-mail fundraising presents the dilemma. A firm that assists a charity in designing fundraising literature and does nothing more is a professional fundraiser. Yet, if this firm provides an additional service, such as mailing the literature for the charity, does it become a professional solicitor? Technically, the answer must be yes, because the act of mailing a letter requesting a gift is a solicitation. This is, however, an exceedingly technical application of the term.

The better view is to regard the firm in this instance as the agent of the charity. Nonetheless, several years ago, this issue was before the Pennsylvania Charities Commission. The fundraising firm involved designed the literature and further assisted the charity by physically introducing the literature into the U.S. mail. The literature was mailed using the charity's preferential postal rate, the envelopes contained the charity's return address, the gifts were returned to the charity, and there was no mention of the firm in the literature. Yet, because the firm provided the service of taking the bags of mail to the post office on behalf of the charity, the commission ruled that the entire operation of the firm was that of a professional solicitor.⁵⁸ So much for the “better view.”

(c) Reasons for Avoiding Solicitor Status

There are several reasons why a firm or individual would prefer to not be regarded as a professional solicitor. One of them is simply that of image. Solicitors are differentiated from consultants; they are characterized as those who go door to door, stand on street corners, or telephone during private time, seeking gifts. They are also portrayed as those who consume a large portion of the contributions intended for charitable ends.

From a law point of view, professional solicitors are often treated more harshly under the state charitable solicitation acts than professional fundraisers. As an extreme example, the statute in one state⁵⁹ is applicable only to those who solicit contributions (as noted, this law terms such persons professional fundraisers); apparently, persons who function only as consultants are not covered at all by the statute. Another illustration is the law in a state⁶⁰ where a fundraising counsel has to register with the state only where he, she, or it has custody or control of contributions from a solicitation.

In some states, professional solicitors must be bonded, although professional fundraisers need not be. In various states, professional solicitors are required to adhere to certain requirements about disclosure, confirmations, and receipts that do not apply to professional fundraisers. For example, in one state,⁶¹ professional solicitors must provide receipts to donors. As another illustration, in two states,⁶² extensive point-of-solicitation disclosure requirements are applicable to paid solicitors but not to professional fundraisers.

(d) Amending the Statutes

The most obvious way to resolve this dilemma is to amend the statutes. One would think this a rather reasonable way to proceed. Yet there is nearly total resistance to this approach, out of fear by the regulators that a loosening of the definition will allow solicitors, generically defined, to escape regulation. State regulators are so concerned about the weekend solicitors that their mindset is expansion of the concept of the professional solicitor, rather than dilution of it.

Nonetheless, there are at least two ways to proceed in this regard. One is to provide certain exceptions to the definition of the term professional solicitor to exclude, for example, organizations that mail fundraising literature where the mailing is in the charity's name and otherwise under its auspices. Another way would be to build the concept of principal and agent into the statutory definition.

Probably a more radical approach is needed. This approach would entail abandonment of these traditional definitions and a fresh start. The new definitions would recognize that many individuals and firms are now hybrids of consultants and solicitors. One of the elements to distinguish one from the other would be, as noted earlier, the matter of which person would receive the charitable gifts. Reasonable individuals can surely conjure up definitions that allow the states to engage in effective regulation of the process of fundraising for charity without overly regulating the authentic fundraising consultant.

The law in one state⁶³ comes the closest to this approach. That statute differentiates among fundraising counsel, professional fundraiser, and professional solicitor. Under this law, a fundraising counsel is one who, for compensation, only consults or otherwise assists charities with respect to fundraising but “who does not have access to contributions or other receipts from a solicitation or authority to pay expenses associated with a solicitation.…” The term professional fundraiser is defined in accordance with the majority approach, and a professional solicitor is one who solicits gifts as an employee of a professional fundraiser. (Among other things, under this law, a fundraising counsel is not required to procure a bond.)

There is a project here—members of the fundraising profession need to develop definitions of those who practice in the field and collateral to it. These definitions could then be submitted to the states in an effort to procure amendments of the state charitable solicitation acts on the point. At present, these definitions (and laws) are too often being written by legislators who do not understand the functions of the fundraising profession.⁶⁴

(a) Terminology

In short, a commercial coventurer is a business that, for differing reasons, wishes to help a charity. To this end, the business agrees to be a part of a promotion—indeed, to be the enervating and principal part—to benefit a charity. The motive may be purely charitable; more likely, it is a blend of motives: part charitable intent, part marketing, and part the development of goodwill in the community or across the country.

The enterprise is termed commercial because a business is involved. The business is a coventurer. The other party to the coventure is, of course, the charity or charities involved in the promotion. Most of the states define this type of promotion as a charitable sales promotion.

Commercial coventuring occurs when a business announces to the general public that a portion (a specific amount or a specific percentage) of the purchase price of a product or service will, during a stated period, be paid to a charitable organization. When properly structured, this activity results in a charitable gift, the amount of which depends on consumer response to the promotion, by the business sponsor.

The term commercial coventure is, in some respects, unfortunate. First, it suggests that the charitable organization involved is engaged in a coventure (joint venture) with the participating for-profit organization. Second, the term implies that the charitable organization involved is doing something commercial. Both connotations have potential adverse consequences in law, particularly in the unrelated business income setting.⁶⁹ Consequently, the phrasing charitable sales promotion, while not ideal, is preferable.

Thus, a commercial coventure works best for all parties concerned when the charity's role in the “venture” is passive. If, however, the charity's participation in the venture is an active one, it could be characterized as a true joint venture, with the charity seen as providing marketing services to the business. The consequence of this could be that the charity is not receiving a tax-free gift but is receiving taxable unrelated business income. Should this be the outcome, the business involved would not be entitled to a charitable contribution deduction (but would be able to deduct the amount paid as a business expense).

(b) Scope of Regulation

A few states regulate commercial coventuring. Why do these states do this? In substantial part, they engage in this form of regulation as part of a consumer protection mentality. But, another aspect of this regulation of philanthropy exists as an attempt to save charities from themselves.

The usual dismay of a business when facing this type of regulation is understandable. The situation involves a business, wanting to do something for charity; at the same time, a state regulator is insisting that the business register with their office, file accountings and other reports, and perhaps even become bonded. The resulting outrage is predictable; one would think that the business would simply decline to be part of the promotion and thus spare itself the burdens of regulation.

Yet this does not happen, because more is going on here than pure charity. A charitable sales promotion entails advertising, an opportunity for the business to associate itself with a charitable cause. Its reputation becomes enhanced because of the charity's reputation. The public sees the business doing something for charity, and the image of the business is improved. In turn, the public purchases the business's products or services, knowing that they are advancing charity in the process. (The consumers receive no charitable contribution deduction, however.) Consequently, both the charity and the business are benefited.

But the states want to be certain that the promised monies make it to charitable ends; they want to be satisfied that the business's promise to make a charitable gift is valid. They want to protect the charity by making certain that a bad bargain is not struck and that the terms of the arrangement are memorialized in a written contract.

(c) State Laws' Definitions

Several states have some form of regulation of commercial coventuring. Disclosure, record-keeping, accounting requirements, registration requirements, and the mandated content of contracts are the principal forms of regulation; a few states require the business to register and acquire a bond. In some states, the concept of the commercial coventure is stated as a sales solicitation for charitable purposes or a charitable sales promotion.⁷⁰ Oddly, one state⁷¹ defines the term commercial coventurer in its charitable solicitation act, but the concept is not thereafter used in the statute. In another state,⁷² to be a commercial coventurer, the entity must act in that capacity on an “infrequent basis”; if it does so on a “regular” basis, it is a commercial fundraising firm. Another state⁷³ defines a charitable promotion but accomplishes its regulation by means of a lengthy inventory of prohibited acts.

The definitions of the term commercial coventure are not uniform—as befits the general state of this area of law. One of the better approaches⁷⁴ defines a commercial coventurer as “[a]ny person who for profit is regularly and primarily engaged in trade or commerce other than in connection with the raising of funds or any other thing of value for a charitable organization and who advertises that the purchase or use of goods, services, entertainment, or any other thing of value will benefit a charitable organization.”

The law of another state⁷⁵ more broadly defines a commercial coventurer as “any person who for profit or other commercial consideration, conducts, produces, promotes, underwrites, arranges or sponsors a performance, event, or sale to the public of a good or service which is advertised in conjunction with the name of any charitable organization or as benefiting to any extent any charitable purpose.”

In another state,⁷⁶ the term commercial coventurer is defined as “any sole proprietorship, partnership, corporation or any other legal entity, organized for profit or formed as a nonprofit mutual benefit corporation, who is regularly and primarily engaged in trade or commerce in this state other than in conjunction with the raising of funds for nonprofit purposes and who conducts commercial fund raising solicitations on an infrequent basis.”

