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8.3 Evaluating whether a transaction involves a third-party donee
Publication date: 27 May 2020
us NFP guide
The existence of a third-party donee (the specified beneficiary or the ultimate beneficiary of the resources) is what distinguishes “three-party” contribution transactions from conventional two-party contribution transactions that involve a direct transfer of resources between a donor and a donee.
As a general rule, if a donor provides resources to an intermediary and identifies a third-party donee as the beneficiary (as described in ASC 958-605-55-78), the special framework is applied unless the intermediary possesses special rights known as variance power (discussed at NP 8.3.2.1).
Excerpt from ASC 958-605-55-78
A donor may specify the beneficiary by name, by stating that all entities that meet a set of donor-defined criteria are beneficiaries, or by actions surrounding the transfer that make clear the identity of the beneficiary, such as by responding to a request from a recipient entity that exists to raise assets for the beneficiary.
In some cases, evaluating whether a transaction involves a third-party donee (and thus, should be accounted for using the three-party framework) is straightforward, but often it is not. For example, in some situations when fundraising is conducted by a foundation on behalf of specified organizations, the existence of a third-party donee is implied, rather than explicitly stated (see NP 8.3.1). In other cases, a contribution transaction that initially appears to involve three parties might, upon closer scrutiny, only involve a donor and a donee (see NP 8.3.2).
Example NP 8-1 illustrates the importance of correctly evaluating whether a transaction involves a third-party donee.
EXAMPLE NP 8-1
Evaluating whether a third-party donee has been specified
Evaluating whether a third-party donee has been specified
University Foundation’s articles of incorporation state that it exists solely to solicit donations and to hold and manage such assets for the exclusive benefit of University.
Donor contributes $1,000 to University Foundation. Does this contribution transaction involve two parties (donor and donee) or three parties (donor, intermediary, and third-party donee)?
Analysis
While the transaction might initially appear to be a gift to University Foundation, in substance it involves three parties. Because the foundation exists solely to support University, all contributions made to University Foundation implicitly involve a specified beneficiary (third-party donee). Foundation has no discretion in determining where the contributed funds should go. Under the three-party framework described in the “Transfers of Assets” subsections of ASC 958-605, University must recognize its rights to the resources held on its behalf by University Foundation. The party that should recognize contribution revenue (University or University Foundation) will be determined based on whether the financially-interrelated fundraising relationship described in ASC 958-30 exists (see NP 8.4.1).
If the transaction is mistakenly assessed as a “two-party” contribution with University Foundation as the donee (and thus, only the guidance in the “Contributions Received” subsections of ASC 958-605 is applied), University Foundation might recognize contribution revenue to which it is not entitled. Furthermore, University’s assets and net assets would be understated, because University would not reflect its rights to the resources held by University Foundation.
8.3.1 Foundations that support several beneficiaries
When a foundation’s fundraising exclusively benefits a single entity (as established through the purpose stated in its articles of incorporation and bylaws), all the contributions it receives will have an implied beneficiary, as illustrated in Example NP 8-1.
Some foundations raise funds on behalf of several named beneficiaries. The supported beneficiaries might be a group of affiliates (for example, subsidiaries of a common parent), or they might be unrelated entities. Either way, if the foundation receives a gift that is donor-designated for one of the beneficiaries, the gift is accounted for using the three-party framework. If the foundation receives a gift that is not designated for one of the beneficiaries, then the foundation itself is the donee. However, sometimes a foundation that bears the name of a single beneficiary will be established to serve a broader purpose. In those situations, a third-party donee should not be implied, which is illustrated in Example NP 8-2.
EXAMPLE NP 8-2
Institutional foundation with broader purpose
Institutional foundation with broader purpose
The articles of incorporation for Hospital Foundation state that it was established to solicit donations and to hold and manage such assets to support the work of Hospital and to address broader health-related issues in the community served by Hospital.
Hospital’s website solicits donations. Prospective donors are informed that fundraising is handled by Hospital Foundation, with a hyperlink provided to the online giving section of Hospital Foundation’s website.
Hospital Foundation uses the three-party model to account for online contributions received from donors who either explicitly stipulate that their gift is to benefit Hospital or who access Hospital Foundation’s online giving area via the donation hyperlink.
Prospective donors can also access Hospital Foundation’s website directly, and its home page clearly indicates its broader purpose. During a reporting period, $5,000 of contributions received by Hospital Foundation had no stipulations (implicit or explicit) related to Hospital. Do those contributions involve two parties (donor and donee) or three parties (donor, intermediary, and third-party donee)?
Analysis
The $5,000 of online contributions are two-party contributions in which the Foundation is the donee.
