Legal Toolkit:
Funding Economic Democracy
An evolving collection of resources by Sustainable Economies Law Center and friends
Contents
Sharing strategies and busting myths
Part 1: Understanding “charitable”
Pivotal determination: what is “charitable?”
Part 2: For intermediaries and fiscal sponsors
Why are intermediaries and fiscal sponsors helpful?
Legal and tax reasons for intermediaries
How intermediaries can pay $ to cooperatives
How intermediaries can “fund” cooperatives �beyond fiscal sponsorship
Adhering to 501(c)(3) responsibilities
Other considerations for intermediaries
Example: Statement of charitable purpose
Example: General description of activities
Example: Agreement for single grant
Example: Helping a cooperative manage taxes
Part 3: For foundations and DAFs
What foundations and DAFs need to know
Embracing direct giving to cooperatives
Expenditure responsibility basics
Repairing the harms of endowments
Getting money out of endowments
A call for endowment transparency
Freeing assets from constraints of “prudence”
Mission-and program-related investments
What diligence is needed with PRIs?
Two tax reasons to donate to cooperatives:
Example: How to donate to our cooperative
Welcome to this Toolkit!
This Legal Toolkit is for anyone trying to get funding to deeply democratic organizations, like cooperatives and worker-directed nonprofits.
These resources are compiled by the Sustainable Economies Law Center, a worker-directed 501(c)(3) nonprofit that provides legal support, education, and funding to deeply participatory organizations we believe are essential to economic transformation. We have cultivated expertise in several legal areas that affect how funding flows to democratic organizations. Since 2016, we have received dozens of grants and donations that we’ve used to fund six cooperatives. In this Toolkit, we share what we’ve learned and what we’ve practiced.
Here is a 20-minute cartoon video that may be a helpful accompaniment to this Toolkit: How Foundations Can Fund and Invest in Economic Democracy.�
It is largely due to lack of legal understanding that many funders are unwilling to fund cooperatives and other projects for economic democracy. We hope this Toolkit can change that! Knowledge is power!
Deeply democratic organizations are essential!
We not only believe it’s essential to fund democratic organizations; we also think funders should move away from funding top-down, hierarchical, and paternalistic charities. This may sound like bold statement, given that the vast majority of nonprofits are hierarchical and/or are led by people who do not represent the communities that the nonprofit seeks to benefit. But the status quo IS the problem, and it’s time to name it: We perpetuate many supremacies and systems of oppression when we support institutions where some people retain control and power over other people. Participatory organizations not only disrupt those patterns of oppression, but they activate the potential of all people to weave together their visions, ideas, needs, and talents toward facing the immense challenges that lie ahead.
With the immense threats to global ecological wellbeing, economic stability, and political democracy, our society desperately needs to support everyday people to build power and participate in shaping all aspects of our lives. We do this by building and funding deeply democratic organizations, like worker-directed cooperatives and organizations, community-owned solar cooperatives, tenant-governed housing cooperatives, and other organizations that foster high levels of engagement and participation.
Charity v. democracy
Conventional charitable models are at odds with democracy in many ways. If democracy is by, for, and of the people, then economic democracy means putting people in charge of decisions about the flow of resources that matter to their lives. But conventional charities and foundations keep the vast majority of people separate from such decisions, presuming it is better to have “independent” and “disinterested” people hold governance roles, making decisions that affect others’ lives. But that is neither legally required nor socially just.
People who have accumulated wealth tend to retain substantial influence and decision-making, even when they put their resources into foundations to give away. This perpetuates a form of supremacy that’s rarely discussed: Hoarder supremacy. Hoarder supremacy presumes that people who have accumulated wealth – by whatever means – are entitled to continue to control resources and make decisions that substantially affect others’ lives. But if some of the deepest problems in our world originate with the unfair accumulation of wealth by some at the expense of others, then keeping hoarders in positions of power is antithetical to how the charitable goals of poverty alleviation and combatting community deterioration.
We are not calling for the democratization of philanthropy. We are calling for the abolition of philanthropy and the release of charitable assets into deeply democratic organizations everywhere. This Toolkit helps serve that goal.
Why a legal toolkit?
The law shapes how resources flow in our society. This Toolkit is to help everyone learn a little about the law, since rules vary depending on:
We never want to see the law – or lack of understanding of the law – be a barrier to getting funding to where it urgently needs to go. Many people in positions of authority, like lawyers, foundation trustees, and financial advisors, tend to disseminate misinformation about the law, which in turn limits the flow of resources. We want to set the record straight and empower foundation staff, cooperative members, and community leaders to know what’s possible.
Money from:
Money to:
This is how funding typically flows.
Currently, most gifts and grants flow to 501(c)(3) organizations. Because this is already common, this Toolkit will not saw much about this, other than to encourage funders to prioritize funding democratic 501(c)(3)s, like those involved in the Nonprofit Democracy Network.
Private Foundation or Donor Advised Fund
Public Charity
Individual seeking a tax deduction
501(c)(3)
501(c)(3)
Intermediary or fiscal sponsor
Non-501(c)(3)
(like a cooperative)
Money from:
Money to:
This arrangement is becoming more common.
To help get money to democratic organizations, some 501(c)(3)s are acting as intermediaries to receive money from foundations and donors, then administer funding to cooperatives. This Toolkit will address this arrangement.
Private Foundation or Donor Advised Fund
Public Charity
Individual seeking a tax deduction
501(c)(3)
501(c)(3)
Intermediary or fiscal sponsor
Non-501(c)(3)
(like a cooperative)
Money from:
Money to:
We need more of this.
Funders can give directly to cooperatives and other non-501(c)(3) organizations. This Toolkit will address this, and the tax and legal considerations that vary depending on where the money is coming from and for what purpose.
Private Foundation or Donor Advised Fund
Public Charity
Individual seeking a tax deduction
501(c)(3)
501(c)(3)
Intermediary or fiscal sponsor
Non-501(c)(3)
(like a cooperative)
Examples we’ll share:
Throughout this Toolkit, we’ll refer to a few examples. The Sustainable Economies Law Center is a 501(c)(3) nonprofit that has helped get funding to six cooperatives. In particular, we’ll share about:
EB PREC: East Bay Permanent Real Estate Cooperative is a multi-stakeholder cooperative that the Law Center incubated and administers funding to.
