Archive for February, 2013

Last April, I blogged about the Giving Pledge, the movement started by Warren Buffet and Bill and Melinda Gates in 2010 which was intended to encourage the wealthiest Americans to commit to giving the majority of their wealth to philanthropy. Initially, the founders focused on domestic billionaires because, as Mr. Buffett put it “…we had our hands full in the U.S.”


givingpledgeIn addition to this particular BHAG (“Big Hairy Audacious Goal”) of increasing meaningful philanthropic participation by ultrahigh net worth families, Mr. Buffett and the Gates’ wanted to take the philanthropic discussion up a notch and try to increase overall giving at all levels.  Don’t discount the symbolism factor of this leadership by example – it is a very powerful motivator and the reason for the public nature of the pledge.  Time will tell if this part of the goal is successful, or even measurable.


But certainly in the rarefied society in which the founders travel, the Pledge appears to be working.  When it was first kicked off three years ago in June 2010, there were 40 signatories.  By April, 2012, when I first blogged about the Pledge, participation had more than doubled to 81.  Today the total stands at 105.  12 of these folks are the first non-US signatories to the pledge, representing the United Kingdom, Australia, South Africa, Germany, Russia, India, and Malaysia.   The combined philanthropic pledge of this new cohort stands north of $10 billion.


The global component of such a movement is actually more difficult than you might think.  Just like everything else, there are definite international cultural differences regarding philanthropy.  Initially, when the founders met with folks in countries as diverse as China, India, and Saudi Arabia, they faced hurdles ranging from civic modesty to an overriding need to perpetuate family dynasties.  Not surprisingly, a lot was lost in translation, leaving some potential pledgers thinking they would be legally and contractually bound (no, just morally bound) or that they would be locked into supporting certain charities or foundations (which they are not).  In fact, the pledge could not be simpler or more flexible – all that is asked is that a majority of a pledger’s wealth go to philanthropic causes “that inspire them personally and benefit society” and that the pledger make a public statement about his/her commitment.


As successful as this campaign has been, we need to keep it in perspective.  Asking anyone at any level of wealth to give away the majority of their net worth to charity is a tough sell.  105 billionaires have made that pledge so far and we celebrate and thank them for it.  Using Forbes list of the “World’s Billionaires” as a scorecard, Buffett and the Gates’ now have only 1,121 folks to go.

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The United States is currently undergoing a massive generational transfer of wealth.  It is projected that at least $41 trillion will transfer from parents and grandparents to the post-Baby Boom generations over the next 40 years.  Further, it is anticipated that this new wealth may usher in a new “golden age of philanthropy” as the members of Gen X (born 1964 – 1980) and Gen Y/Millennials (born 1981 – 2000) – collectively called “Next Gen” — take over the reins of financial decision making.  The first “golden age” conjures up the major givers of a century ago such as Rockefeller, Morgan, and Carnegie.  This new golden age includes leaders Warren Buffett and Bill Gates, neither of whom is part of this current generational cohort, but also includes Mark Zuckerberg and Priscilla Chan – 28/27 years old, John and Laura Arnold – 38/39 years old,  and Sergey Brin and Anne Wojcicki – both 39 years old.  (See my recent post “Megaphilanthropy – Can You Even Get Your Head Around It?”)


Much handwringing will occur in all marketplaces as marketers try to sell their products and services to these folks.  This includes the not-for-profit sector as organizations and causes struggle to make meaningful connection and increase their share of wallet.  Understanding what makes this new wave of philanthropists tick is crucial.


A recent study by the Johnson Center for Philanthropy and 21/64 examined the motivations of these young philanthropists.  The participants in the study all come from very charitable high net worth families. For example, 53% of their families give over $250,000 annually to charity, while 30% give over $1,000,000.  So they tend to emerge from a high achieving, high expectation gene pool.  The good news is, contrary to the generational sloth perceived by certain Baby Boomers of the upcoming generations (“kids today – lazy, no motivation, no social conscience”) these Gen Xer’s and Millennials appear to take a long term view of philanthropy and look to get into it sooner.