The more common way to reference a commercial coventure is represented by the law of a state,⁷⁷ where the statute defines a commercial coventurer as a “person who for profit is regularly and primarily engaged in trade or commerce in this state other than in connection with the raising of funds for charitable organizations or purposes and who conducts a charitable sales promotion.” A charitable sales promotion is defined as “an advertising or sales campaign, conducted by a commercial coventurer, which represents that the purchase or use of goods or services offered by the commercial coventurer are to benefit a charitable organization or purpose.” One state takes a slightly different approach, defining a charitable sales promotion as “an advertising campaign sponsored by a for-profit entity which offers for sale a tangible item or provides a service upon the representation that all or a portion of the purchase price will be donated to a person established for a charitable purpose.”⁷⁸

One state⁷⁹ regulates commercial coventuring not by its charitable solicitation act but through application of its fraudulent advertising law. That law relates to the practice of a person who “sell[s] merchandise” or “solicit[s] programs or any other advertising when any part of the proceeds will be donated to any organization or fund.” Another state's rule is found in its business and professions code, where a sales solicitation for charitable purposes is detailed as “the sale of, offer to sell, or attempt to sell any advertisement, advertising space, book, card, chance, coupon device, magazine subscription, membership, merchandise, ticket of admission or any other thing or service in connection with which” there is an appeal for charitable purposes, or the name of a charity is used “as an inducement” for making the sale, or any statement is made that all or any part of the proceeds of the sale will be used for a charitable purpose.⁸⁰

As noted, one state's law does not contain any provisions expressly relating to commercial coventurers (although one of the drafts of the statute did).⁸¹ Nonetheless, the attorney general's office in the state interprets the term professional fundraiser to embrace a commercial coventurer (the for-profit business) where the company guarantees a sum of money to the charitable organization involved, irrespective of the number of products or services sold during the course of the promotion. Thus, a commercial coventurer in this circumstance would have to register with the state and satisfy the other requirements applicable to professional fundraisers (see previous discussion). This attorney general's office is also of the view that where the for-profit business in the venture agrees to pay a fixed amount to the charitable organization for each product or service purchased (a usual feature of a commercial coventure), the company is functioning as a charitable trustee and, therefore, must comply with the state's Charitable Trust Act. This requirement entails registration with the attorney general's office. As one commentator so correctly stated the point, this interpretation of the law “is strained at best and would probably not withstand legal challenge.”⁸²

One state⁸³ is unique in that it expressly exempts commercial coventurers from the scope of its charitable solicitation act.

(d) Forms of Regulation

Once a promotion is defined as a commercial coventure, then what? In one state,⁸⁴ for example, a commercial coventurer is required to maintain “accurate and current” records during the promotion and for three years thereafter, have a written contract with the charity, and file reports with the state, including an accounting of the funds received and disbursed. Moreover, in this state, the charity involved must annually report to the state about the commercial coventures it has authorized, the terms and conditions of each contract, and a statement about whether it received the requisite accounting.

The law of another state⁸⁵ contains similar requirements and adds registration, payment of a fee, and (as noted) a bond. Some states mandate certain elements in the contract.

In one state,⁸⁶ disclosure to the public is the principal requirement of the law. (This statute is applicable only where the commercial coventurer expects that more than half of the proceeds of the solicitation will be derived from transactions within the state.) In this state, where the rule applies, a commercial coventurer must disclose in each advertisement for the promotion the dollar amount or percent per unit of goods and services purchased or used (or, in some instances, a reasonable estimate) that will be transmitted to charity.

In two states,⁸⁷ much of the foregoing applies. That is, there are rules about the content and filing of the agreement between the charity and the commercial coventurer, record-keeping, and public disclosure.

The state laws that force contracts between charitable organizations and commercial coventurers to contain various provisions are useful, in that certain requirements are essential in any agreement between these parties. These elements include (1) the goods or services to be offered to the public, (2) the geographic area where the offering is to be made, (3) the starting and final dates of the offering, (4) the representation to be made to the public about the amount or percent per unit of goods or services purchased or used that will benefit the charitable organization, (5) a final accounting by the commercial coventurer, and (6) the date when and the manner in which the benefit is to be conferred on the charitable organization.

(e) Some Practical Problems

State regulators in jurisdictions with charitable solicitation acts often do not insist on compliance with their laws in every case. Some fundraising events or campaigns are so clearly proper that intervention by the regulators is not warranted—even though the fundraising is not in conformity with the state law requirements. These regulators are often overburdened; if “selective nonenforcement” is the result, so be it. The regulators might regulate in these circumstances if asked (such as by complaint), otherwise the fundraising is ignored.

This is often the case with a commercial coventure (or, if you will, the charitable sales promotion), particularly a national promotion. With a national campaign, the business involved is often a well-known and respected enterprise; the charity is equally well known and well perceived. There is no particular nexus with the state. (The definition of a commercial coventurer in one state⁸⁸ includes the point that the business involved be one that is primarily functioning “in this state.”) Regulation would likely achieve only unnecessary paperwork for all parties concerned. So the regulators do not enforce the law, although technically they should.

Sometimes it is not clear whether the promotion is really a commercial coventure. Perhaps a product is purchased but another company makes the gift. Or, there may be two businesses involved, and one does not comply, thinking that any compliance with state law is the responsibility of the other. In some situations, there is overregulation. Requiring commercial coventurers to take out bonds, for example, seems unnecessary.

One of the issues is that charities sometimes do not realize that they are named as beneficiaries of the promotion. Yet, many state laws forbid gift solicitations in the name of a charity unless the organization has given permission for use of its name.⁸⁹ Some charities say they do not understand what they are to receive; this usually can be cured by a contract. Some ventures state that the businesses will contribute a “portion” of the sales amount; the state laws that regulate in this area, however, require a fixed amount or a stated percentage, plus (if applicable) a cap.⁹⁰

Some in philanthropy do not care for commercial coventures. They believe that coventures can be demeaning for the charities and that the businesses are interested only in benefiting by association with the charities rather than having any true charitable motive. While there is truth in these beliefs, they are not the entire story. These ventures can be advantageous for charities.

This is an area that does not readily lend itself to more regulation. Too much regulation, and the companies probably will not engage in the promotions because of the compliance costs. Some charities receive millions of dollars annually by this means. Thus, the question is: How much new law, if any, should be brought to bear here? A consultant is quoted as saying that the “potential for it [this type of giving] to be a scam is huge.”⁹¹ Well, that may literally be true (there is a potential for just about anything), but should the states enforce the laws they have, should charities look out more for themselves, or should charitable sales promotions be further regulated or even outlawed?

(a) Basic Prohibitions

In most of these states, a person may not, for the purpose of soliciting contributions, use the name of another person without the consent of that other person. Usual exceptions concern the use of the names of officers, directors, or trustees of the charitable organization by or for which contributions are solicited. This prohibition extends to the use of an individual's name on stationery or in an advertisement or brochure, or as one who has contributed to, sponsored, or endorsed the organization.

A person may not, for the purposes of soliciting contributions, use a name, symbol, or statement so closely related or similar to that used by another charitable organization or governmental agency that it would tend to confuse or mislead the public.

A person may not use or exploit the fact of registration with the state to lead the public to believe that the registration in any manner constitutes an endorsement or appeal by the state.

A person may not misrepresent or mislead anyone, by any manner, means, practice, or device, to believe that the organization on behalf of which the solicitation is being conducted is a charitable organization or that the proceeds of the solicitation will be used for charitable purposes, where that is not the case.⁹³

A person may not represent that the solicitation is for or on behalf of a charitable organization or otherwise induce contributions from the public without proper authorization from the charitable organization.

(b) Extraordinary Prohibitions

Some state's laws contain prohibitions that go far beyond the foregoing and reach into domains normally covered by other bodies of law—such as those pertaining to tax-exempt status or deductible charitable giving—or not addressed by other law at all. These prohibitions are extraordinary and, were it not for the fact that they are rarely enforced, would play havoc with the functions of many charitable organizations and the fundraising professionals whose services they utilize. In many instances, these rules apply even in the absence of any fundraising.

What follows are examples from various state laws. Although specific state statutory provisions are cited, other states may well have the same provisions. As noted, it is essential that the laws in each applicable state be reviewed in relation to a charitable fundraising undertaking.

For example, in one state,⁹⁴ it is a prohibited act for a charitable organization to “expend an unreasonable amount of money for solicitation or management.” While this is probably the rule for tax-exempt status in general, it is, in the state regulation setting, fraught with free speech and due process implications. Every charity should strive for this result, but how are unreasonable expenses determined and who makes the determination?

As another example, under the law of the same state, it is a violation of law for a charitable organization to “engage in any financial transaction which is not related to the accomplishment of its charitable purpose, or which jeopardizes or interferes with the ability of the charitable organization to accomplish its charitable purpose.” This type of prohibition accords the regulators carte blanche authority to scrutinize everything a charity does in the state—and raises additional due process concerns.

In another state,⁹⁵ it is unlawful for any person to “use or permit the use of the funds raised by a charitable solicitation for any purpose other than the solicited purpose or the general purposes of the … organization on whose behalf the solicitation was made.” Directors, officers, and employees of charitable organizations, take heed.

In this state, it is also illegal for a charitable organization to represent or imply that a contributor to it will be entitled to a charitable contribution deduction for the gift unless the charity has first obtained either a determination from the IRS that the gifts are deductible or a letter of opinion from a lawyer on the point. This type of law can be troublesome (and/or perhaps expensive) for a charitable organization that does not need a ruling from the IRS, such as a religious organization or an organization that is tax-exempt pursuant to a group exemption.

It is also contrary to law in this state for anyone to indicate that any portion of a membership fee or sales price paid to a charitable organization is a deductible gift unless the IRS has so ruled. This prohibition does not apply where the payor is notified in writing that the amount is not deductible. Further, in this state, a charitable organization violates the law if it accepts a contribution of cash or tangible property with a value exceeding $5.00 unless, at the donor's request, a written receipt is provided.

(c) Focus on Solicitors

State laws often use the concept of the prohibited act to further regulate the activities of professional solicitors. (These prohibitions are among the many reasons it is usually important for a company or individual to be classified as a professional fundraiser rather than a professional solicitor, if at all possible.)