People Power: People Power Solar Cooperative is another cooperative we incubated and administer funding to.
Hasta Muerte: Hasta Muerte Coffee Cooperative is a worker cooperative that has received two grants with the support of the Law Center.
Sharing strategies and busting myths
In this Toolkit, we’ll help dispel some common myths and misconceptions that create barriers to funding democratic organizations. Misconceptions we’ve heard often include:
In addition to helping dispel the above myths, we’ll share resources and strategies to help democratic organizations be prepared to receive funds, support nonprofits to become fiscal sponsors of grants to cooperatives, and help foundations carry out the steps necessary to provide direct grants to cooperatives.
Mapping this Toolkit
Part 1 of the Toolkit addresses the pivotal question of what is “charitable.” As we’ve acknowledged, conventional charitable models have, in practice, been at odds with democracy, to the point where many people are under a mistaken belief that democratic organizations can’t be charitable. However, we’ll explain that democratic organizations can be far better suited to solving social problems and therefore advancing charitable purposes, whether or not they are structured as 501(c)(3)s. Whether you are a cooperative, a foundation, or a funding intermediary, it’s important to learn how to analyze what is or isn’t “charitable.”
Part 2 includes resources for 501(c)(3) organizations that want to act as intermediaries and fiscal sponsors to help get funding to non-501(c)(3)s, like cooperatives.
Part 3 delves into rules specific to private foundations and donor advised funds (DAFs), including rules related to expenditure responsibility, endowments, program related investments, and mission-related investments. �
Extra resources and tips are provided at the end.
And sample documents and other tools are provided on light blue slides.
Part 1: Understanding what’s “charitable”
Pivotal determination: what is “charitable?”
Money held in 501(c)(3) organizations – both public charities and private foundations – must be used for charitable purposes, or other purposes listed under section Internal Revenue Code section 501(c)(3), such as educational and religious. When foundations make grants, they tend to give to organizations that have received a 501(c)(3) tax exemption letter from the IRS. In this way, they rely on the IRS’ opinion, rather than make their own determination of what advances charitable purposes. But this approach limits possibilities for funding economic democracy. It’s critical to start giving to democratic organizations, whether or not the organizations have chosen to seek tax exemption under 501(c)(3).
Important: Giving to a 501(c)(3) is not the only way to advance charitable purposes. It is only necessary to determine that a gift advances charitable purposes. This means that leaders and staff of 501(c)(3)s should hone their skills to make this determination in a variety of contexts. We’d encourage everyone to watch this 20-minute cartoon on How Foundations Can Fund and Invest in Economic Democracy, particularly starting at minute 9:30, to see a brief overview of how interpretations of “charitable” are evolving.
How would you go about determining whether a grant to a cooperative advances charitable purposes? We offer some “due diligence” tools below.
The boundaries of charitable purpose have expanded
In past decades, the boundaries of “charitable purpose” have shifted in ways that not easy to see unless you pay close attention to IRS decisions. The shift can mainly be observed in the activities for which the IRS does and does not grant tax exemption. The Law Center has been in a unique position to observe this, having provided legal support to dozens of organizations that have explored the boundaries. We’ve seen many activities receive tax exemption even when the IRS might previously have considered them too commercial in nature or too oriented toward private benefit. Now, the IRS is seeing that charitable purposes can be advanced in circumstances where communities organize to meet their own material needs through cooperation and mutual aid. In their applications to the IRS, nonprofits pointed to evidence of their community’s economic challenges and disempowerment, then cited the growing body of literature indicating that self-organizing and community-led solutions may be the most effective at addressing such problems.
This shift has opened doors for private foundations �and public charities to play an expanding role in �funding cooperatives and other non-501(c)(3)s.
The boundaries of 501(c)(3) law move �to accommodate our understandings of problems and their solutions.
The boundaries of educational purpose have expanded
Previously, the IRS was prone to recognizing activities as educational only if they carried some hallmarks of institutional education, such as classroom instruction, credentialed instructors, organized presentation of a curriculum, and administration of testing.
Today, we have evidence to show that such instructional methods are less effective than hands-on, practical, social, and experiential modes of learning. We also know that people everywhere need spaces where they can experience and practice democratic participation and new economic structures, because it is only through such experience that people can gain confidence to shift away from the disempowering and extractive structures of the dominant system. With conscious structuring, cooperatives and mutual aid groups may be the most effective training grounds for the solidarity economy and can thereby broaden the scope of activities viewed as “educational.” This, too, expands the space in which 501(c)(3)s can fund cooperatives.
Oh!
Schools are not the only place where education happens!
How foundations can “due diligence” democratic groups
When it comes to funding cooperatives and other non-501(c)(3)s, expenditure responsibility may demand more diligence to ensure the group is advancing charitable purposes. But the inquiry can be the same: Who and how? A BIPOC-led group that gives its members power to take action to advance broader community benefit has already transformed one corner of the world, and it is creating the conditions for the spread of transformation. This, alone, is advancing charitable purposes, because it creates the space in which communities can begin to nourish themselves in the long term.
The most important questions to ask about a group are: Who are they and how do they organize themselves? When funders are overly focused on what a group will do, it undermines the very self-determination that makes economic democracy powerful. Any funding that is conditioned on specific deliverables and measurable outcomes will undermine democratic processes that should shape the work into the future. It will tie hands, preventing a group from hand-crafting its work through daily decisions that are responsive, adaptive, diverse, holistic, decentralized, and participatory. The most effective groups are the ones that can – at any moment – draw upon the ingenuity of diverse group members to inspire and activate the work that is most needed. The work should be collectively determined and intrinsically motivated, not pre-determined by external funding.
Ask: Who is doing this work?
Here are a few thoughts on how to set prioritize the “who:”
A newly formed group of everyday people from marginalized backgrounds has the potential to do transformative work if they have taken special care in deciding how to organize themselves.
Ask: How does this group organize itself?