Some key findings:

  • Driven by Values, No Valuables – Values appear to drive the Next Gen philanthropists, not valuables.  Surprisingly, or not, these values have often been learned at their parents’ knees.  89% credit their parents for their social consciousness, while 63% credit grandparents, 56% close friends and 47% peers.  They seek a balance between honoring the family legacy and assessing the needs of the day (eg. – supporting religious organizations versus environmental causes).  While they feel a commitment to philanthropy that is rooted in the past, they plan to meet that commitment in different ways in the future.
  • Impact First – This may be more perception than reality but Next Gen see embracing “philanthropic strategy” as a distinguishing factor between them and their parents and grandparents.  They see prior generations as being motivated more by a desire for recognition or social standing while they see themselves motivated by the desire for impact above all else.  They want to see, and find satisfaction in, the results of their philanthropic investments.
  • Time, Talent, Treasure, and Ties – Giving without significant, hands-on engagement feels like a hollow investment with little assurance of impact.  Relationships with the organizations they support are crucial.  The consensus is that one gives with all one has to give.
  • Crafting Their Philanthropic Identities – Philanthropy has traditionally been a second or third act, engaged in as one “matures” into their golden years.  Next Gen does not want to wait for this and is looking to currently craft their individual identities and actively ponder and develop their own legacies.


The results of this study are certainly encouraging.  Next Gen philanthropists of means want to move from success to significance more quickly and more often than their parents.  Those of us who look to assist in this transformation (advisors, fundraisers) should expect today’s givers to be more engaged and more demanding of results – and that this trend will only accelerate over the coming years.

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Several days ago, a very troubling story hit the newswires.  Its seems that former San Diego mayor Maureen O’Connor got herself into a pickle, allegedly gambling, winning and losing over $1 billion over a ten year period.  This gambling addiction amounted to the unfathomable sum of almost $300,000 per day! (For a discussion of the tax consequences, see Tony Nitti’s tax blog.) Very sad.  According to the New York Times, Ms. O’Connor ended up “……eventually liquidating her savings, auctioning her belongings, selling off real estate, borrowing from friends and taking more than $2 million from a charity set up by her late husband, a fast-food tycoon.”


It was the last part of that sentence, about raiding the charity, that caught my eye.  Pure and simple, what she did was steal.  More technically stated in the private foundation world, it was extreme “self-dealing”.


The private foundation (PF) is a wonderful tool for high net worth individuals and families to amass assets to fund charitable endeavors.  Similar to the PF is its more accessible cousin, the donor advised fund (which I blogged about earlier this week.)  But, the very basic underpinning of these tools is that, once a donor has funded them, the donor no longer owns the assets and the assets can no longer be used for his/her private benefit.  Period.


Now, Ms. O’Connor’s situation is admittedly a whopper (or, perhaps more correctly, a Jumbo Jack®, since her late husband, Robert O. Peterson, founded the Jack-in-the-Box fast food chain).  Unless you have a really warped sense of right and wrong, it is pretty obvious that taking money from a private foundation and using it to gamble is not particularly kosher (nor is a Jumbo Jack®).  But, what about more subtle acts of self-dealing?


These rules are complex and should be examined on a situation-by-situation basis.  The takeaway is that all those involved with PF’s should be aware of the potential for abuse and should take corrective action before any issue escalates.    Let’s take a quick look at three not-unusual self-dealing circumstances:

  • Suppose that you make a legally binding pledge in your own name to endow an academic chair at your alma mater.   Can you fulfill that pledge with a grant from your private foundation?  The answer, most likely, is a resounding NO!  According to the IRS, using a private foundation’s assets to satisfy a donor’s legally enforceable charitable pledge is an act of self-dealing and not permissible.
  • What about hiring a family member to manage the foundation?  Self-dealing?  Yes, virtually by definition.  Permissible?  POSSIBLY.  Hiring a “disqualified person”[1] may work as long as the compensation and any expense reimbursements are reasonable under the circumstances and paid for services related to carrying out the foundation’s exempt purpose.  Safe to say, it is not reasonable to pay your idiot son-in-law a six figure salary to act as the janitor for the office of the family foundation.  But it may be reasonable to pay your MBA-credentialed daughter to manage the affairs of the foundation at a rate comparable to that paid by a similar organization under like circumstances.  It is very important to never lose sight of the old adage:  Bulls and bears make money while pigs get slaughtered.
  • Can you provide an all-expense paid retreat for the members of the board of your family foundation at an exotic locale?  Probably not because there would presumably be a large percentage of personal pleasure in such an excursion.  Better to hold the retreat as a rundown Motel 6 in Scranton, PA in the dead of winter – it would certainly be hard to prove under those circumstances that the expenses were anything but reasonable.  Also better to ask the question beforehand than to get penalized afterward.


Now, of course, there may be ways around some of these speed bumps – as we all know, most everything in the tax world is a lovely shade of gray as opposed to stark black or white.  And it is certainly difficult to endow a private foundation and not feel like you still have an ownership interest.  But the fact is, PF’s work the way they do in order to safeguard their charitable purposes as much as possible.  This requires stringent rules and a minefield of penalty taxes.[2]  Since PF’s are a creation of the government, the government is within its rights to regulate their usage through the imposition of these taxes and, when things get too out of hand, through criminal prosecution as well.


Apparently, that fact was lost on Maureen O’Connor.

[1] A disqualified person is generally any person who has a vested financial interest in a PF including substantial contributors (as defined), foundation managers, anyone owning more than 20% of an entity that is a substantial contributor, family members of any of the preceding individuals, or entities that are owned more than 35% by the individuals described above.

[2] The tax on self-dealing (§4941), tax on excess business holdings (§4943), the tax on investments that jeopardize charitable purpose (§4944), and the tax on taxable expenditures (§4945).

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donor advised fund


Moving down the Philanthropic Continuum, we come to one of my favorite tools in the charitable toolbox, the Donor Advised Fund (DAF).  Often referred to as the “poor person’s foundation” (but in a good way), the DAF enables the donor to accelerate charitable contributions into the current year without necessarily making grants to any public charities in that year.  DAF’s work very well in a whole range of circumstances but to me, they are tailor-made for the following situations:


  • Case 1:  The potential donor is faced with a significant liquidity event (sale of a business, exercise of stock options, large bonus, etc.) and is looking for a way to shelter some of that income.  S/he has always been charitably inclined but has never engaged in more than some current annual giving and does not know exactly where s/he wants to ultimately donate the funds.  Using a DAF provides a current year deduction coupled with the luxury of time to figure out the exact future distribution of funds.
  • Case 2:  Charitable giving is an important part of the donor’s life and s/he wants to ensure that she always has funds to give away. Using a DAF as s charitable savings account enables her to make her deductible contribution today while deferring the ultimate giving until later in life.  Meanwhile, assuming reasonable returns, the funds grow tax free, providing more assets.
  • Case 3:  A young couple wants to simulate the formalities of a private foundation in order to instill the culture of philanthropy in its children. A DAF is the perfect vehicle providing structure with minimal administrative burdens (no tax return, no excise tax, no required minimum distributions, etc.)


Here’s how it works:


  • There are numerous sponsoring organizations of DAF’s including commercial vendors like Schwab, Fidelity, and Vanguard and not-for-profit organizations such as the Jewish Communal Fund, the American Endowment Foundation and the New York Community Trust.  You choose the fund that works best for you taking into account investment choices, fees, account minimums, minimum subsequent investments and administrative services and conveniences.  The one common thread is that every one of these organizations is a “501(c)(3)” tax exempt charitable organization (or affiliate of the commercial advisor).
  • You make your irrevocable, tax deductible contribution to the DAF and claim credit for it in the year made.  (Some of these DAF sponsors accept gifts as low as $5,000.)  You do not get any further deduction for grants made from the fund.  The funds are no longer yours, although you retain advisor status over them.
  • Typically you can name your fund, although you cannot use the word “foundation” in the title.  Therefore, the “Smith Family Charitable Fund” would be acceptable but the “Smith Family Charitable Foundation” would not.
  • Unlike a private foundation, there is no requirement to make annual grants from the fund, so you can defer your distributions until far in the future.  Future generations of family members can assume advisory roles at the appropriate time to direct the ultimate disposition of the assets.
  • There is no separate tax return requirement or required bookkeeping.  The DAF sponsor does it all for you.
  • In any one year, the deduction for cash contributions made to your DAF cannot exceed 50% of your adjusted gross income (AGI).  Noncash contributions are limited to 30%.  Excess amounts are carried over and deducted over the next 5 years, subject to the same income limitations each year.  Contrast this to private foundations, which are subject to a lower limitation of 30%/20% of AGI.
  • There is a legal fiction that holds this all together – when it comes time to make a grant, you stand in an advisory role, merely recommending the grant to the DAF sponsor.  The DAF sponsor is responsible for the due diligence and technically does not have to honor your request.  More realistically, however, as long as you are recommending a grant that falls within the DAF sponsor’s guidelines (typically a grant to a domestic 501(c)(3) organization), the DAF will make the grant in the name of your fund.


In a future post, we will discuss the pros and cons of private foundations vis-à-vis DAF’s.  For right now, suffice it to say that donor advised funds work best for philanthropists with a need to control the timing of their charitable contributions and who desire a charitable pocketbook to help them support public charities that they find worthy.  Private foundations are more suitable for those who want to engage in the business of philanthropy.  Because of this, these tools are not mutually exclusive and each has its place at the table.

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Extra, extra, read all about it!  There’s good news, and there’s bad news.  First, the good news:

  • According to the Chronicle of Philanthropy, more of America’s billionaires are starting to give away their fortunes before they reach middle age.  Among 2012’s top 5 philanthropists were 3 couples under the age of 40.  (Mark Zuckerberg, 28, Facebook founder along with his wife Priscilla Chan, 27 – $498.8MM; John Arnold, 38, founder of hedge fund Centaurus Energy and his wife, Laura Arnold, 39 – $423.4MM; and Sergey Brin, 39, Google co-founder and his wife Anne Wojcicki, 39 – $222.MM).


Life is changing.  Drawn to the possibility of influencing social issues for decades to come, the young and super-rich are turning philanthropy into a newlywed activity instead of a deathbed one.


But now the bad news:

  • The top 50 donors on the Chronicle’s list committed a total of $7.4 billion to charity in 2012.  The median gift was $49.6 million, down significantly from 2007’s high of $74.7 million.




Other interesting factoids:

  • As with everything else wealth-related in this country, the results are skewed on the high end.  The top 3 donors out of 50 on the list accounted for more than 50% of the assets committed to charity from the whole group.  The top donor, Warren Buffett, 82 years old, gave $3.1 billion to three family foundations, the Howard G. Buffett Foundation, the NoVo Foundation, and the Sherwood Foundation. By itself, this $3.1 billion represents 42% of the top 50’s contributions.
  • 72% of the dollars pledged went to big, elite institutions of higher education, arts and culture, hospitals, and private foundations.
  • On the flip side, community foundations won eight gifts from top donors last year totaling about a billion dollars.  This was more than the total of the last 10 annual lists compiled by the Chronicle!  Way to go, community foundations!
  • And, most importantly — today’s philanthropists are choosier about where they give and demand workable plans for long term results.  For example, in the past, a donor supporting college scholarships might have been interested in how many recipients actually graduated as a result of his/her gift.  Today, many of these same donors want to know about the long term results of their “investments” – for example, how the recipients are doing years after entering the professional world.