For example, in one state,⁹⁶ it is a prohibited act for a professional solicitor to solicit for a charity without written authorization of two officers of the charity and without exhibiting a copy of the authorization, along with “personal identification,” to persons solicited. This authorization must state a period of time for which it is valid, and a copy of it must be filed with the state.

(d) Unusual Provisions

Given the scope of the states' prohibited acts and the penchant of the states for avoidance of uniformity, it is to be expected that some states will have some rather unusual laws in this field. Here is a sampling.

In one state,⁹⁷ a person may not, when soliciting contributions for charitable purposes, “impede or obstruct, with the intent to physically inconvenience the general public or any member thereof in any public place or any place open to the public.” Presumably, everyone is a member of the general public, so this rule has universal application (at least in this state). The difference between a “public place” and a “place open to the public” is not clear. Nonetheless, it is clear that this rule, where applicable, is designed to restrain the more aggressive approaches to fundraising.

In another state,⁹⁸ a charitable organization, or anyone acting on behalf of one, may not solicit contributions using any “uniformed personnel of any local, state or federal agency or department.” There is, however, an exception for firefighters' solicitation in uniform. This rule is obviously designed to eliminate the pressure that is inherent when someone in governmental uniform solicits charitable gifts. Sometimes the distinction between charitable giving and “protection” is facially difficult to discern.

In another state,⁹⁹ it is a violation of law for a person to “[v]ote or use personal influence” as an officer or director of a charitable organization, where a majority of the board members of the charity are professional fundraisers or their designees, “on matters on which such officer or member has a financial or material conflicting interest.”

In still another state,¹⁰⁰ one who solicits charitable contributions may not use the words “police,” “law enforcement,” “fireman,” or “firefighter” unless a “bona fide police, law enforcement, rescue squad or fire department authorized its use in writing.”

In yet another state,¹⁰¹ the law provides that a charitable organization, professional fundraiser, or professional solicitor may not, in connection with a charitable solicitation, engage in a “deceptive act or practice.” This term embraces an act or practice which “[h]as a capacity to mislead whether by affirmative representation or omission” and “[i]s misleading in a material respect in that it concerns information that is important to a person's decision to make a contribution or concerns information that is likely to affect a person's decision to make a contribution.” This law also contains prohibited acts relating to the awarding of prizes, offering of sweepstakes and other promotional efforts, and use of advertising and promotional material.

In still another state,¹⁰² an employee of a nonprofit corporation organized in the state or of a corporation authorized to do business in the state may not “own or operate or have any pecuniary interest, directly or indirectly, with any business enterprise relating to the product, aims, goals or purposes of the corporation as set forth in its charter.” This rule prohibits, among other aspects of this matter, a nonprofit organization to which the rule is applicable, from having a for-profit subsidiary and having individuals work for both organizations. This prohibition flies in the face of the federal unrelated business income tax rules that, under today's law, encourage the “spin-off” of unrelated activities into separate, taxable organizations.

(e) Duplicative Rules

In some states, the list of prohibited acts includes acts that are violations of the charitable solicitation statutes in any event. For example, some states' laws make it a prohibited act for a charitable organization to use the services of an unregistered professional fundraiser or professional solicitor. Likewise, these states make it a violation of the law for a professional fundraiser or professional solicitor to provide services for an unregistered charity.

(f) Conclusion

For the most part, there is nothing wrong with the foregoing prohibitions. (As noted, some bump up against constitutional law barriers.) It may be supposed that the public would agree with these restrictions. Thus, they are politically sound, which explains why many of them appear in several state charitable solicitation acts.

These rules, nonetheless, once again raise the question of uniformity. As fundraising becomes more and more national (and, for that matter, international), is philanthropy, and thus the country in general, served by these rules? The answer for some of them clearly is yes; the law is not going to tolerate fundraising for charity that openly misuses the name or symbol of another or otherwise engages in some form of misrepresentation. At the same time, these rules are being deployed to drive paid solicitors out of certain states, and in some instances micromanage the programmatic and financial affairs of charitable organizations.

These prohibitions, then, can amount to traps, subjecting a charitable organization—solely because it engages in fundraising—to rules that have little or nothing to do with fundraising. In some situations, these rules seem overly broad and inconsistent with free speech principles, yet there is no recorded instance of a challenge to them.

(a) Basic Elements

What are the basic elements that should be in a contract between a charitable organization and a professional fundraiser? The place to begin in answering that question is to enumerate the nine elements that any contract of this nature should contain. These are:

1. A description of the services to be provided by the party designated as provider of the services
2. A statement of the fees to be paid by the party designated to receive the services
3. A provision indicating legal ownership of any property that may be utilized or created in the contractual relationship
4. A provision stating the duration of the agreement
5. A provision stating the parties' ability to terminate the agreement
6. A provision stating the state's law that governs interpretation of the agreement
7. An indemnification clause, whereby one party agrees to absorb the costs of certain liabilities found against the other party
8. A provision stating that the contract memorializes the entire agreement between the parties and cannot be amended except in writing by the parties
9. A statement of the effective dates of the agreement

These items, then, should be reflected in any contract between a charitable organization and a professional fundraiser. Many of the specific clauses will vary, of course, depending on the type of fundraising involved. But, irrespective of whether the fundraising involved will utilize direct mail, special events, annual campaign, planned giving, or whatever, or whether the fundraising is in the context of a capital campaign, the advice is the same: the professional fundraiser and the charitable organization are best served by a reasonably detailed statement of services to be provided, and of amounts and schedules of fees to be paid.

(b) Specific Elements

A clear statement about the amount and timing of payment of fees to the professional fundraiser will minimize, if not eliminate, the likelihood of fee disputes. If the fees are to be paid in phases, and the charitable organization is to make payment following the close of a phase, the professional fundraiser should be certain that the charity's payment obligations along the way are clearly stated. If the fundraiser desires timely payment, some monitoring and prodding of the charitable client may be necessary.

A full statement of services to be performed is the trick to avoiding breach-of-contract litigation. The professional fundraiser must thread a way between two extremes: not promising to do more than should or can be done, yet not making the statement of services so skimpy as to cause the charitable client to wonder what it is paying for.

The professional fundraiser should be cautious about verbal statements that may heighten expectations of the client. This type of statement may later arguably become part of the contractual relationship. Because of the potential validity of oral agreements, a clause confining the agreement to its written form is essential.

As noted earlier, it is important to state in a contract who owns each particular property that is to be used in connection with, or may be created as the result of, the provision of services. In the specific context of the professional fundraiser's contract, the ownership of these properties should be addressed: mailing lists, intellectual property, artwork, and photographs. Additional properties may also be the subject of an ownership clause.

It is rarely a good idea for a professional fundraiser to guarantee results to a charitable organization client. If this is done, however, the fundraiser should be certain that the guarantee—and any accompanying conditions—is well stated.

A charity's contract for professional fundraising assistance is a contract for what the law terms specific performance. This is particularly true where the charity is contracting with one or more individuals. The charitable organization involved should insist that the contract be nontransferable. These conditions are generally present when the professional fundraiser is a company. The charity is contracting with the particular firm and presumably has no interest in having the obligation to perform services transferred to another company (or to an individual). Indeed, the charity may insist that the contract specify the provision of services by one or more named fundraising professionals who are employed by or otherwise affiliated with the company.

When the fundraising professional is an individual, the contract should state that he or she is rendering services as an independent contractor, rather than as an employee.

If the agreement states that the charitable organization client is to provide an approval (e.g., of the text of a letter or the graphics of a brochure), the agreement should also state that the approval shall be in writing. The professional fundraiser should subsequently be certain that the approval is obtained on a timely basis, in writing.

(c) Fee Arrangements

Caution should be exercised by the fundraising professional in describing the fee arrangement. It is considered, in many quarters, to be unprofessional or even unethical for a fundraiser to be compensated on a contingent, percentage, commission, or similar fee basis. The antitrust laws, however, prevent enforcement of this type of prohibition, which usually is in a code of ethics. In general, a fee arrangement under these terms is by no means illegal, although in extreme instances a contingent fee arrangement may jeopardize the tax-exempt status of the client charity.¹⁰⁵

Contingent fee arrangements exist in many ways in addition to a stated percentage of contributions received. For example, compensation tied to the number of solicitation letters mailed, where the fundraiser controls the timing and extent of the mailing, is a form of contingent compensation.¹⁰⁶

A percentage limitation, in state law, on the amount of compensation that can be paid by a charitable organization to a professional fundraiser is unconstitutional.¹⁰⁷

(d) Solicitor Status

Some state laws preclude a fundraiser from treatment as a professional fundraiser where the compensation is other than a “flat fixed fee” arrangement. If the compensation is otherwise, the professional may be classified as a professional solicitor. This adverse result can, in turn, lead to more stringent governmental regulation.¹⁰⁸ A trend in charitable lawmaking is to stringently monitor and restrict the activities of solicitors. This is being done by means of strenuous precampaign contract reviews, greater disclosure and reporting requirements, and more.

The description of services in the contract should be reviewed from this definitional standpoint. One of the essential elements of the definition of a professional solicitor is that the solicitor is an active participant in the solicitation process.¹⁰⁹ A professional fundraiser can all too easily fall into this trap by agreeing to, for example, mail the solicitation letters or place the solicitation telephone calls.