Over the years, Sustainable Economies Law Center has developed several lists and sets of principles that could be implemented by solidarity economy groups at the levels of legal, financial, and governance structures. Every group we provide legal support to then teaches us something new about the ingredients of participatory democracy and community wealth-building. Our lists and principles have never been static, and we expect they never will be, because we foresee decades of continued learning. To learn more about how our lists and principles have taken shape and continue to evolve, see the resources at the end of this Toolkit.
As a legal organization, we’ve been prone to focusing on the “hard” ingredients – the ones that groups bake into their bylaws, policies, and operational practices. These are essential ingredients, as they prevent projects from getting swallowed up by dominant forces of wealth and power concentration. But ultimately, it’s the “soft” ingredients that give groups their power – the culture, social practices, rituals, symbols, language, and spirit of a group. These are the ingredients that determine whether people are intrinsically and joyfully motivated to come together, do the work, and build their lives around social transformation in the long term.
How can a funder, viewing a group from the outside, learn to recognize a group that has organized itself in transformative ways? We’ll offer a set of questions that might guide such an inquiry, with the reminder that the questions are likely to evolve over time. The questions are: Does this group actively and intentionally 1) spread power, 2) spread wealth, and 3) root that power and wealth in the community in the long-term?
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If we are to replace a colonialist, white supremacist, dominance-based culture, then people need to live and actively practice something different in all aspects of their lives, which is why we should question any solution or organization that emulates the dominance culture and its hierarchies. The ingredients of participatory democracy must be infused in legal structures, governance structures, everyday practices, and culture of a group. There is no one way to spread power, so we suggest asking groups open questions, like: How does your group spread power? And ask it in the negative: How does the group work to prevent the formation of static hierarchies?
Fixed power structures tend to reproduce historic caste systems, result in concentration of power and wealth in the hands of few, make a group less resilient in the face of change, and suppress the infinite potential of a group to apply creative energy toward everyday action. This is not to say that all hierarchies are bad; it is to say that any hierarchies should be consciously designed, not unconsciously assumed, consented to by their participants, and part of larger heterarchical systems that allow power to move in fluid and diverse ways to many parts of a group.
The resurgence of white supremacy, among other things, has led a growing number of groups to question a culture of dominance in all of its manifestations. In the past few years, the Sustainable Economies Law Center has observed a shift: We’ve provided legal support to several hundred groups that are intuitively adopting collective and non-hierarchical structures. They manifest this on paper – such as through their participatory and deliberative decision-making processes, and by spreading everyday work and decisions through decentralized structures.
Participatory structures must also take shape through culture and practices. We see many groups intentionally fostering belonging and embedding trauma-informed healing into everything, including workplaces, real estate projects, and solar projects. We see groups practicing radical inclusivity, because to not do so could leave any group member in fear of being left out. We see groups weaving ritual and creativity into their togetherness, to bring their full humanness into the work and build commitment. We see groups welcoming and supporting ongoing conversations about power dynamics within the organization. All of this is essential for the trust-building that is necessary to the functioning of collectives. In hierarchical environments, people tend to armor up and act from fear and defensiveness. By fostering belonging, collective groups activate the inexhaustible energy of love and affection that is most powerful in fueling a movement.
Spreading power in this way also leads to integrated and holistic solutions to social problems. When power and problem-solving is spread throughout communities, people bring the perspective of their whole lives and communities. This is why East Bay Permanent Real Estate Cooperative is not just a real estate organization. Because their members and workers bring holistic perspectives to the work, EB PREC also supports members to build community and mutual aid, and they incubate the Black worker cooperatives that will eventually inhabit the commercial spaces owned by the cooperative. This is why it’s important to make unrestricted gifts and grants to a group, rather than to fund specific projects and deliverables.
2) How does this group spread wealth?
How can groups actively spread the wealth, assets, and benefits of their work, and defend against pressures of extraction, wealth concentration, and reproduction of racialized inequalities? There are many facets to this, including choices related to employee compensation, returns paid to investors, and access to the assets and benefits an organization provides. As a general rule, wealth tends to spread more fairly and equitably when decisions about it are democratized. For example, many worker-governed nonprofits we know of gravitate naturally toward adopting equal pay structures or narrow pay ratios, with compensation set after substantial group deliberation. Putting caps on staff pay and setting other guardrails against inequities is important. Sustainable Economies Law Center recently examined 990 tax returns of local nonprofit affordable housing developers and learned that some of their Executive Directors are making as much as $700,000 per year. And at the cooperative REI, the CEO makes $3.2 million per year. This shows that it is not enough to verify that something is structured as a cooperative or nonprofit; due diligence could include questions about staff pay and how it is determined. It’s also important to look to the structure of equity and debt financing. Even nonprofits and cooperatives could accept financing on terms that put undue pressure on the community to channel wealth to lenders or investors, diminishing the wealth that could otherwise be spread to communities.
Wealth can also spread or concentrate depending on the orientation of a group. As a general rule, 501(c)(3)s are oriented toward public benefit, while cooperatives are designed to operate for the mutual benefit of their members. However, this is a false binary created by our legal system. Quite possibly, the most transformative work is being done by groups that blend mutual and public benefit, activating the intrinsic drive of community members to provide for themselves and others simultaneously.
To validate this approach, it helps to acknowledge that this is how most things in natural ecosystems work. In the solidarity economy, we are seeing that most cooperatives are oriented toward broader community benefit. However, this is not always the case. Many cooperatives do exist solely to benefit a defined group of people, without a mission or orientation of broader public benefit. Particularly when conducting due diligence with cooperatives, it’s important to ask if and how the cooperative holds itself to values of community benefit.
Another trend we are seeing is that solidarity economy groups are focusing on creating community-owned assets, while moving away from individual/household asset-building strategies. Individual wealth-building models tend to reinforce the idea that individuals must fend for themselves, and they fail to activate the full power of communities to provide for each other. In housing, for example, some groups see it as counter-productive to set up individual equity-building structures, and instead find it more important to put assets in the hands of small collectives of people who can harness their creativity, social ties, and ingenuity to build the greatest wealth and stability for all.