This is all good stuff, but it also points out that, while philanthropic giving in this country is significant, it pales when compared to governmental outlays and the overall gross domestic product.


To illustrate:  According to Giving USA, in 2011 Americans gave $298.4 billion to charity, which was up 4% in current dollars over 2010 but only up .9% in inflation adjusted dollars.  It is too early to tell what 2012 looks like vis-à-vis 2011, but early indications from BlackBaud are that we will see a similar result – around $300 billion.  Any way you slice it, that represents only 10% of expected total US Government budget outlays for fiscal year 2013 ($3,803 billion) and only about 2% of expected gross domestic product ($16.335 billion).  My point in citing these numbers from President Obama’s 2013 Budget Message to the Congress is not to start a debate on the integrity of the numbers themselves, but to try to put an order of magnitude to the issue.  Only 2% of estimated GDP is contributed to charity – compared to 10% expected to be paid out by the US Government for the entitlements of Social Security, Medicare and Medicaid.  It has been suggested that cuts in social programs can be made up by increases in charity.  My simplistic analysis suggests otherwise, particularly given the less than robust growth in charitable giving in recent years.


Because philanthropy is a market like any other, it is naïve to think that private donors can replace government as the permanent provider of the social safety net.  Private donors have the power of choice to fund those programs that speak to them and to ignore others, and that is how it should be.  The “marketplace of philanthropic impulses” is neither government-controlled nor societally-dictated but evolves from donors’ perception of societal needs and is funded by those who want to try to fill those needs.  Because the investment decisions made follow the choices of independent and sophisticated donors, the application of philanthropic capital to societal needs will be erratic, at best.  The social safety net cannot be significantly replaced with such a market-based solution.  But it, as well as other worthwhile charitable causes, can certainly be enhanced by robust private charitable giving.

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Every so often we have to sit back and assess our own performance – am I accomplishing what I set out to and, if not, why?  When I first conceived of this blog, Charitable Nation, I envisioned a freewheeling discussion of all things philanthropic, from the motivation of particular philanthropists and success stories of certain charities to the nuts and bolts of the tax law affecting philanthropy.  I believe that this wide ranging discussion is necessary because, frankly, my colleagues in the accounting, legal, and wealth management professions typically do only half the job in advising their clients in the field of philanthropy.  Don’t get insulted – you all do a fine job in advising on the tools and techniques of planning but you often get lost when dealing with the clients’ “touchy-feely” motivations in pursuing certain estate planning and philanthropic strategies.


So looking at Charitable Nation, I realized that in recent weeks I too was falling prey to the technicians’ trap of focusing too intently on tools and techniques and ignoring the second part of the blog’s title “From Success to Significance.”  In fact, daydreaming in the clouds on what could be is probably the most crucial first step in philanthropic planning.  Without inspiration, all else fails.


When you think about it, life can really be defined by two separate but interrelated spheres.  The first sphere is the overriding one of belief systems, needs, desires, and motivation that points us in the direction of where we want to go.  Sometimes, this sphere is crystal clear but more often it is nebulously defined and leaves us scratching our heads and wondering why we do what we do – and why we spend time doing things that clearly do not advance our own goals.  In fact, this sphere can be distilled down into that one little word:  “Why?”  The second sphere is the rock solid, step-by-step, transaction-based set of tools that we use to accomplish our goals, whatever they may be.  It, too, can be described in one word:  “How?”  Combining these two provides us with the motivation to make a difference and the tools to get us there.


There are all kinds of descriptions leading to the same place – the “roadmap” of figuring out where you want to be and then planning the appropriate concrete steps, the use of “mission” and “vision” statements in both the business and not-for-profit worlds to motivate stakeholders, etc., etc.  In advising families, particularly with respect to charitable planning, we refer to this approach as the Planning Horizon, depicted graphically below.