Another frequent characteristic of a professional solicitor is that this type of a person receives the gifts directly from the donors and remits the net amount to the charity. A professional fundraiser should be paid a fee by the charity, with the charity having received the gifts directly, and the contract should make that feature clear, or at least avoid any language contemplating the receipt of gift funds by the professional fundraiser.

(e) State Laws

It goes without saying that parties to a contract are expected to obey all applicable laws. It is not necessary, however, for the contract to contain language expressly reflecting that general obligation.

Nonetheless, among the laws that directly relate to both the professional fundraiser and the charitable organization client are the various charitable solicitation acts. These laws impose registration, reporting, bonding, and other requirements on both professional fundraisers and their charitable clients.¹¹⁰ Because the registration and reporting forms for both parties cross-refer, the professional fundraiser should at least contemplate a clause in the contract that requires both parties to notify each other of the states in which they are registered and of any adverse regulatory developments that may arise.

Many states mandate that certain elements be in the contract that a charitable organization has with a professional fundraiser and/or with a professional solicitor.¹¹¹ These laws usually also require retention of the contract in the records of the parties for a stated period of time (often three years after the conclusion of the solicitation) and often require filing of the contract with the state. (It must be reiterated that a charitable organization, professional fundraiser, and/or professional solicitor involved in a solicitation in one or more of these states is expected to comply with the requirements of each of them. Thus, for example, a contract with respect to a solicitation intended to take place in all of the states should contain all of the provisions mandated by each of these laws.)

Usually, this contract content requirement is more extensive with respect to a contract involving a professional solicitor.¹¹² For example, in one state,¹¹³ the rule involving a charitable organization's contract with a professional fundraiser is that the contract must “contain such information as will enable … [the regulatory office] to identify the services the … [professional fundraiser] is to provide and the manner of his [or her or its] compensation.” By contrast, under the law of this state, the contract between a charitable organization and a professional solicitor must “clearly state the respective obligations” of the parties, and “state the minimum amount which the charitable organization shall receive as a result of the solicitation campaign, which minimum amount shall be stated as a percentage of gross revenue.”

One of the most extensive contract content requirements applicable to agreements between charitable organizations and professional solicitors is that of the state¹¹⁴ in which the contract must contain provisions as to (1) an “estimated reasonable budget disclosing the target amount of funds to be raised over the contract period”; (2) the type and amount of projected expenses for the period; (3) the amount projected to be remitted to the charitable organization; (4) the period of duration of the agreement; (5) the “geographic scope” of the fundraising; (6) a description of the methods of fundraising to be employed; (7) a clause assuring “record keeping and accountability”; (8) if the contract provides that the fundraiser will retain or be paid a stated percentage of the gross amount raised, an estimate of the “target gross amount” to be raised and to be remitted to the charitable organization; (9) if the contract provides for payment at an hourly rate for fundraising, the total estimated hourly amount and the estimated number of hours to be spent in fundraising; (10) the amounts of all commissions, salaries, and fees charged by the fundraiser, and its agents and employees; (11) the method used for computing these commissions, salaries, and fees; (12) if the fundraiser, its agents and employees, or members of the families of these persons own an interest in, manage, or are a supplier or vendor of fundraising goods or services, disclosure of that relationship; (13) if the foregoing rule is applicable, the method of determining the related supplier's or vendor's charges; and (14) the fact that the contract was approved and accepted by a majority of the directors of the charitable organization and by the president of the organization.¹¹⁵

One state¹¹⁶ has a law prohibiting two provisions from appearing in a contract between a charitable organization and a professional fundraiser and/or professional solicitor: (1) the charitable organization may not use contributions from a solicitation for its charitable purposes until some or all fundraising expenses have been paid; and (2) the fundraiser or solicitor may engage in a direct mail or other solicitation in the name of the charitable organization for the purpose of “paying or offsetting preexisting fundraising expenses.”

In one state,¹¹⁷ the contract between a charitable organization and a professional fundraiser and/or professional solicitor (or commercial coventurer) may be canceled by the charitable organization within 15 days after the date the contract is filed with the state; this right of cancellation must be stated in the agreement.

In another state,¹¹⁸ if this type of a contract involves a “possibility” that the charitable organization “might ultimately receive” less than 50 percent of the gross receipts of the solicitation involved, that fact must be “specifically and prominently” disclosed in the contract (and orally, before execution of the contract).

(f) Conclusion

As is the case with all laws, everyone involved is presumed to know them. In the fundraising context, both the contracting charity and the professional fundraiser are expected to know and conform with the state charitable solicitation acts. Some of these laws mandate the contents of contracts between charities and fundraisers. These are independent obligations, bearing potential liabilities (e.g., civil penalties and/or injunctive relief) for both parties. Neither party should assume that the other is in compliance with these laws.

A professional fundraiser should have a solid, comprehensive, and professional-looking prototype agreement to present to prospective charitable clients. With a suitable agreement, a professional fundraiser can concentrate on development work without fear of the consequences of a defective contract.

(a) Introduction

These state laws require compliance by charitable organizations that engage in fundraising. They apply to these charities by the law of the state in which the organization is located and by the law of the other states in which the organization solicits contributions. Further, these laws directly affect charities by reason of the regulation of those who help them raise funds, namely, professional fundraisers, professional solicitors, and commercial coventurers.

Without doubt, these charitable solicitation acts are well intentioned. Fundraising abuses are taking place, and the public needs and deserves a place to lodge complaints and be assured that the frauds are prosecuted and punished. The law is clear that each state, in the exercise of its police power, has the authority to enact and enforce this type of law.¹¹⁹ Indeed, the states' attorneys general have considerable inherent ability to regulate in this field even without the statutory backup.

Sometimes, however, the cure is worse than the disease. Fundraising regulation, as currently written, is one of those instances. The standard contemporary state charitable solicitation acts are unnecessarily complex, onerous, stringent, and burdensome. They are all too often prompted by a motive to “get” someone or are otherwise ill conceived. The laws are often written by legislators with a dim view of what they are doing and administered by bureaucrats with a negative view toward philanthropy. In too many states, the fundraising regulation zeal is leading to the creation of regulatory empires, staffed at taxpayers' expense by lawyers and investigators whose skills are sorely needed in far more important arenas of governmental service. The paperwork and the costs imposed on charities and their professional consultants often exceed any value these overreaching laws may provide.

The ridiculousness of this situation can be readily seen when one stops to think about what is being regulated. This is not a matter of public health and safety. This is not drug trafficking or nuclear waste disposal. This is charitable giving! Some public education and disclosure would go a long way toward solving the problems in this area. If individuals are uncertain about a particular charity and cannot obtain some wanted information, they have a simple solution: do not give.

The shame of it all is that the legislators and regulators have lost sight of what they are regulating. Philanthropy is the lifeblood of the American system. Billions of dollars are annually provided for services that government cannot and will not supply. Giving to charity is what fuels this machine. But fundraising regulation is retarding the legitimate fundraising process, although gift solicitation is a constitutionally protected act of free speech. In short, fundraising for charity is overregulated—often unnecessarily, harmfully, and counterproductively.

Some believe that one answer to all of this regulation is a model charitable solicitation act.

(b) Model Law Elements

For a variety of reasons,¹²⁰ any uniformity and simplicity to be achieved in the field of fundraising regulation for charity are not likely to be the result of enactment of a model charitable solicitation act. Nonetheless, the idea of a model charitable solicitation act lingers in some quarters. Thus, this concept is worth a brief look.

A prototype charitable fundraising regulation law is, obviously, a matter of judgment. The preferred scope of such a law is in part dependent on one's view of the appropriate role of government. One person's thoughts about the components of a fundraising law are likely to be anathema to someone else. Thus, the elements presented here constitute one view. Having said that, it must be noted that all things are relative—these elements are not presented from the standpoint of what is ideal but from the standpoint of what is realistic. For some, the preferential situation is no regulation of charitable fundraising at all. The fact is that charitable fundraising regulation will continue, however, so the question is not whether this type of regulation should exist but what form it should take.

The dual concepts at play in the area of regulation of fundraising for charitable purposes are preapproval and disclosure.

(c) Preapproval

The core of the typical state charitable solicitation act is preapproval, in the sense that registration in advance of fundraising is required. This registration may be in the form of a license or permit, but the fundamental principle is the same: a charitable organization must acquire permission from the state before it can engage in fundraising within the jurisdiction. There is no reason to believe that this basic requirement will be eliminated; indeed, it is a quite reasonable requirement.

The objective to be obtained here is balance, this being the area where one requirement of registration can be more onerous than another because of the complexity of the application process. The number of questions asked and the substance of the answers requested are extremely relevant. What is reasonable in this setting is, again, a matter of judgment, but the model act would ask for only basic information needed to assure the state regulators of compliance with the overall statute.

The model charitable solicitation act would likewise require registration of professional fundraisers and professional solicitors. The model act would not require registration of commercial coventurers, however, because this type of regulation places unnecessary burdens on the business involved and should be a matter of registration (and reporting) by the charitable organization.¹²¹

(d) Reporting

The model act would not have reporting separate from the registration requirement. Instead, the prototype law would provide that each registration (whether for charitable organizations, professional fundraisers, or professional solicitors) have a duration of one year. Reregistration each year would supply the state regulators with ample information required to enforce the statute.

Again, the contents of the reapplication should be reasonable, so as not to overly burden the regulated while still providing adequate and meaningful information to the regulators.

(e) Definitions

The typical state charitable solicitation statute opens with a series of definitions, and the model law would be no different.