As one manifestation of this, East Bay Permanent Real Estate Cooperative owns a house where residents cannot be evicted on the basis of non-payment of rent. Rather, EB PREC residents agree, when there are financial challenges, to be part of collective problem-solving processes that might convene other cooperative members, staff, and neighbors to collectively generate solutions. In this way, community members come to see their collective wellbeing as intertwined, and this perspective leads people to move wealth to where it is most needed. This is an asset of incalculable value.
3) How does this group root that power and wealth in the community in the long-term?
In the past, many projects that have built wealth and power for communities have, all too easily, been co-opted, sold off, or captured by a group of people serving private interests. The worker-owned New Belgium Brewing was recently purchased by a giant beverage company, which resulted in a generous pay-out for current workers, but without compensation to the future workers and surrounded communities that a worker-owned company might have benefited. When committing philanthropic resources to solidarity economy projects, it’s important to ask how a group is adopting safeguards that will keep community wealth and power rooted in the long-term. For example, how does a land or housing organization ensure that its real estate will be retained as permanent community assets, and not swallowed up by the speculative market? What will prevent a successful worker-owned cooperative from selling to a large corporation?
The governance and financial provisions baked into a group’s structure can help prevent this, but only to the extent that a passionate group of people will take action to enforce them. Looking beyond legal provisions, groups can take measures to build both external and internal resilience.
External resilience: Groups that are nested and networked within broader movements are less likely to sell-out, because they are likely accountable to and able to gain support from other groups. It will be natural for many groups and projects to come and go, and when groups close down, their assets can be spread around and absorbed by other groups, rather than disappear or be acquired in the speculative market.
Internal resilience: Groups can take many steps to build internal resilience and reduce likelihood that a group will be taken down by interpersonal conflict, toxic power dynamics, implicit or explicit bias, asset mismanagement, or over-reliance on single leaders or experts. Internal resilience measures may include high levels of transparency, robust conflict engagement systems, systems for spreading responsibility, knowledge and skill among many group members, and trainings on issues of bias and white dominant culture.
Due Diligence Questionnaire for Organizations
1) How does the organization spread power?
Due Diligence Questionnaire for Organizations
2) How does the organization spread benefits/wealth/nourishment?
Due Diligence Questionnaire for Organizations
3) How does this organization root power and wealth in the community in the long term?
Part 2: For intermediaries and fiscal sponsors
Why are intermediaries and fiscal sponsors helpful?
Since 2016, Sustainable Economies Law Center has served as an intermediary between foundations/donors and cooperatives, through what is generally known as fiscal sponsorship. We didn’t plan to serve this role, but found ourselves stepping in to support when we saw cooperatives face barriers to accessing funds.
The barriers were both legal and practical. First, as described on the next page, many funders want to give only to 501(c)(3)s. Second, acting as an intermediary can somewhat reduce the administrative burden for the cooperative and funder, if it removes the need for expenditure responsibility. Third, intermediaries can help cooperatives manage their tax burdens by managing the timing of funding. Finally, as a practical matter, we collaborate closely with many cooperatives on legal, policy, and movement work, so we are familiar with their work and leaders, which puts us in a good position to understand their funding needs and connect them to helpful resources.
For legal reasons, we hope to see many more 501(c)(3)s to serve such intermediary roles. And legal reasons aside, intermediaries can be a helpful bridge to getting more funding to frontline communities and small democratic groups. As the REO Collaborative explains, large philanthropies lack relationships with frontline groups and are less responsive to their needs. “Grassroots-centric intermediaries” can hold closer relationships, follow the leadership of, and be responsive to the needs of frontline groups.
Legal and tax reasons for intermediaries
We have played the role of intermediary between funders and cooperatives when:
Non-501(c)(3)
(like a cooperative)
Private Foundation or Donor Advised Fund
501(c)(3)
Intermediary or fiscal sponsor
Intermediaries can be a form of “fiscal sponsor”
The phrase “fiscal sponsorship” confuses many people, so it’s worth clarifying. It applies to more than 6 different kinds of relationships. A nonprofit law firm (Adler & Colvin) has categorized fiscal sponsorship to include:
Project
Contracts with
�501c3 Sponsor
Model A: Project operates within the FS corporation. You could call it
“comprehensive fiscal sponsorship.”
Model B: Project exists autonomously and contracts with FS corporation to do work.
Model C: Project exists autonomously and FS administers grants to project.
These slides and video explain how fiscal sponsorship can support democratic organizations. The Law Center also provides Model A fiscal sponsorship to democratic groups that operate fully under our umbrella, which means the projects are also 501(c)(3)s. This Toolkit focuses more on legal aspects of our Model B and C fiscal sponsorship.
Project
Grants to
501c3 Sponsor
or
How intermediaries can pay $ to cooperatives
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The Law Center has funded cooperatives both by spending money to support them (see next page) and by paying money directly to them. When we pay money to them, we always do so under an agreement that says we will pay lump sums in exchange for the cooperative committing to do work. For accounting and 990 reporting purposes, these contracts fall into two categories, although the lines between them can easily blur. This roughly tracks the forms of fiscal sponsorship sometimes described as Models B and C.
How intermediaries can “fund” cooperatives �beyond fiscal sponsorship
In addition to paying money to cooperatives, the Law Center has also directly spent money to support the cooperatives we work closely with. We don’t even consider this “fiscal sponsorship,” but generally think of it more as a collaboration, which can take countless shapes.
With People Power and EB PREC, the two cooperatives that the Law Center helped form and incubate, some of our early expenditures were to pay staff and contractors to do work to develop the cooperatives. This was especially helpful while the cooperatives were in early stages, and had not yet set up their own payroll and other administrative systems. Further, because we did many collaborative projects and co-hosted events with the cooperatives, we often paid for project and event expenses directly. One cooperative developer has remained on the Law Center’s payroll to continue growing the cooperative, partly because working for a 501(c)(3) helps them access federal student loan forgiveness.
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Adhering to 501(c)(3) responsibilities
Charitable purpose: As a 501(c)(3) responsible for using all of our funds to advance tax exempt purposes, the Law Center does its own analysis to determine whether the cooperative is advancing charitable purposes, and we document it in writing. (See examples below.) With EB PREC and People Power, we’ve determined that the cooperatives, as a whole, are advancing charitable purposes. When we pay them money, our agreements describe their work quite broadly, and rarely specify “deliverables,” unless the funding source has mandated specific deliverables. In other cases, such as with Hasta Muerte Cooperative, we determined that the coop was carrying out specific projects that were charitable/ educational.
