Your favorite non-profit is running a capital campaign. They approach you for support asking for an amount larger than you are willing to write a check for today. No problem. You can contribute part of it each year over a three to five-year period. When you commit to this in writing, it is considered a pledge. The non-profit can take these pledges to a bank and borrow the money to complete its project now and pay back the bank as the pledges are received.
What if you cannot make the pledge payments? Are you legally obligated to pay? What if you are unwilling to make the pledge payments because of some change at the non-profit which you no longer support? Are you still obligated to make the pledge payments?
When Charitable Pledges are Enforceable
Most courts view charitable pledges as legally enforceable commitments. State law determines a pledge’s enforceability. A conflict can arise between state laws when the donor and the charity are in different states. Pledges have been held binding because:
- Work has begun (or a liability has been incurred) because the non-profit relied on the pledge being fulfilled. Lenders often use pledges as collateral for a loan to a non-profit.
- The donor’s pledge has induced other people to also make pledges.
- The non-profit’s acceptance of the pledge is a promise to designate funds according to the donor’s direction and the pledge is supported by that promise.
- The non-profit agrees to do something (or not do something) in exchange for the pledged funds.
- In some states public policy requires the donor’s liability on a pledge. Ohio, for example, considers a pledge to be the same as a promissory note.
The directors of a nonprofit corporation or the trustees of a charitable trust may have a duty to pursue the collection of legally enforceable pledges. Donors who decline to fulfill a pledge and clearly have adequate resources may force directors to act to fulfill their fiduciary duty. Pledges are considered assets of the non-profit. Failure to protect those assets could result in personal liability for the director or trustee.
In extreme cases, failure to collect a pledge could be considered forgiveness. Forgiving a pledge could be interpreted as a gift back to the donor which is not an appropriate use of charitable assets. The IRS could impose sanctions against the organization and possibly jeopardize the non-profit’s tax-exempt status.
This may seem extreme and a highly improbable action for a non-profit to take. Non-profits may have the right to sue donors over pledge defaults. The board of directors does have a duty to preserve non-profit assets, but no court to date has held a non-profit liable for refusing to enforce a pledge. The cost of taking legal action and the impact a lawsuit might have on the relationships with other donors must all be considered.
You might think a prudent way to address this issue would be to contribute the full amount to a donor advised fund (DAF) and distribute it annually from the fund to fulfill your pledge. This might make a lot of sense if you are using appreciated securities to fund the gift. A DAF can easily handle the gift of securities and convert it to cash without paying capital gains tax. Unfortunately, IRS rules prohibit a taxpayer from fulfilling a legally enforceable pledge with a payment from a DAF.
A DAF is technically referred to as a sponsoring organization, but it is a non-profit organization. Your contribution to the DAF is a completed gift to the sponsoring organization and they have legal control over the donation. You have advisory privileges, but the DAF is owner of the funds. You can make recommendations and the DAF routinely follows your recommendation. However, the DAF is under no legal requirement to comply with your request.
The pledge you make to your non-profit is an obligation to give money in the future. When the DAF relieves you of the obligation by granting your recommendation to make a gift, you are receiving an impermissible “prohibited benefit.” An excise tax of 125 percent of the prohibited benefit can be levied by the IRS to the taxpayer receiving the benefit. The IRS could also levy a 10 percent excise tax of the prohibited benefit against the DAF for granting the distribution if they knew it would result in a prohibited benefit to the donor.
The Tax Cuts and Jobs Act (TCJA) passed at the end of 2017 provided some relief on the issue of using a DAF to fulfill a pledge. IRS Notice 2017–73 states donors can now utilize grant recommendations from a DAF to satisfy a pledge provided the following requirements are met:
- The DAF makes no reference to the existence of any charitable pledge when making the grant;
- The donor does not receive any benefit, directly or indirectly, that is considered more than incidental;
- The donor does not claim a charitable contribution deduction for the DAF disbursement, even if the charity mistakenly sends the donor a tax acknowledgement.
In summary, the pledge process is an important part of fundraising for non-profits. Don’t make a pledge without careful consideration of how you will be able to fulfill the obligation, and where those dollars will be coming from.
Rick’s Tips:
- Most courts view charitable pledges as legally enforceable commitments.
- Failure to enforce pledge collection could result in personal liability for the trustees of a non-profit.
- IRS rules prohibit donors from fulfilling a legally enforceable pledge from their donor advised fund.