A model statute in this field, however, would have a definition of the term charitable organization that is not so broad as to embrace entities and purposes that, in other law contexts, are not “charitable.”¹²² Likewise, the statute would be clear as to its scope: it would apply to the solicitation of charitable contributions, not to the sale of goods and services where some or all of the proceeds will be devoted to charitable ends.¹²³

The model statute would also wrestle with and resolve the difficult matter of the proper definition of the terms professional fundraiser and professional solicitor.¹²⁴ These definitions would differentiate the consultant from the true solicitor, yet simultaneously avoid placing fundraising counsel in the category of solicitor simply because of use of the telephone and/or the mails in the raising of contributions for charitable purposes.

(f) Contracts and Bonds

The model charitable solicitation act would mandate written contracts between charitable organizations and professional fundraisers, professional solicitors, and/or commercial coventurers. This requirement is for the benefit and protection of charitable organizations, if for no other reason. The mandatory contents of these contracts would be minimal, however, trusting the parties to strike a fair bargain.

Entities or individuals that have access to the contributed funds would have to be bonded (or otherwise deposit adequate security with the state). Thus, this requirement would not normally be imposed on professional fundraisers and commercial coventurers.

(g) Compensation

The model law would not (indeed, lawfully, could not) contain a percentage limitation on allowable fundraising costs incurred by charitable organizations and/or on the amount payable to professional fundraisers or professional solicitors.¹²⁵ Nor would such a provision be made mandatory as part of contracts.

The model law would require the parties to disclose all compensatory arrangements as part of the registration process. This law, however, would not require a charitable organization, when soliciting contributions, to disclose fundraising costs at the point of solicitation, nor would it mandate disclosure of the use of professional fundraising counsel or a professional solicitor. The law would, nonetheless, require a charity to state on its solicitation materials that additional information is available from the charity on request and would require the charity to promptly respond to this type of inquiry.

(h) Exemptions

The model charitable solicitation act would have exemptions. Bona fide religious organizations; colleges, universities, and schools; most health care organizations; and foundations related to these entities would be exempt from the entirety of the statute. This can be done without becoming entangled in equal protection violations¹²⁶ and should be done to eliminate from the regulatory process those charitable organizations that simply are not “part of the problem.”

Other types of entities may be exempted from the registration and reporting requirements because information about them is otherwise readily available in other ways. This exemption would extend to fraternal, veterans', and other membership groups that confine the solicitations to their membership.

The model law would not make availability of the exemptions conditioned on not using professional fundraisers or professional solicitors. This type of limitation is discriminatory, often petty, and in many instances counterproductive, because often these organizations should be encouraged to use, not penalized for using, professional assistance.

(i) Other

The model law should contain other provisions that could induce simplicity and uniformity, such as reciprocal agreement provisions, uniform accounting principles, use of other states' (and perhaps the federal government's) reporting forms, and simultaneous reporting dates.

(j) Prohibited Acts

One of the most difficult aspects of the states' charitable solicitation acts is the number of prohibited acts.¹²⁷ Some prohibited acts are reasonable and would be included in the model law. These include misrepresentation of the purpose of a solicitation, implied assertions of endorsement by the state, implied assertions of endorsement of the charity involved by others when that is not the case, use of names of others without consent, use of the name of a similar charitable organization, and making false or misleading statements.

The prototype statute would not, however, attempt to regulate collateral matters, such as the amount of money expended for fundraising or management, or the application of the funds raised in ways that may interfere with the ability of the charitable organization to further its charitable purposes. These matters are more appropriate for the inherent investigatory efforts of a state's attorney general or for the process of obtaining and retaining tax-exempt status.

(k) Sanctions

The model act would authorize the usual range of sanctions, including investigations, use of subpoenas, revocation of registrations, injunctions, civil penalties, and criminal penalties. It would not interfere with the usual and other inherent enforcement options for the states' attorneys general. It would not, however, authorize private actions.

(l) Commentary

The objective in constructing a model charitable solicitation act would be to achieve a balance between the exercise of a state's police power (to protect its citizens against fraudulent or otherwise misleading solicitations for gifts) and the free speech right of charitable organizations to solicit contributions for their support (and thus not unduly impede the process of funding programs that are vital to the very same citizens). There is no need to flood charitable organizations with paperwork requirements or to force fundraising consultants to adhere to rules meant for solicitors, when no useful purpose is achieved by doing so. Fundraising outlaws must be caught and punished, but not at the expense of hobbling bona fide charity.

The fact is that, all too often, these laws are not well thought out. The ideal would be a uniform and minimal prototype law in each of the states. The charities could then comply with the rules rather readily, and enforcement could focus on the true offenders.

Unfortunately, a model law does not seem feasible as a practical matter. Resolution of the present-day mess may be achieved through reciprocal agreements, uniform accounting principles, similar registration and reporting forms, and/or a company to facilitate compliance by charitable organizations and others. Still, when legislating in this area, some model framework is important, if only to minimize the more egregious provisions.

(a) Charity Auctions as Businesses

The federal tax law envisions a tax-exempt organization as being a bundle of businesses. For this purpose, a business is any activity that entails the production of income from the sale of goods or the performance of services.¹³⁰ An activity does not lose its identity as a business merely because it is carried on within a larger aggregate of similar activities or within a larger complex of other endeavors of the organization.¹³¹

Some businesses are related ones, in that the conduct of them helps advance the organization's exempt purposes (other than simply through the generation of funds). Other businesses are unrelated, because the conduct of them does not relate to achievement of a charitable, educational, or similar purpose; this type of business usually is carried on solely for the purpose of generating income.¹³²

Thus, a charity auction is a business; it is the performance of a service (selling items). These auctions are not inherently exempt functions; in the case of private schools, for example, the conduct of an auction is not an educational undertaking. Consequently, the conduct of a charity auction is the conduct of an unrelated business by the charitable organization.

The net revenue of a charity auction would, therefore, be taxable as unrelated business income were it not for one or more exceptions. The principal exception relates to the fact that, for an unrelated business to create taxable income, it must be regularly carried on.¹³³ An annual auction held by a charitable organization is not an activity that is regularly carried on; thus, the net income is not taxable. (If a charity were to hold an auction every weekend, for example, this exception would not be available.)

Another important exception is the one for businesses that constitute the sale of merchandise, substantially all of which has been donated to the exempt organization.¹³⁴ This exception was written for thrift shops, but it is available in the case of auctions, irrespective of their frequency.

The third exception is for businesses in which substantially all the work in carrying it on is performed by volunteers.¹³⁵ If a charity auction is conducted entirely by volunteers, the net income from it is not taxed. (Some charity auctions are able to rely on all three exceptions.)

Thus, it is almost inconceivable that the “net income” realized as the result of a charity auction would be subject to unrelated income taxation, but only because of some specific statutory exceptions.

(b) Charitable Contribution Deductions—Donors of Items to Be Auctioned

In general, the contribution of an item to a charitable organization, for the purpose of being auctioned, creates a charitable contribution deduction. The usual rule is that the deduction is equal to the fair market value of the contributed property.¹³⁶ (This analysis is based on the assumption that the charity holding the auction is a public charity and not a private foundation.)¹³⁷

There are, however, some wrinkles here. If the item donated is tangible personal property that has appreciated in value, the charitable deduction is confined to the donor's basis in the property.¹³⁸ This is because the gift was made for an unrelated purpose—resale by the donee.¹³⁹

If the item donated has a value in excess of $5,000, the deduction depends on a bona fide appraisal.¹⁴⁰ An appraisal summary must be included with the donor's tax return. The charitable organization must report the sale to the IRS (assuming the auction took place within three years of the gift).¹⁴¹

There is no charitable deduction for a gift of the right to the use of property.¹⁴² Thus, for example, if someone contributes the opportunity to use his or her vacation property for two weeks, there is no charitable deduction equal to the fair rental value of the property. (Moreover, the period of time the property is used by the winning bidder must be considered by the donating individual(s) as personal time for purpose of the rules regarding the deductibility of business expenses in connection with the property.)¹⁴³

There is no charitable deduction for a gift of services.¹⁴⁴ Thus, for example, if a lawyer donates his or her will-drafting services, there is no charitable deduction equal to the hourly rate the lawyer would charge for his or her time in preparing the will. Notwithstanding this rule in the regulations, there would be no deduction in any event because there is no deduction for gifts of property created by the donor.¹⁴⁵

Further, special rules apply when a business makes a charitable contribution of items from its inventory,¹⁴⁶ a charitable contribution of scientific property used for research,¹⁴⁷ and a charitable contribution of computer technology and equipment for elementary and secondary school purposes.¹⁴⁸

The substantiation rules (see following discussion) apply with respect to gifts of items that have a value of $250 or more and are auctioned by a charitable organization.¹⁴⁹

(c) Charitable Contribution Deductions—Acquirers of Items at an Auction

The law in the area of charitable giving in general once was that, for a payment to a charitable organization to be deductible as a gift, the payor had to have a donative intent. The law, however, has shifted to a more mechanical computation: in general, deductible payments to a charity are those that exceed the fair market value of anything that the “donor” may receive in return, other than items of insignificant value. Nonetheless, in the auction and comparable contexts, the donative intent rule still applies: no part of a payment to a charitable organization that is in consideration for goods or services can be a contribution unless the person intended to, and did, make a payment in an amount that exceeds the fair market value of the goods or services.¹⁵⁰

Whether one who acquires an item at a charity auction is entitled to a charitable contribution deduction is another matter. Thus, it was correct to observe that, regarding the enactment of the substantiation and quid pro quo rules (see following discussion): “It was widely assumed that Congress was after folks who buy stuff at auctions and then deduct most or even all of the price as a charitable contribution.”¹⁵¹

There are two schools of thought here; both are facially valid. One is that the auction is the marketplace, so that whatever is paid for an item at an auction is its fair market value at that time. Pursuant to this view, the transaction is always a purchase in its entirety; there is no gift element and thus no charitable deduction.