Retaining discretion: In general, the Law Center crafts agreements that retain our “variance” power, meaning that we have discretion to change the use of the funds to ensure they are used for charitable purposes. Without variance power, our accountants might treat our payments to cooperatives as pass-throughs, meaning the funds would not show up as income or expenses on our books. But acting as a mere funnel of money to cooperatives would sidestep our responsibilities as a 501c3, and could give the appearance that we are funneling money to private interests.
Monitoring: As a public charity, we do not have to do full expenditure responsibility on the money we pay to cooperatives. But we must reasonably satisfy ourselves that the funds are used for charitable purposes, which means staying in touch with the cooperative to understand their work. Our agreements rarely ask the cooperative to write a report to us, unless the funding source requires a report. (See example language below.)
Other considerations for intermediaries
Tax planning for cooperatives: Because cooperatives generally pay tax on their net income, we sometimes craft agreements with them to help them postpone taxable income to later fiscal years. For example, if we are holding $100,000 for a cooperative, our agreement might state that they can invoice us for some or all of it when they need it, while retaining our discretion to vary the use of funds. In this way, it does not become payable to the cooperative until they invoice us, which can help them reduce taxes for a given year. (See example language below)
Cost planning for intermediaries: Because the Law Center’s work is to support economic democracy, our relationship with cooperatives has tended to be quite different from that off many fiscal sponsors. Many fiscal sponsors charge a fee of 3% to 15% for administering funds. Rather than collect or retain an administrative fee from cooperatives, the Law Center has, conversely, pulled from our own unrestricted funding to provide even more money to cooperatives. More recently, however, we began to charge a small fee in some cases of 1% to 3%. This is because our annual bookkeeping and auditing expenses have increased substantially as a result of processing ever larger grants for cooperatives. In 2021, our total revenue was $7M, and around $5M of that was for fiscal sponsees, which has brought our annual bookkeeping and accounting costs from around $35,000 per year to $85,000 per year.
Example: Statement of charitable purpose
[This is language from a General Fiscal Sponsor Agreement with People Power Solar Cooperative where the Law Center agrees to receive and administer grants and donations over a period of 2 years. When we receive funding, we then enter into a specific “Development Agreement” where People Power agrees to do certain work in exchange for receiving that funding.]
As a 501c3, the Law Center can only provide such funding if People Power – an autonomous cooperative corporation – is advancing the Law Center’s charitable and educational purposes. The Law Center believes that a just and equitable transition to renewables is only possible if we find ways for ordinary people to develop, co-own, and share the benefits of renewable energy projects. As such, it substantially advances the Law Center’s purposes to pilot, learn from, and educate communities about a model that actively engages everyday people in building and owning solar projects. People Power could be described as a “movement cooperative,” because it is designed not only to provide energy, but also to build a large membership base and serve members’ collective goal to transform our systems for energy development and ownership.
Example: General description of activities
[Having determined that People Power, as a whole, advances charitable purposes, we generally do not require highly specific deliverables from them when we pay money to them. Instead, we include a general descriptions of activities the cooperative will engage in. Below are general commitments People Power made in an agreement where we paid them $40,000 from a general operating support grant the Law Center received for its work on energy democracy. ]
Project Development & Movement-building: Analyze and implement ways to advance community-owned energy by:
Example: Agreement for single grant to cooperative
[This is language from a one-time grant agreement with Hasta Muerte Coffee Cooperative. The language of this agreement was largely pulled from the wording of the agreement with the funder, since the Law Center became bound to report to the funder on progress toward the grant goals.]
The Law Center agrees to pay Hasta Muerte Cooperative (HMC) $75,000, half immediately and half within three weeks of January 1st, 2022, and HMC agrees to work between now and June 30, 2022 toward achieving the Pathway Invitational grant purpose. Specifically, the purpose of the grant is “To provide project support to a community cooperative in Oakland educating Oakland residents on collective small business ownership” to achieve the outcome of “educating local residents on collective ownership with a narrative to shift ownership into the hands of low-income People of Color.” The following activities will be used to measure the progress toward the purpose and outcome of the grant:
�HMC acknowledges that the funds for this agreement totaling $75,000 were provided by the San Francisco Foundation, to which the Law Center has an obligation to submit an interim and final report, and HMC therefore agrees to cooperate in providing the Law Center with any information it might need for those reports to San Francisco Foundation.
Example: Low-key “monitoring”
[This language shows how the Law Center is fulfilling its obligation to make reasonable efforts to ensure funds are used for charitable purposes. Our close working relationship with EB PREC and EB PREC’s website allow us to “monitor” the use of funds, without requiring the EB PREC write detailed reports or provide a separate accounting for the use of funds. As a public charity, our responsibility to monitor is much lighter than that of a foundation which must do expenditure responsibility, as described in a later section.]
Sharing progress updates: The Law Center is obligated to monitor EB PREC activities enough to ensure the funds go toward work advancing charitable purposes. EB PREC will share periodic oral updates with the Law Center in regular meetings. EB PREC also agrees to either make public on its website details about its progress toward the above, or provide the Law Center with a report detailing such progress upon request. On the website or in the report, EB PREC will share its lessons learned, challenges, and successes, as such information will aid other communities in replicating the model.
Example: Retaining discretion (“variance power”)
[This is language from an agreement to pay EB PREC aggregated funds the Law Center received for EB PREC development. It shows that we are not simply acting as a “pass-through,” but are retaining discretion to ensure the funds are used for charitable purposes.]
Changing the use of funds: As a 501(c)(3) bound to serving charitable purposes, the Law Center retains the discretion to change the use of funds to ensure they are used for charitable purposes. If the Law Center anticipates changing the use of funds, it will give EB PREC as much notice as reasonably possible, and both parties will participate in up to 2 conversations or mediations if requested by the other party, with the goal of finding a resolution that adheres as closely as possibly to the original plan described above. The Law Center recognizes that a unilateral decision to change the use of funds could harm the community and undermine EB PREC’s good work, given the substantial effort and planning that has gone into the above work, so far. Thus, any decision to change the use of funds can only be made by the Law Center after notice and attempts to problem-solve, and after determining that there is no less disruptive way to mitigate potential harms to the Law Center and its other fiscal sponsees from legal and financial liability arising from threats to the charitable purpose.