Unless Hospital is explicitly specified as the intended beneficiary or the contribution originated from the hyperlink on Hospital’s website, Hospital has no rights to contributions raised through Hospital Foundation’s website. Even though Foundation bears Hospital’s name, contributions received by Hospital Foundation are not implicitly deemed to be for the benefit of Hospital. Hospital Foundation has the discretion to choose to support any cause or entity that falls within its broader mission (for example, a community health fair, blood drive, or vaccination campaign), which is clearly stated on its homepage.
Foundations may enter into arrangements whereby gifts without donor restriction must be divided among the beneficiaries according to a prescribed formula. Such a formula might be specified in the articles of incorporation or bylaws of the foundation, or in an inter-entity agreement among the foundation and its benefited organizations. In those cases, the foundation does not have discretion to determine how the funds should be distributed, and, therefore, the foundation’s beneficiaries are implied third-party donees.
Example NP 8-3 illustrates a fact pattern when undesignated gifts have implied third-party donees (beneficiaries) resulting from a formula arrangement, and the beneficiaries are unrelated entities.
EXAMPLE NP 8-3
Foundation supports two specific organizations – formula is used
Foundation supports two specific organizations – formula is used
Arts Foundation’s articles of incorporation state that it was organized to solicit donations and to hold and manage donated assets for the benefit of two independent NFPs: Civic Ballet and Community Theater. An agreement among the three organizations states that gifts that are not donor designated for a specific organization will be split equally between Civic Ballet and Community Theater.
Donor makes a gift of $5,000 to Arts Foundation that is not designated for either Civic Ballet or Community Theater. Does that transaction involve two parties (donor and donee) or three parties (donor, intermediary, and third-party donee)?
Analysis
On its surface, this transaction appears to involve only two parties (Donor and Arts Foundation). However, because the inter-entity agreement specifies that undesignated contributions will be split equally between Civic Ballet and Community Theater, beneficiaries are implicit in every undesignated contribution. Therefore, the transaction would be accounted for using the three-party contribution framework.
If the inter-entity agreement did not exist, the transaction would only involve two parties. Even though Arts Foundation must ultimately distribute the gift to one or both of its supported organizations, Arts Foundation would have the ability to choose how to distribute the funds. An illustration involving a foundation that raises funds for a group of affiliates can be found in Example 2 in ASC 958-20-55-8 through ASC 958-20-55-13.
8.3.2 Gifts when potential third-party donees are disregarded
Some transactions that might appear to specify a third-party donee might not actually have one for accounting purposes. In those cases, the guidance for typical two-party contributions would apply. This might occur in the case of gifts that provide variance power to the intermediary and gifts made to donor-advised funds, as described in the following sections.
8.3.2.1 Gifts that involve variance power
If a donor specifies a third-party donee but grants the intermediary variance power, then the intermediary has the legal power to redirect the donated assets to a different beneficiary. An intermediary that possesses variance power can recognize contribution revenue, because it has discretion on how the assets are distributed and the named beneficiary has no recognizable rights for accounting purposes. In these situations, the two-party contribution model applies.
Variance power is a legal concept and defined in the ASC Master Glossary. As used in ASC 958-605-25-25, the focus is on two aspects: unilateral power and an explicit grant of the right. Unilateral power means that the recipient organization can override the donor’s instructions without approval from the donor, specified beneficiary, or any other interested party. For variance power to be operational, the donor must explicitly grant it to the intermediary as stated in ASC 958-605-25-28.
ASC Master Glossary definition
Variance power: The unilateral power to redirect the use of the transferred assets to another beneficiary. A donor explicitly grants variance power if the recipient entity's unilateral power to redirect the use of the assets is explicitly referred to in the instrument transferring the assets. Unilateral power means that the recipient entity can override the donor’s instructions without approval from the donor, specified beneficiary, or any other interested party.
A recipient entity that is directed by a donor to distribute the transferred assets, the return on investment of those assets, or both to a specified unaffiliated beneficiary acts as a donee rather than an agent, trustee, or intermediary, if the donor explicitly grants the recipient entity variance power—that is, the unilateral power to redirect the use of the transferred assets to another beneficiary.
Excerpt from ASC 958-605-25-28
A specified beneficiary shall recognize its rights to the assets (financial or nonfinancial) held by a recipient entity as an asset unless the recipient entity is explicitly granted variance power.
According to the definition, the grant of variance power must be explicitly referred to in the gift agreement. In practice, the variance power might be mentioned in the gift agreement and explained in a separate gift policy document or the intermediary’s formation documents (articles of incorporation/bylaws or trust agreement).
Example NP 8-4 illustrates how variance power functions in a gift agreement.
EXAMPLE NP 8-4
Variance power granted to a federated fund-raising organization
Variance power granted to a federated fund-raising organization
An individual contributes $1,000 to Federated Fundraising Organization (FFO) through a workplace campaign and designates that their gift should go to Community Food Bank. FFO’s campaign literature and donor form state that even if donors specify a particular beneficiary, FFO’s allocation committee has the authority to redirect their gift if the committee perceives greater need elsewhere in the community.