The other school of thought is that an item auctioned at a charity auction has a fair market value, irrespective of the amount expended for it at an auction. This approach would allow a charitable deduction for an amount paid at a charity auction that is in excess of the value of the property.

In actual practice, most items disposed of at a charity auction are acquired for a value that does not involve any gift element (because the amount paid is roughly equal to the value of the item or perhaps is less), and thus there is no charitable deduction. If a person wants to claim a charitable deduction, the burden of proof is on the putative donor, who must prove that the amount paid was in excess of the property's fair value.

This burden of proof can probably be met when it is relatively easy to prove the fair market value of the item, such as an appliance or automobile. Where the value of an item is difficult to discern, however, it will be arduous for a patron of the auction to convince the IRS that a portion of the amount paid was a deductible gift.

The determination of the fair market value of an item is the work of appraisers. Essentially, they look at comparables. If a house sold for $200,000, all other factors being equal, that is the value at the time of sale of the neighboring houses. Thus, the critical factor is the determination of the market. This involves geographical, economical, and timing elements.

Some disparage the idea that the value of an item sold at a charity auction is set at the time of that purchase.¹⁵² There cannot be any dispute, however, that the auction is a market. Thus, one must logically assume that the price paid for an item at a charity auction is its fair market value. This is particularly the case where the value is difficult to ascertain commercially. For example, if a charitable organization auctioned an automobile with a sticker price of $30,000, and received $35,000 for the vehicle, it is reasonable to assume that the individual who acquired the vehicle is entitled to a charitable deduction of $5,000. If, however, a charitable organization auctioned a football, signed by members of the team, which the organization valued at $500 and which sold for $2,000, who is to say what the value of that package was at the time of the auction? The organization may have made a good-faith estimate of $500 of value, but that may not necessarily be the true value of the item under the circumstances of its sale. If the auction was the marketplace, the fair market value of the football was $2,000, not $500.

The substantiation rules (see following discussion) apply with respect to gifts made in the context of acquiring an item auctioned by a charitable organization, assuming the gift element is $250 or more.

(d) Substantiation Rules

The position of the IRS on charity auctions can be found in rulings as far back as 1967.¹⁵³ There is little question, however, that charitable organizations and their donors have not, over the intervening years, understood the IRS's stance, which, frankly, has been quite clear and sensible. Consequently, Congress believed it had to enact legislation in this area and, in 1993, it did.

At this point in the analysis, it is necessary to place the subject in context. Can it honestly be said that an individual who attends an auction sponsored by a charitable organization is there to make a gift? Someone who wants to contribute to the charitable organization can obviously do so, without attending the charity's auction. Individuals participate in the auction to help support the charitable organization and to purchase items.¹⁵⁴

The statutory substantiation rule is this: a donor who makes a separate charitable contribution of $250 or more in a year must, to be able to deduct the gift, obtain the requisite written substantiation from the donee charitable organization.¹⁵⁵ This substantiation must be an acknowledgment of the gift and must contain the following information: (1) the amount of money and a description (but not the value) of any property other than money that was distributed; (2) whether the donee organization provided any goods or services in consideration, in whole or in part, for any money or property contributed; and (3) a description and good-faith estimate of the value of any goods or services so provided.¹⁵⁶

These rules are applicable with respect to gifts of items to be auctioned (assuming a charitable contribution deduction is available or desired). Also, as far as acquisition of an item at a charity auction is concerned, if there is no gift element, it is clear that the rules do not apply.

Where, however, (1) the patron at a charity auction believes that he or she had made a charitable contribution in the course of acquiring an item, (2) the ostensible gift element is $250 or more, and (3) a charitable deduction is desired, the rules come into play. The “donor” must notify the charitable organization that he or she believes that a gift was made at the auction, with the intent of receiving the necessary acknowledgment. If the charity agreed that a gift was made, it would issue a written substantiation showing the amount that was “contributed” (here, the full amount of the winning bid) and a description and good-faith estimate of the value of the item acquired. The difference, then, would be the amount deductible as a charitable gift.

The process would not function so smoothly if the charitable organization believed that no part of the payment is a charitable gift. It might refuse to issue the acknowledgment or refuse to commit itself to a good-faith estimate of the value of the item auctioned. As a practical matter, however, relations with donors and patrons are such that a charity usually cannot be that cavalier.

These rules will place considerable pressure on charitable organizations. To return to the previous example, is the organization willing to issue a substantiation acknowledgment that the auctioned football has a value of $2,000, so that the winning bidder can claim a charitable deduction of $1,500? A charitable organization that knowingly provides a false written substantiation to a donor may be subject to the penalty for aiding and abetting an understatement of tax liability.¹⁵⁷

(e) Quid Pro Quo Rules

Congress has required this: when a person makes a gift to a charitable organization in excess of $75 and receives something of material value in return, the charitable donee is to make a good-faith estimate of the value of the item and notify the donor that only the difference between the fair market value of the item and the amount paid for it (if any) is deductible as a charitable contribution.¹⁵⁸

Here, the application of the tax rules in the charity auction context becomes less pellucid. Superficially, the quid pro quo rules would seem to apply in the charity auction setting where the amount transferred exceeds $75 and there is a gift element.

A quid pro quo contribution is a payment “made partly as a contribution and partly in consideration for goods or services provided to the payor by the donee organization.”¹⁵⁹ Thus, it can be argued that the purchase of an item at an auction, at a price known to be in excess of the fair market value of the item, is both a contribution and a payment made in consideration of something (a purchase).

Nonetheless, if the donor and the donee are in harmony, and if the amount paid at an auction exceeds $75, the charitable organization can make the necessary disclosure, notifying the donor that the deductible amount is confined to the payment less the value of the item. It is important that the charitable organization be correct in this regard, because of the penalties imposed.¹⁶⁰

(f) Sales Tax Rules

As discussed, every transaction at an auction is, in whole or substantial part, a purchase. Thus, the charity is engaging in sales, which can trigger application of the state's sales tax. This is a state-by-state matter, and thus it is difficult to generalize on the point, other than to say that the law of the applicable state should be reviewed.

A state is likely to exempt charitable organizations from having to pay the state's sales tax. This exemption, however, does not mean that the entity is exempt from the requirement of collecting the sales tax.

(a) Summary of the Facts

A married couple (H and W) claimed charitable contribution deductions for their payments (in 1997 and 1998) to the National Heritage Foundation (NHF) of money, which NHF used to pay premiums on a life insurance policy for the life of W. The policy was a charitable split-dollar life insurance contract. Under this contract, NHF was entitled to receive 56 percent of the death benefit and the couple's family trust was entitled to receive 44 percent of the benefit.

Eleven years before the first of these payments, the couple formed a family trust. They are the trustors, first designee trustees, and initial beneficiaries of this trust. Their children and W's parents or siblings become beneficiaries of the trust on the death of the couple.

In October 1997, H and W established a “foundation” (a donor-advised fund) within NHF. On the same day, H wrote to NHF stating that the family trust intended to purchase an insurance policy on the life of W and would grant NHF an option to acquire an interest in that policy. The policy was issued. The couple owned the policy through the trust.

H, as trustee of the trust, and NHF entered into a death benefit option agreement, relating to the policy. H agreed to pay $4,000 of the $40,000 annual premium on the life insurance policy. H and NHF agreed that, if NHF paid $36,000 of the annual premium, NHF would be entitled to its share of the death benefit. The agreement provided that the family trust and NHF each own a separate interest in this life insurance policy.

Later in 1997, H and W sent money ($36,000) to NHF for deposit into their foundation. An accompanying letter from H stated that NHF was not required to use the payment to pay the premium on the life insurance policy but that H “expected” NHF to use the payment to pay the premium. The next day, the couple paid the $4,000 of the premium.

NHF credited $36,000 to the foundation account. It simultaneously debited the foundation account $36,000 to pay NHF's portion of the life insurance policy premium. Also on the same day, NHF paid its $36,000 portion of the premium to the insurance company. The same series of transactions occurred the next year. As to both years, NHF provided the couple with a document that stated that it did not provide any goods or services to the donors in return for the contribution.

The couple stopped making payments to NHF after 1998. The statute that was designed to shut down these programs²⁰⁰ took effect for transfers after February 8, 1999.

The IRS disallowed the charitable contribution deductions claimed by the couple for the transfers in 1997 and 1998 to NHF.

(b) Law

A person may not deduct a contribution of $250 or more unless the person substantiates the contribution with a contemporaneous written acknowledgment of the contribution by the charitable donee.²⁰¹ This acknowledgment must include a statement as to whether the donee organization provided any goods or services in consideration for the contribution and provide a good-faith estimate of the value of any goods or services provided.

