By Michael J. Huft

One of the classic functions of a charity is to provide assistance to people in need, including in cases such as severe injuries suffered in an accident, severe illness, or great loss suffered in a disaster. And there are many charities that provide financial assistance in these circumstances. Problems arise, however, when an individual suffers a misfortune, and his or her friends and relatives want to raise funds to help that individual. Since contributions made directly to a person in need are not deductible as charitable contributions, it is not uncommon for the individual's friends and relatives to try to solve that problem by funneling the contributions through a charity, or even by planning to establish a new charity to receive contributions for that individual.

That is where the problems arise. If the charity does nothing more than receive a contribution with one hand and then automatically turn it over to the intended recipient with the other hand, it has acted merely as a conduit. In that case, the contributor will be treated as having made the contribution directly to the intended recipient with no involvement of the charity and will not be eligible for a deduction. If the charity agrees to participate on these or similar terms, including by providing charitable receipts to donors, it could find itself in trouble, either for helping contributors to achieve improper deductions, or for the use of charitable assets without proper fiduciary oversight (which could lead to a loss of exemption).

A contribution to a charity for the support of an individual in need is deductible only if the charity (typically through its board of directors or trustees) makes its own determination that a particular individual is worthy of charitable assistance and then decides to provide that assistance. The charity can then seek contributions to provide the needed funds, and any individual can then make a contribution to the charity designated for the benefit of that individual, provided that the charity retains the discretion as to how to use that contribution for that individual and to what extent. This is similar to a donor making a contribution to a charity and designating it for a particular program of that charity, such a building project — the contribution is restricted in that the charity cannot divert it to other uses, but the charity nevertheless retains the discretion as to how to use the contribution for that purpose.

An important concept in this regard is that of a "charitable class." In order to qualify for recognition as a charitable organization, an organization must be operated for the benefit of a recognized charitable class, that is, a sufficiently large or indefinite group of persons who, because of their circumstances, are potential beneficiaries of specific charitable activities. An organization established to provide benefits for one designated individual, or for a small group of individuals, no matter how worthy, will not qualify as a charitable organization. Rather, the organization must have the potential to benefit any member of a charitable class. It may well be that, as a result of the limited resources (whether financial, operational, personnel, time available or otherwise) of the organization, only a small number of the members of the class are actually benefitted. Nevertheless, as long as the organization retains the discretion to benefit any member of a larger group and makes its selection of beneficiaries on an objective, disinterested basis, it will qualify as charitable.

The friends and relatives of a needy individual may, of course, suggest to a charity that it consider their friend and relative for receipt of funds raised by the charity, and the charity may very well select that individual as a charitable beneficiary. In doing so, the charity must independently make an informed determination of need. It is important that the charity monitor the use of funds provided to, or for the benefit of, the recipient to ensure they are used appropriately and that the recipient does not receive more than is necessary, which would be a possibility if the charity served as no more than a conduit of funds from friends and relatives. Another important consideration is that the charity should be one that already is involved in providing funds to needy individuals, either as its principle purpose or as a substantial activity. If the charity's exemption is based on some wholly unrelated charitable purpose, there is a much greater likelihood that the IRS could find that it is acting merely as a conduit of funds, even if it goes through the formalities of making a determination of need. That is because the individual in need is not a member of the charitable class ordinarily served by the charity.

Similar principles apply in a couple of other areas that we will explore in the coming months (and that are subject to similar misunderstandings) — these include making contributions to a foreign institution through a "friends of" organization, and providing assistance through a fiscal agency (or fiscal sponsorship) arrangement.

The rules in this area are complex and often subtle. It is not always easy to determine whether a particular arrangement with a charity to collect and provide funds for the alleviation of a needy individual is a proper charitable activity of the charity or whether donors are entitled to a charitable deduction. The assistance of experienced, skilled professionals in fashioning these types of arrangements is important to make sure the charity is operating in accordance with the applicable rules.