Example: Helping a cooperative manage taxes
[The language below helps EB PREC manage the timing of its taxable income, because it is a cooperative and not fully tax-exempt. The full balance of funds we hold for EB PREC does not become payable to them or receivable by them until they determine they need the funds and invoice us for them. To further validate that the funds are not yet payable, we indicate that the Law Center may directly spend the funds for EB PREC’s development, rather than pay the funds to EB PREC. In this way, the funds we hold for EB PREC are not a liability on our books, but they are treated as restricted funds on our balance sheet.]
The Law Center agrees to pay EB PREC $_________ by May 6, 2022. The Law Center also agrees to receive and hold additional funds as a fiscal sponsor for EB PREC, which EB PREC may periodically invoice the Law Center for if and when such funds are reasonably necessary for the continuation of the below-described work. At the time of this Agreement, the Law Center is holding an additional $_____ for the purposes of developing EB PREC.
Rather than pay all funds to EB PREC, EB PREC and the Law Center may together decide that the Law Center should make direct expenditures in furtherance of the work, rather than pay EB PREC all funds. This might include paying the salary and benefits of a Law Center employee who works to support EB PREC’s development.
Part 3: For foundations and donor-advised funds
What foundations and DAFs need to know
This Part covers areas of law that can help foundations and donor-advised funds (DAFs) understand how they can directly fund cooperatives and other non-501(c)(3)s, and how they can democratize control of their assets more generally.
First, we cover expenditure responsibility, which both foundations and DAFs must learn to do if they are to fund non-501(c)(3)s.
Second, we address some of the rules that apply to foundation assets both inside and outside of endowments, because we believe many foundation staff lack a solid understanding of the rules, and often hold a false believe that such assets cannot be accessed to fund charitable work.
Third, we discuss program-related investments (PRIs) and mission-related investments (MRIs) and the rules that govern each.
We’d also encourage everyone to watch this 20-minute cartoon on How Foundations Can Fund and Invest in Economic Democracy, which distills a substantial amount of relevant legal information.
Embracing the work of direct giving to cooperatives
When granting directly to cooperatives and other non-501(c)(3)s, private foundations and DAFs have more legal compliance responsibilities than public charities do. They must do expenditure responsibility (described in more detail below) to oversee and report on the use of funds.
Most foundations and DAFs that fund cooperatives avoid doing expenditure responsibility by pushing compliance labor onto intermediaries and fiscal sponsors, as we described in the above Part. This can somewhat reduce administrative burden to the cooperative and foundation, but we’d urge funders to give directly to cooperatives and start doing expenditure responsibility work themselves. As an intermediary, the Law Center has learned a lot from this work, and we think funders would benefit from getting to know the inner workings of grantees, deepening learnings about solidarity economy work, and sharing learnings with the public. From this perspective, expenditure responsibility could be enlivening! The documentation and reporting requirements of expenditure responsibility need not be viewed as a bureaucratic burden, but could instead be treated as an opportunity to learn about, document, and share stories about transformative work.
Non-501(c)(3)
(like a cooperative)
Private Foundation or Donor Advised Fund
Expenditure responsibility basics
Expenditure responsibility requirements of foundations and DAFs are established in tax code section 4945(h), further described by the IRS here, and described in detail in Federal regulations section 53.4945-5(d). Section 4966(c) clarifies that this responsibility applies to DAFs. Expenditure responsibility requires that the funders “exert all reasonable efforts and to establish adequate procedures—
(1) to see that the grant is spent solely for the purpose for which made,
(2) to obtain full and complete reports from the grantee on how the funds are spent, and
(3) to make full and detailed reports with respect to such expenditures to the [IRS].”
In many ways, this mostly mirrors the procedures for monitoring and reporting that many foundations already use, with a few added steps, like attaching a report to the 990.
Both funders and grantees can take part in making the expenditure responsibility process smooth and informative. We provide more detail on the requirements below.
Report:
Here’s what �we did �with the money.
Expenditure responsibility pre-grant inquiry
Federal regulations section 53.4945-5(d) provide step-by-step details on expenditure responsibility. It begins with an obligation that the funder conduct an inquiry into the potential grantee enough to give reasonable
“assurance that the grantee will use the grant for the proper purposes. The inquiry should concern itself with matters such as: (a) The identity, prior history and experience (if any) of the grantee organization and its managers; and (b) any knowledge which the private foundation has (based on prior experience or otherwise) of, or other information which is readily available concerning, the management, activities, and practices of the grantee organization.”
The regulations go on to say that the scope of the inquiry will vary from case to case, such as if the funder given to the grantee previously, or other factors like the size and purpose of the grant.
As discussed in Part 1 of this Toolkit, we’d suggest that funders’ inquiry focus more on the who and how of the grantee’s work, as opposed to the specifics of what work the grantee will do with the funds. The sample Due Diligence Questionnaire can serve this purpose of understanding the integrity and participatory nature of the group.
Expenditure responsibility grant agreements
Regulations require that there be an agreement with the grantee stating the purpose of the grant, including requirements:
“(i) To repay any portion of the amount granted which is not used for the purposes of the grant,
(ii) To submit full and complete annual reports on the manner in which the funds are spent and the progress made in accomplishing the purposes of the grant, [...]
(iii) To maintain records of receipts and expenditures and to make its books and records available to the grantor at reasonable times, and
(iv) Not to use any of the funds:
(a) To carry on propaganda, or otherwise to attempt, to influence legislation [...]
(b) To influence the outcome of any specific public election, or to carry on, directly or indirectly, any voter registration drive [...]
(c) To make any grant which does not comply with the requirements of section 4945(d) (3) or (4), or
(d) To undertake any activity for any purpose other than one specified in section 170(c)(2)(B) [those defined as charitable, educational, scientific, etc.].”