A donee organization provides goods or services in consideration for a person's payment if, at the time the donor makes the payment to the donee, the payor receives or expects to receive goods or services in exchange for that payment.²⁰²

The U.S. Supreme Court wrote that a charitable contribution is one for which the donor has “no expectation of any quid pro quo.”²⁰³ The Court also wrote that the “sine qua non of a charitable contribution is a transfer of money or property without adequate consideration.”²⁰⁴

The federal tax law that effectively eliminated the use of charitable split-dollar insurance plans²⁰⁵ makes reference to situations where there is an “understanding or expectation” that a person (such as a charitable organization) will directly or indirectly pay a premium in conjunction with one of these plans.²⁰⁶

(c) Analysis

The couple argued, of course, that NHF was not required, and did not promise, to use the contributions to pay the premiums on the insurance policy on the life of W. The court held, however, that NHF “provided consideration” for the payments because, at the time the payments were made to NHF, the couple “expected” to receive a share of the death benefit under the policy.²⁰⁷ Also, they “expected” NHF to use the funds they provided to pay NHF's portion of the premiums on the policy in 1997 and 1998.²⁰⁸

This “expectation” on the part of the couple was deemed “reasonable” by the court because it was in NHF's financial interest to pay premiums on the couple's life insurance policy in return for a guaranteed death benefit.²⁰⁹

NHF did not state in its substantiation documents that it paid premiums for the insurance policy on the life of W under which the couple would receive a portion of the death benefit. Also, NHF failed to make a good-faith estimate of the value of these benefits. This arrangement was characterized by the court as a “scheme,” including a “pot sweetened by charitable contribution deductions.”²¹⁰

The court held that the charitable contribution deduction was not available to this couple because the substantiation provided by the charitable donee was deficient.

(d) Commentary

This is the type of decision that gives courts a bad name—for being simply unrealistic. Beating up on charitable split-dollar life insurance programs is easy in the aftermath of the frenzied and unprincipled reaction in Congress that resulted in the statute that essentially outlawed these programs, but one would think the court would give some thought to the real-world consequences of its holding.

The substantiation rules are designed to cause disclosure of, and reduction of a charitable contribution deduction by the amount of, the provision of a good or a service by the recipient charitable organization. The Tax Court, in this case, blithely slid around, equating the provision of goods and services with consideration and benefits with expectations. This was a careless reading of the law.

Individuals and other persons make charitable contributions with expectations all the time. A person donates a parcel of land to a charity, expecting that the charity will improve the property, thereby enhancing the value of a neighboring piece of property that the person owns. An individual makes a charitable contribution to a donor-advised fund, with the expectation that the charity will always follow the advice of the donor. Parents make contributions to a university with the expectation that one or more of their children will be admitted to the institution. These expectations are not goods or services; it has not been thought that these types of situations trigger a good-faith estimate by the charity of the “value” of these expectations.

It would have been perfectly acceptable for the court to rule that NHF was not under any legally binding mandate to pay the premiums and that NHF independently elected to invest the money, in an opportunity provided by the couple, in a manner to generate a reasonable rate of return.²¹¹

Now, instead, if the court is correct, an expectation is consideration defeating the concept of a charitable gift. Search in vain for authority for this conclusion in the opinion—it is not there. As noted, donors make (deductible) charitable gifts with expectations all the time.

This is one court opinion where the court simply lost its perspective. It was not sufficiently careful in its writing; the least it could have done was narrowly tailor its conclusions to the facts of the case. For example, the court sloppily wrote that the “NHF receipts [more correctly, substantiation documents] do not comply with the substantiation requirements … because NHF incorrectly stated in the receipts that [H and W] received no consideration for their payments.”²¹² Well, the substantiation requirements do not call for disclosure of consideration; they call for disclosure of and an estimate of the value of goods or services provided.

It may well be that, as the court wrote, H and W “received substantial benefits from NHF under the life insurance policy.”²¹³ But that is just how matters turned out. In any event, it is not these benefits that the substantiation requirements, according to the court, intended to be disclosed. Rather, the ostensible good or service provided was the expectation of receiving these benefits.

The error inherent in this opinion is reflected in the applicable federal tax statutes. The body of law pertaining to the substantiation requirements makes reference to the provision of goods or services. The body of law concerning the charitable split-dollar insurance rules refers to understandings or expectations. If Congress wanted the substantiation rules to apply in connection with expectations, it would have written that statute to say as much. The Tax Court blithely lifted the language of one statute and dumped it onto another one, thereby substantially expanding the reach of the latter.

This is not so much an anticharitable split-dollar insurance holding as an expansive charitable gift substantiation requirement holding. Charities and fundraisers must be ever so cautious in preparing the substantiation documents, for now—if the Tax Court is correct—charities must not only value what they provided in exchange for the gift, they must peer into the misty reaches of donor motivation and intent to discern what donors expect to be provided and value that.

This is the great fault with this opinion. It is one of the first court opinions construing the substantiation requirements. It has placed donors and donees in a precarious position. Mere expectations can—according to this decision—defeat, in whole or in part, charitable contributions. The lack of a substantiation alone can preclude a charitable deduction. And just how does one value an expectation?

Unnecessarily, this court opinion injected great confusion into the realm of substantiation that, obviously, was not needed. Had the insurance benefit been provided in exchange for the transfer of the money, that clearly would have to be valued and made the subject of a good-faith estimate. But the expectation that the investment would be made in the insurance should not have to be valued and made part of the substantiation documentation. This is a most unfortunate decision—one that is greatly lacking in common sense and applicability in real life.²¹⁴

(a) Statistical Portrait

It is estimated that, as of 2019, there were 873,228 donor-advised funds.²⁴⁰ The average size of these accounts was $162,556.

Grants from donor-advised funds to qualified charities, as of 2019, totaled an estimated $27.37 billion, representing an increase of 15.4 percent compared to 2018; the grant-making from these funds in 2018 amounted to 23.72 billion. Contributions to these funds increased by 7.5 percent to $38.81 billion, compared to $36.1 billion in 2018. Charitable assets in these funds increased from $122.18 billion in 2018 to $141.95 billion in 2019.

The aggregate grant payout rates from donor-advised funds have exceeded 20 for every year on record. The payout rate for 2019 was 22.4 percent, compared to the payout rate for 2018 of 21.2 percent.

(b) Donor-Advised Fund Law Basics

A donor-advised fund is a fund or account (1) that is separately identified by reference to contributions of one or more donors, (2) that is owned and controlled by a sponsoring organization, and (3) as to which a donor or donor advisor has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in the fund or account by reason of the donor's status as a donor.²⁴¹

A sponsoring organization is a public charity that maintains one or more donor-advised funds.²⁴² Sponsoring organizations include community foundations, publicly supported organizations²⁴³ (including those affiliated with national investment firms),²⁴⁴ colleges and universities, and hospitals. A donor advisor is a person appointed or designated by a donor.²⁴⁵

Contributions to donor-advised funds are owned and controlled by the sponsoring organizations. Donors part with all rights, title, and interest in the gift money or other property (albeit retaining advisory privileges).²⁴⁶

A donor-advised fund is an intermediary. That is, it is interposed between a donor and an ultimate charitable recipient. This is not a new concept. Other charitable entities are intermediaries, including private foundations, endowment funds, supporting organizations, charitable remainder trusts, and charities that function as fundraising entities for other charities. Detractors of donor-advised funds refer to these ultimate charitable recipients as “working charities.” This distinction is not recognized in the law.

A distribution from a donor-advised fund is taxable if it is to (1) a natural person, (2) any other person for a noncharitable purpose, or (3) any person (other than an individual) unless expenditure responsibility is exercised by the sponsoring organization with respect to the distribution.²⁴⁷

Although public charities are generally eligible grantees, as to distributions from donor-advised funds, disqualified supporting organizations are not. There are three categories of disqualified supporting organizations. One of these categories encompasses Type III supporting organizations²⁴⁸ that are not functionally integrated Type III supporting organizations.²⁴⁹ The second category of disqualified supporting organization embraces Type I and Type II supporting organizations²⁵⁰ and functionally integrated Type III supporting organizations²⁵¹ where a donor, donor advisor, or related party directly or indirectly controls a supported organization²⁵² of any of these types of supporting organizations.²⁵³ The third category of disqualified supporting organization entails a Type I supporting organization, a Type II supporting organization, or a functionally integrated Type III supporting organization where the Department of the Treasury determines by regulations that a distribution to one or more of these entities “otherwise is inappropriate.”²⁵⁴

If a donor, donor advisor, or a person related to a donor or a donor advisor with respect to a donor-advised fund provides advice as to a distribution from the fund that results in any of those persons receiving, directly or indirectly, a benefit that is more than incidental, an excise tax equal to 125 percent of the amount of the benefit is imposed on the person who advised as to the distribution and on the recipient of the benefit.²⁵⁵ More specifically, this tax applies, in addition to a donor or donor advisor,²⁵⁶ to a member of the family of a donor or a donor advisor²⁵⁷ and to a 35 percent controlled entity.²⁵⁸ An individual is determined to be a member of the family by use of the definition of the phrase in the private foundation setting, which applies to individuals who are, with respect to a donor or donor advisor, the spouse, ancestors, children, grandchildren, great-grandchildren, and the spouses of children, grandchildren, and great-grandchildren.²⁵⁹ Also, members of the family include the brothers and sisters (whether by the whole or half blood) of the individual and his or her spouse.²⁶⁰ The term 35 percent controlled entity means (1) a corporation in which donors, donor advisors, and members of their families own more than 35 percent of the total combined voting power; (2) a partnership in which these individuals own more than 35 percent of the profits interest; and (3) a trust or estate in which these individuals own more than 35 percent of the beneficial interest.²⁶¹ Constructive ownership rules apply in this context;²⁶² they are similar to those that apply in the private foundation law setting.²⁶³

If a manager of the sponsoring organization involved agreed to the making of the distribution knowing that the distribution would confer more than an incidental benefit on a donor, donor advisor, or related person, the manager is subject to an excise tax equal to 10 percent of the amount of the benefit.²⁶⁴ The maximum amount of this tax on fund management per distribution is $10,000,²⁶⁵ and both of these taxes are subject to a joint and several liability requirement.²⁶⁶ These taxes on more-than-incidental benefits are subject to abatement.