How many parties are there to this contribution?
Analysis
By agreeing to contribute under the stipulated terms, donor explicitly grants variance power to FFO. Thus, this would be a two-party contribution transaction between the donor and FFO. FFO would account for the contribution based on the “contributions received” subsections in ASC 958-605. If FFO subsequently grants $1,000 to Community Food Bank, it would be accounted for as a separate transaction in which FFO is the donor and Community Food Bank is the donee.
If the campaign materials did not contain a variance power statement (i.e., the variance power was not explicit), FFO would have no ability to override the donor’s designated beneficiary and would be required to pass those gifts on to Community Food Bank. Under that scenario, donor’s gift would be accounted for using the “three-party” transaction framework.
8.3.2.2 Intermediaries that require donors to grant variance power
Variance power can be granted in any gift agreement involving any type of NFP. However, for certain types of intermediary organizations, possession of variance power is an inherent operating characteristic. That is, these organizations require donors to grant variance power in connection with gifts.
- Community foundations. By design, a community foundation’s governing body must possess the power to modify donor-imposed restrictions if, in the board’s judgment and discretion, the restrictions become unnecessary, incapable of fulfillment, or inconsistent with the charitable needs of the community. By incorporating variance power into gift agreements, the foundation avoids inefficiencies associated with long-lived giving vehicles (charitable trusts, endowments, or similar perpetual gifts) in which outdated donor restrictions might require the use of resources for purposes that are no longer sensible, practical, or efficient (for example, the care of individuals with diseases that have been eradicated).
- “American friends of…” charities. These are NFPs formed to support a specific foreign entity. Under IRS rules, charities that make grants to foreign entities are prohibited from serving as a conduit to enable the free flow of funds from American donors to foreign causes. Strict IRS regulations relate to both the letter and the spirit of the law as to how domestic NFPs may raise and transfer funds to foreign entities. For example, in order for contributions raised in support of a project of a foreign entity to be deductible by the donors, the sponsoring charity must have approved the project as being in furtherance of its own exempt purposes, and its board must have full control of the donated funds and discretion as to their use (which is typically achieved through a grant of variance power).
Example NP 8-5 illustrates the use of variance power in a gift made to a community foundation.
EXAMPLE NP 8-5
Donor grants variance power to a community foundation
Donor grants variance power to a community foundation
The governing board of Local Zoo wishes to create and build a donor-restricted endowment. It signs an agreement with Community Foundation establishing The Local Zoo Endowment as a fund to be held and managed by Community Foundation. Local Zoo will solicit endowment gifts for the fund. The resulting assets will be owned, held, and invested by Community Foundation, with distributions made to Local Zoo annually based on Community Foundation’s spending policy. The agreement contains a “variance power” provision stating that the Local Zoo Endowment fund will be operated subject to Community Foundation’s governing documents and policies, which include the granting of variance power in connection with gifts made to the endowment.
When soliciting gifts for the endowment fund, Local Zoo’s campaign materials (including the donor response cards) inform prospective donors that the endowment will be owned, held, and invested by Community Foundation. Donors also are notified that, in giving to the endowment, they will be granting Community Foundation variance power to redirect their donations if Local Zoo ceases to exist or to function in a manner that is consistent with the needs of the community.
How should Local Zoo and Community Foundation account for gifts received in response to Local Zoo’s endowment campaign?
Analysis
Gifts made to the Local Zoo Endowment fund would be accounted for as gifts to Community Foundation, not gifts to Local Zoo. This is because donors explicitly grant variance power by using donor-response cards clearly stating that the gifts are subject to Community Foundation’s unilateral power to redirect the resources to another beneficiary.
Community Foundation would recognize the fair value of gifts received for by the Local Zoo Endowment fund as contribution revenue. Local Zoo would be precluded from recognizing any rights to the endowment assets. Instead, it would recognize contribution income when Community Foundation makes distributions to Local Zoo.
8.3.2.3 Gifts to donor-advised funds
A donor-advised fund is a separately-identified fund or account over which a donor expects to have advisory privileges over the distribution or investment of the assets, but which is owned or controlled by a sponsoring charity (the “charitable sponsor”). The donor funds the account by making irrevocable, tax-deductible contributions to the charitable sponsor, and advises the sponsor how they would like the funds to be spent (for example, to benefit a specific charity). However, that advice is not legally binding on the charitable sponsor and, therefore, functions merely as a recommendation to the sponsor. Typically, although the charitable sponsor will act based on that advice, it has no legal obligation to do so.
Because the donor’s recommendation of a donee is only advisory in nature, a gift to a donor-advised fund is recognized as contribution revenue by the charitable sponsor. It is not accounted for under the three-party contribution framework. If the charitable sponsor subsequently chooses to make a grant based on the donor’s recommendation, this would be a separate transaction between the charitable sponsor as donor and the recommended charity as donee.
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