To respect the democratic process of the grantee and to support them to adapt to changing needs and circumstances, we’d suggest that funders describe the grant purposes in general terms, rather than spell out a prescriptive use of funds. An agreement can instead describe a process for making the work of the grantee visible (such as on their website), so the funder can have an ongoing window into the grantee’s work and satisfy itself that funds are being used for charitable purposes. The funder will ultimately be able to satisfy itself of the charitable purpose through annual reports.
Expenditure responsibility reports
Reports from grantees should include “reports on the use of the funds, compliance with the terms of the grant, and the progress made by the grantee toward achieving the purposes for which the grant was made.” These reports will need to be provided by a grantee after the end of every fiscal year the grant covers, meaning there may need to be both a progress report and final report if the grant covers two fiscal years.
Reports to the IRS will be included on the funder’s 990-PF tax filing, after checking boxes in Part VI-B. To streamline reporting, the funder could simply attach a report from the grantee, as long as it also includes the following required contents:
(i) The name and address of the grantee, (ii) The date and amount of the grant, (iii) The purpose of the grant,
(iv) The amounts expended by the grantee (based upon the most recent report received from the grantee), �(v) Whether the grantee has diverted any portion of the funds (or the income therefrom in the case of an endowment grant) from the purpose of the grant (to the knowledge of the grantor), (vi) The dates of any reports received from the grantee, (vii) The date and results of any verification of the grantee's reports undertaken pursuant to and to the extent required under paragraph (c)(1) of this section by the grantor or by others at the direction of the grantor.
Repairing the harms of endowments
Most endowments were created with an assumption that a foundation’s charitable purpose would be best served by long-term or even perpetual existence. This may be a deeply harmful assumption!
First, the “prudent” management of endowment funds has come to be practically synonymous with investing in Wall Street or private equity, which nearly always means growing the foundation’s assets at the expense of exploiting ecosystems and communities. This means the investing arms of foundations actively undermine charitable purposes.
Second, given current climate and economic crises, the long-term charitable purposes cannot be fulfilled if humans and many other living things are so imminently threatened. Arguably, the only way to fulfill the endowments’ charitable purpose is to spend it on substantial interventions, immediately.
Third, the perpetual duration of foundations reinforces hoarder supremacy, as described at the beginning of this Toolkit. The family and friends of those who disproportionately accumulated wealth should not hold long-term control over the very communities that are deeply harmed by wealth inequality and unjust supremacies.
Getting money out of endowments
The boards and staff of many foundations act as if their hands are tied and that they can’t tap into their endowments. But not all endowments were created equal. Quite possibly, the corpus of many, most, or even all endowments could be tapped, particularly given the urgency of present global circumstances. Some endowments have variance clauses, could be amended, or could be tapped under other legal arguments, like imprudence of failing to spend funds, impossibility, or impracticability.
It’s important to examine all endowments and test assumptions. Some foundations refer to the bulk of their assets as “endowments” even when the use of such assets is, in fact, unrestricted. Other assets may be restricted, but it’s critical to look more closely. Has a restriction expired? Can the restriction be altered on the basis of unforeseen circumstances (such as severe threats to communities from climate change, inequality, or white supremacy)? Can the restriction be altered by a board decision, staff decision, or living donor decision?
Kinds of “endowments”
It’s important for every foundation to dig deeper into their documents to understand the nature of anything they may call an “endowment.” They may discover they have:
A call for endowment transparency, p. 1 of 2
The Law Center has drafted but not yet disseminated a request to foundations to make public and transparent information about their endowments. We’re sharing it in this Toolkit because we believe this is an important message to begin disseminating. We welcome anyone to take this message and help get it out there!
Dear charitable foundations,
We are writing to request that you make publicly available the document(s) governing your foundation’s endowment and other long-term restricted assets.
First, we believe the public deserves to know what agreements and policies govern foundations’ assets. Already, foundations do have to share extensive information about their financial management and activities every year by law. Unfortunately, current disclosure requirements miss a crucial piece of the puzzle: Form 990s and conventional financial audits fail to disclose details about the policies and decisions that affect the vast majority of foundation assets. Endowments can be shrouded in secrecy, and even foundation staff may lack an understanding of what governs their endowment(s). Public disclosure will benefit everyone by fostering widespread understanding of endowment terms and better informing decision-makers. Even if a handful of foundations agreed to share endowment documents, the collaborative process of demystifying those documents and understanding creative ways to work within them would provide significant benefit to all foundations with endowments.
A call for endowment transparency, p. 2 or 2
Second, beyond fostering transparency and good decision-making, there is urgent context for this request: The U.N. Intergovernmental Panel on Climate Change (IPCC) says we must cut carbon emissions in half by 2030 to avert irreversible climate catastrophe. Meanwhile, emissions continue to rise, and there are no interventions by governments aimed at anything close to cutting emissions in half. In addition, racial inequity and white supremacy are on the rise in the U.S., and global wealth inequality continues to deepen. Big name funders and individuals in philanthropy have already recognized the need for foundations to rapidly increase giving by forming the “Initiative to Accelerate Charitable Giving,” which most directly responds to the Covid-19 pandemic and racial justice protests. While the Initiative calls for legal changes to accelerate giving, we believe voluntary endowment transparency would be a logical next step for funders sympathetic to this call.
Given the extreme threats brought on by our interlocking crises, we believe that communities everywhere need to apply available resources toward major interventions. The charitable purposes of endowments may be best served by channeling resources toward such interventions, and particularly in a transparent manner. Thus, it’s important for the public to understand what agreements, variance clauses, amendment clauses, and other policies may enable foundations to make best use of charitable assets.
Moreover, voluntary disclosure and sharing would be an important step for foundations looking to move past the trope of foundations being secretive, acting behind closed doors, and hoarding power. We believe this is a necessary step for foundations looking to prioritize trust-based and racial equity approaches to philanthropy
We are grateful for your time and attention to this and invite you to respond to this request by completing this form.