These taxes may not be imposed if a tax with respect to the distribution has been imposed pursuant to the excess benefit transactions rules.²⁶⁷

A donor must obtain, with respect to each charitable contribution to a sponsoring organization to be maintained in a donor-advised fund, a contemporaneous written acknowledgment from the organization that the organization has exclusive legal control over the funds or assets contributed.²⁶⁸ (This fact should be reflected in the donor-advised fund agreement.) This requirement is in addition to other charitable gift substantiation requirements.

Nearly all tax-exempt organizations that are charitable entities under the federal tax law are required to file annual information returns or submit an annual report to the IRS. Organizations with gross receipts that are normally less than $50,000 annually are required to submit a short annual report (informally known as the e-postcard).²⁶⁹ Organizations with gross receipts normally less than $200,000 annually and with assets less than $500,000 are required to file a short annual information return.²⁷⁰ Other organizations file a more extensive annual information return.²⁷¹ Sponsoring organizations with donor-advised funds, however, are required to file the more extensive annual information return, irrespective of size.²⁷²

The more extensive annual information return is accompanied by a host of schedules. The return includes a checklist of required schedules.²⁷³ One of the questions in this checklist is: “Did the organization maintain any donor advised funds or similar funds or accounts for which donors have the right to provide advice on the distribution or investment of amounts in such funds or accounts?”²⁷⁴ If the answer to this question is “yes,” the organization is required to attach a schedule to its return.²⁷⁵

This schedule bears the euphemistic title of “supplemental financial statements.” The schedule requires the organization to report the (1) total number of donor-advised funds and other “similar” funds it owns as of the end of the reporting year, (2) aggregate value of contributions made to them during the year (separately reported), (3) aggregate value of grants made from them during the year (separately reported), and aggregate value of the assets in the funds at the end of the year (separately reported).²⁷⁶

The schedule also contains a question asking the filing sponsoring organization whether it “inform[ed] all donors and donor advisors in writing that the assets held in donor advised funds are the organization's property, subject to the organization's exclusive legal control”²⁷⁷ and a question inquiring as to whether the organization “inform[ed] all grantees, donors, and donor advisors in writing that grant funds can be used only for charitable purposes and not for the benefit of the donor or donor advisor, or for any other purpose conferring impermissible private benefit.” These two questions are to be answered by checking “yes” or “no” boxes; explanatory statements are not requested.

The more extensive annual information return also inquires as to whether a donor-advised fund maintained by the filing sponsoring organization had any excess business holdings at any time during the year.²⁷⁸ The return includes a question as to whether the sponsoring organization made any taxable distributions.²⁷⁹ Further, the return asks if the sponsoring organization made any distribution to a donor, donor advisor, or related person.²⁸⁰

(c) Commentary

It is obvious that fundraisers for charity must embrace—rather than ignore or be fearful of—donor-advised funds. The amounts available for grants, and the number of donors who are contributing by means of these funds, are stupendously growing. The above-referenced Chronicle of Philanthropy article quoted a fundraising professional as saying that, “[a]s donor-advised funds increase in popularity, we're seeing a wider, larger portion of the overall donor population that's making gifts in this way.”²⁸¹

The basic approach to effective fundraising involving donor-advised funds is to adjust marketing materials and engage in other efforts to learn of potential donors from these funds in charities' donor bases, then solicit gifts from these funds in a manner that is specific to the funds. Soliciting charities should make it clear that they understand giving from DAFs and that they are eligible grantees.

One of the fundamental mistakes a fundraiser can make is to accept the argument that some critics advance that DAFs are “black-box” charities.²⁸² That is not the proper attitude! While there are arguments about how much disclosure sponsoring organizations should be subject to by law, and whether a mandatory payout should be imposed on donor-advised funds, the fact is that there are billions of dollars destined for charity and it is the task of fundraising professionals to see that their organizations/clients obtain their appropriate share of the money.

Perhaps the first nonprofit advisor urging this embrace of donor-advised funds by fundraising professionals rejected claims that the primary purpose of these funds is to help “wealthy people…receive tax benefits” and divert charitable contributions from “working” charities.²⁸³ He wrote that “[n]early all families and individuals who establish donor-advised funds have a strong desire to support their favorite charities and causes.” The main point of this article is that the existence of funds at sponsoring organizations “has made it easier for financial, tax, and legal advisors to talk to their clients about philanthropy—and that is leading to more giving now and in the future.” This writer outlined some “simple steps” that charitable organizations can take to “encourage more DAF holders to support their organizations.” His view is that “[n]onprofit organizations should view DAFs as friends, not enemies,” adding that “[e]verybody in the nonprofit world should support any technique that creates more opportunities for charitable giving.” Without donor-advised funds, he noted, the “charitable conversation between advisors and clients would occur less often, and fewer assets would be allocated for charitable purposes.”²⁸⁴

The fundraising professional quoted in the Chronicle article also said that her organization has donors that see a donor-advised fund “as a useful vehicle for managing their finances and their philanthropy while also engaging with organizations that they support.”²⁸⁵

Another fundraising professional quoted in this article said that “[w]e can't complain about that money sitting there not being dispersed if we're not doing something proactive to get those funds out to the mission,” adding that “[i]f they're not gonna ask for them, someone else is. And that'll be me.”²⁸⁶

(a) Model Law

But, what to do? One solution that has been touted over the years is a model charitable solicitation statute.²⁸⁷ The thought underlying this proposal is that charitable organizations could more easily comply with the laws in all of the states if these laws were the same. There is some truth to this, although many of the compliance burdens would not change and could even increase. As to the latter, a lobbying effort to enact a model law could result in the substitution of a more strenuous statute for a weaker one in some states, or the adoption of a rigorous statute in a state where previously there was none.

The proposal simply has too many flaws, which is probably why it is still only a proposal. To date, the charitable organizations have not been able to agree on the contents of a model charitable solicitations act because the issue is too divisive (starting with the question of exemptions). Furthermore, the state regulators cannot agree on a uniform statute in this area. Thus, there is little likelihood that both the regulated and the regulators will agree on a law.

Also, the lobbying effort involved would be prodigious and enormously costly. It would probably take millions of dollars to formulate a law and then see it through to enactment in every state. Who would coordinate that effort? Where would the funds come from? Would simplicity really result from uniformity, or would it lead to more regulation in more states? These and other questions and dilemmas make the enactment of a uniform charitable solicitation act in every state unrealistic.

(b) Reciprocal Agreements

As discussed, several of these state laws contain reciprocal agreement provisions.²⁸⁸ These provisions are considerably underutilized.

Here is an opportunity to breathe some uniformity into these laws and reduce the regulatory burdens, while simultaneously inducing more compliance in this area of law. This approach does not require amendment of the statute, only application of it. Pursuant to these provisions, a state regulator can allow a charitable organization to file, as its registration and/or annual report, a copy of the documents as filed in the home state. Many of these provisions also enable regulators to grant exemptions from compliance where the exemptions are part of the law in the home state.

Therefore, it is not so much uniformity of law that is required as it is unification of the process of complying with the law. How much easier it would be on charities that want to comply, but are overwhelmed by the complexity, if they could prepare documents in their home states and file copies of them in other states. The process would also be advanced and enhanced if there were greater uniformity regarding exemptions.

(c) Uniform Annual Report

Another proposal is the idea of a uniform annual report. This proposal is likewise grounded on the thought that it is not the laws that need changing so much as the process of complying with them. It truly would be simpler for all concerned if a charity required to file annually in several states could file the same document.

Once again, however, reality intrudes and spoils the potential. The fact is that the state regulators, until recently, have not been able to agree on the contents of an annual report. (An effort was undertaken once to create a uniform annual report that reflected the requirements of every state; the resulting document was so large and unwieldy that the project collapsed, literally of its own weight.)

A task force of the National Association of State Charity Officials has developed a uniform registration form, and several states and the District of Columbia have agreed to accept it. The task force has prepared an information chart stating the addresses of state regulators, the fees to be paid, whether a state supplemental form will be required, and who must sign the form. There are additional instructions for completion of the form for different states. It is not clear how the forms and state supplements will be distributed or how the information chart will be kept up to date.

This, then, is the most promising of the simplification approaches. Even here, however, the forces of division and complexity have quickly intervened, with some states not being able to avoid the temptation—or, in some instances, statutory mandate—to require additional information by means of supplemental forms.²⁸⁹

(d) Other Forms of Uniformity

Still other forms of uniformity are possible. The states could strive for uniform rules and regulations by introducing some commonalities into such subjects as definitions and cost allocations, but the regulators cannot agree.

Even uniformity of enforcement would help. Some states are known to be strict in their enforcement of these laws; others have a reputation for being lackadaisical. This state of affairs creates an atmosphere of cynicism and lawbreaking, where some charities register only in the “tough” states, waiting to register in the others when and if they “get caught.”

Another possibility lies with the Internet. The process of registering in and reporting to many states could obviously be alleviated by means of this medium. Yet, to date, there has been no effort—by a for-profit or nonprofit organization—to implement such a program.²⁹⁰