Several new items have been added to the tool bag of public charity direct marketers and fundraisers, courtesy of the Internet. Though these tools often seem – and frequently are – simple and easily implemented, they may present unexpected risks to charities and donors alike, as well as to intermediaries.
The new tools include direct solicitations for donations via e-mail, online donation capabilities on the Web sites of nonprofit charities, third-party donation portals and online malls that promise to donate a percentage of each purchase to specified nonprofits. For the donor, the risks are whether the intended charity actually receives the donated funds and whether the donation will be tax deductible.
For charities and third-party intermediaries, the perils involve how and by whom donated funds are collected. The role, if any, of third parties is critical to this question. A related issue is credit card factoring. Another concern is whether the charity or third party, by seeking donations over the Internet, risks running afoul of state-by-state solicitation registration requirements.
Charitable donations. Public charities often derive a significant portion of their revenue from donations by the general public. In return for their beneficence, federal and state law permits donors to deduct these charitable contributions from their pretax income (with some limitations ), thus reducing their income tax obligations.
For such donations to be considered deductible, however, they must be made directly to the intended charity or to an authorized agent of the charity. Furthermore, even when a deduction is made to an authorized agent, it may become nondeductible if the full amount of the donation is not forwarded to the charity, if donations are commingled with the third party’s funds or if the payment of donated funds to the designated charities is not made on a periodic and frequent basis (e.g., weekly or monthly at worst).
Though the exact portion is not known, a large percentage of online donations is made through third parties (including many through a charity’s own Web site). In many cases these intermediaries are not authorized agents of the designated charity, so the donations are not tax-deductible to the donors.
Some donation portals (Web sites where an individual can make an online donation to registered charities) appear to be scrupulous about sticking to the agency rule and other Internal Revenue Service requirements. Others, however, are less so, sometimes egregiously. One such portal Web site discovered by the IRS not only states that it is not an agent of any charities but also that it keeps 15 percent of each donation as an administrative fee.
Online malls that donate a portion of proceeds to charities present a somewhat different situation. Participating vendors rebate anywhere from 1.5 percent to 12.5 percent of qualifying purchases to the mall operator, which then forwards the contribution to the charity upon receipt from the vendor. It would seem, under the IRS’ guidelines, that such donations are not at all deductible to the purchaser. Fortunately, few, if any, such malls make a claim otherwise. However, the merchant’s donation could, in theory, be deductible if the mall operator is an authorized agent of the designated charities. However, before merchants claim the donations as charitable contributions on their tax returns, they should verify that the online mall operator is an authorized agent of the designated charities.
A greater problem has arisen in the charity mall arena. At least one such mall operator has been charged with having no arrangement whatsoever with any charities and of pocketing the funds that were earmarked for charities. While the perpetrator may be prosecuted under fraud statutes, the donor has been ripped off and is not entitled to a charitable contribution deduction. Furthermore, any charity that had signed up to be represented by this or other fraudulent charity malls (or donation site, for that matter), could itself have to answer to authorities.
The additional issue of taxation arises for the third parties that collect online and e-mail contributions but either are not authorized agents of designated charities or that otherwise do not comply with IRS rules (such as charging a fee to the nonprofit, commingling funds or failing to make periodic payments). Because funds eventually transferred to charities are not deductible to the original donor, they are treated as taxable revenue to the intermediary. It may claim a charitable deduction of its own for amounts so transferred, but there are limits based upon the income of the intermediary.
The bugaboo is that fraud also arises in these situations. Intermediaries that collect supposedly donated funds but fail to satisfy the IRS’ requirements may be subject to fraud statutes if donors believe they are making direct charitable contributions.
Of course, in all of these scenarios that fail to meet the IRS requirements, the donor has, in fact, not made a contribution that is tax-deductible. Given heightened IRS scrutiny of the whole area of Web-based fundraising, taxpayers who claim online charitable contributions may be more likely to be audited. If the online contribution mechanism does not pass IRS muster, a taxpayer who claimed such a deduction on the reasonable belief that it was deductible would instead owe the IRS income tax on the disallowed deduction, plus a possible penalty.
Credit card factoring. Even when a charity offers an online donation capability through its Web site, the payment may not actually be made directly to the charity. Because of the cost and perceived inconvenience of establishing merchant banking accounts, many small nonprofits use third parties’ factors to process credit card donations. It can probably be safely assumed that an agency relationship exists between the charity and the factor. However, factoring is a violation of merchant card agreements, a criminal act in at least one state (Florida) and prosecuted as fraud in several other states. Civil liability may also inure. The directors of all charities should be particularly cautious about subjecting their organizations, for which they have a well-defined fiduciary duty, to criminal sanctions.
Solicitation registration requirements. Many states and hundreds of counties and municipalities require the registration of all charities that solicit funds, as well as third parties that solicit on behalf of charities, in their territories. Often, they must register before they begin soliciting. Some states and local governments have argued that if any resident of their jurisdictions either receives an e-mail solicitation from a charity (or authorized agent), or accesses a charity Web site and sees a solicitation, that charity must register with that jurisdiction. The law on this question is undecided. Until Congress acts or a conclusive judicial ruling is made, all charities, fundraisers and other third parties that solicit funds on behalf of charities should be cognizant of this potentially troublesome issue.
A second question is which entities would fall under such registration statutes were they to be applicable to online and e-mail solicitations? Most third-party donation sites, including donation portals and online malls, explicitly claim that they are not soliciting funds. It would seem that such statements are intended to avoid these registration requirements. However, a traditional application of the common law suggests that such disavowals have no legal effect. In other words, if registration requirements apply in the situations discussed here, they would also apply to these third parties.
Conclusion. While the jury is out on the effectiveness of online and e-mail fundraising and solicitation for charities, it can be a relatively low-cost adjunct to charities’ other fundraising efforts. However, there are controllable risks which charities and third parties that participate in such programs should acknowledge and eliminate. Fortunately, eliminating those risks is relatively easy and inexpensive.
Anytime a charity participates in a Web-based donation program with a third party, a formal agency relationship should be established between the charity and the third party. In addition, the third party should be required to pass along the entire donation to the charity and transfer those payments on a frequent, regular basis. The charity should also insist that funds collected by the third party on they charity’s behalf either be segregated until transferred, or that those funds be adequately accounted for by the third party with audit rights by the charity.
Charities that use third parties to process online and e-mail donations would be wise either to obtain a merchant bank card relationship of their own, or use an alternative online payment service such as PayPal. This would give them more control over the funds, minimize the potential for fraud and avoid legal issues related to credit card factoring.
If a charity is already engaged in Web-based fundraising with third parties, it should conduct a simple review or legal audit of its current practices and institute any necessary safeguards. Failure to heed this advice could result in serious legal issues for charities and their boards. As directors have ultimate fiduciary control and duty to their organizations, it is they who should be vigilant in ensuring that the organization’s staff adheres to these simple requirements.