Freeing assets from archaic constraints of “prudence”
Most states have adopted some form of the Uniform Prudent Management of Institutional Funds Act (UPMIFA), which requires so-called “prudent” management of endowments and other restricted assets. Under federal law, the concept of prudence also shows up in the requirement that 501(c)(3)s don’t make “jeopardizing investments” under IRC 4944. We’ve previously hosted a webinar calling out the problems with conventional standards of “prudence,” which generally require that fund manager make diversified profit-oriented investments. This means that prudence has become virtually synonymous with Wall Street investment. As a result of these problems, we’d strongly urge foundations to remove any restrictions that might trigger prudence requirements. Alternatively, with funds that cannot be freed, foundations can become activists for new interpretations of prudence by rejecting conventional investment standards on the grounds that changed global circumstances make them imprudent.
This is not prudent, or if it is prudent, then we need to stop being prudent:
Mission-related and program-related investments
Mission-related investments (MRIs) and program-related investments (PRIs) are phrases that create some confusion but their differences are pivotal. Here’s a video where we explain the differences and the harmful binaries they create. “Mission-related” is a colloquial phrase referring to investments made with consideration of the relationship of the investment to the foundation’s charitable purpose, but which still require the foundation to make prudent decisions and avoid jeopardizing the foundation’s assets. By contrast, investments made to advance charitable purposes, or “program-related” investments, are not bound by prudence rules, and instead prioritize community benefit, rather than to secure a financial return for the foundation.
If the terms governing foundation assets allow, we’d suggest that foundations pull all money out of both conventional investments and MRIs, and shift entirely to making grants and PRIs. In this way, foundations can resource the most transformative work being done by groups that may not meet “underwriting” standards of conventional investments.
What diligence is needed with PRIs?
A significant problem that we’ve observed is that foundations apply the same due diligence considerations to PRIs as they do to income-oriented investments. This is often out of alignment with the law, that specifically states that the purpose of a PRIs should NOT be the production of income. Thus, due diligence should not be overly (if at all) focused on the organization’s ability to repay the PRI and generate income for the foundation.
The three things a foundation needs to determine with a PRI are provided here, with the language of federal law provided in italics (from 6 CFR § 53.4944-3(a)(1) - Exception for Program-Related Investments):
�PRIs in non-501(c)(3)s are also subject to expenditure responsibility, just as grants are.
Structuring PRIs
Another problem that we’ve observed is that the loan and investment documents that foundations provide their PRI investees are often nearly identical to the documents used in income-oriented investments. As noted above, the law states that no significant purpose of a PRI should be to earn income for the foundation and the primary purpose should be the advancement of charitable purposes. Thus, it’s problematic to see foundations using 40-page loan agreements with terms designed to guarantee a foundation’s return at the expense of seizing assets from an organization advancing charitable purposes. Does it advance charitable purposes to penalize the organization when it cannot make on-time payments?
From the regulations (6 CFR § 53.4944-3(a)(2)(iii) - Exception for Program-Related Investments): “In determining whether a significant purpose of an investment is the production of income or the appreciation of property, it shall be relevant whether investors solely engaged in the investment for profit would be likely to make the investment on the same terms as the private foundation.”
Thus, foundations that are making PRIs using the same boilerplate investment terms as income-oriented investments should change their approach to re-prioritize charitable purposes.
A few final things
Two tax reasons to donate to cooperatives:
Many people are in the habit of donating primarily to 501(c)(3) charities and not to cooperatives. This is based on some misconceptions about tax! Let’s clear up two things:
Most people can’t benefit from the charitable tax deduction: This is widely misunderstood, and a critical thing to help people understand. The vast majority of people believe that they should itemize their tax deductions, but, come tax time, around 90% of people take the standard deduction, and therefore do not benefit from having made tax-deductible donations to 501(c)(3)s. This means it makes no difference to most people whether they give to a 501(c)(3) or a non-501(c)(3). So let’s donate to cooperatives!
Cooperatives can receive untaxed gifts: While most cooperatives are not tax-exempt, it does not mean that all grants and donations to cooperatives will be taxable income to the cooperative. Under Section 102 of the tax code (as interpreted by the Supreme Court), true “gifts” – inspired by generosity and without strings attached – are not counted as part of income for the purpose of determining taxes due. Many people know that this applies to gifts to individuals, but even most lawyers and accountants don’t realize that this applies to businesses. See our table of case law research showing business entities and corporations can receive untaxed gifts. While 501(c)(3)s give to cooperatives with strings attached (requiring funds be used for charitable purposes), individuals and businesses can make untaxed gifts to cooperatives. So let’s donate to cooperatives!
Example: How to donate to our cooperative
Given all the myths and misunderstandings about giving to cooperatives, here is something that cooperatives and other non-501(c)(3)s could adapt and use in their fundraising materials and website:
Whether you are an individual, a business, a foundation, a donor-advised fund (DAF), or other charity, you can make gifts and grants to our cooperative! You can learn more from this Toolkit about the practical, legal, and transformational aspects of giving to cooperatives.
The main thing to know is that the cooperative is not a 501(c)(3) nonprofit, so this means:
Resources
What’s next for this Toolkit?
There’s so much more to say and explore! We tried to stick to the basics and what we think is most important to removing barriers to funding economic democracy. But these resources could be expanded and improved upon in many ways:
Are you interested in contributing? Email Janelle@theselc.org and Mohit@theselc.org, who co-lead the Law Center’s Wealth Redistribution work, where some of these directions are already taking root. Thank you!
Speaking of funding!
Sustainable Economies Law Center is at a funding crossroads: We need to raise $1 million per year for 2023 and beyond. Three of our multi-year grants have ended, and the cost of everything has risen. If we are to keep doing this work and creating toolkits like this, we need you! Can you help connect us to resources to nourish our work? Our coworkers Alejandra Cruz (alejandra@theselc.org) and Mohit Mookim (mohit@theselc.org) would be delighted to connect. If you are inspired to give right now, here’s the link.
Funding the Law Center is very different from donating to most nonprofits, because democracy! We use participatory budgeting, so all 18 staff work to spread our funds across dozens of programs. There are no bosses around here making budgets or taking higher salaries. The funding flows like water to where it can nourish the work we all find so inspiring and impactful. Here’s a gallery of projects that would be fed by funding.
Much gratitude!