The Planning Horizon is a metaphorical horizontal line.  Conversations that take place above the horizon deal with the wealth holder’s deepest and most personal goals and objectives for their wealth.  Conversations that take place below the horizon focus on strategies, planning devices, and products to achieve those goals.  Because most advisors are technically oriented, they tend to spend far more time on the “how?” of planning than the “why?”  The adviors are playing to their own strengths.  They feel more comfortable in the technical world than in the motivational world but this can be problematic.  I submit that they should consider reversing their approach and spend the bulk of their time in getting to really know what makes the wealth holder tick rather than just designing technically competent plans.  This “getting to know you” will make the ultimate plan design far easier and will dramatically increase the probability of implementation.


For example, introspective wealth holders definitely spend more time “above the horizon” thinking about what they are trying to achieve and why they want to achieve it.  “Below the horizon” is a means to an end which advisors can implement fully only if they completely grasp what drives the wealth holder.  Therefore, advisors who ignore the “touchy feely” segment of the planning process do so at their own peril.  Their chance of connecting with their introspective clients diminishes and any plans they devise will fall short when they don’t take the client’s true motivations into account.


The same can be said about less introspective wealth holders.  Because the wealth holders themselves may not feel completely comfortable confronting their goals and aspirations head on, they need guidance in framing these issues or they will not act.  In such a case, if the advisor ignores the “why?” s/he will definitely be setting the client up for a failed plan.  The fact is, you can build a truly fine Ferrari for your client but without gas in the tank, it isn’t going anywhere!


So the moral of the story is clear – all of us, wealth holders and advisors alike — need to spend more time thinking about our goals and objectives.  What motivates us to act?  Who are we trying to benefit and how?  How do we truly move from success to significance?

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I’m on kind of a “Pease limitation” kick this week.  In my earlier blog post I railed about the limitation which basically scales back the itemized deductions of high income taxpayers by 3% of any excess adjusted gross income (AGI) over certain levels.  Essentially, once you reach the magic AGI number ($250,000 for singles, $300,000 for married filing jointly), your itemized deductions, including the deduction for charitable contributions, are dialed back by 3% of the excess income over that threshold amount.  (Example – a single individual with $375,000 of AGI would lose up to $3,750 of itemized deductions:  $375,000 – $250,000 = $125,000 x 3% = $3,750).  This limitation has an effective overall limitation to it – you cannot lose more than 80% of your total deductions.


I know what some of you are thinking – why should I feel sorry for the fat cats?  But I am not asking you to feel sorry for these folks – I am asking you to consider fairness and transparency in our tax system, both of which are in seriously short supply these days up and down the spectrum of the tax law.


The “Pease limitation” is a perfect example.  Through the careful use of smoke and mirrors, it can effectively add up to 1.2% to the ordinary tax rate.  Think of it this way – a top bracket taxpayer who is subject to the “Pease limitation” earns an additional $1,000.  His itemized deductions will be reduced by 3% of that $1,000, or $30.  This reduction in deductions is essentially an increase in income – his increase in overall taxable income will be $1,030.  Multiply that additional taxable income by 39.6% to get the additional tax of $408.  $408 divided by $1,000 is equal to 40.8%, which is 1.2% higher than the stated top rate of 39.6%.


But wait, there’s more!….

  • Combine this haircut along with the Obamacare tax on “excess” earnings of .9% and the top rate is further increased to 41.7% for earned income.  In our example, the marginal tax would be $417 instead of $408;
  • If the marginally generated income is actually net investment income rather than earnings, the situation is worse – the top tax rate on investment income rises to 44.6%, or $446 in our example;
  • And we haven’t even touched the phaseout of personal exemptions or the alternative minimum tax (AMT) yet!


So I guess that’s it – Phil Mickelson’s possible decision to stop making millions playing golf seems rational under these circumstances, correct?  If you’re gonna take what I earn, I may as well not earn it.  Well, I think that’s a bit extreme.  Let’s put it into some perspective.


The “Pease limitation” comes into play ONLY with INCREASES IN INCOME.  It has nothing to do with increases in deductions.  So the argument that charitable contributions will suffer because of the limitation itself is misguided.  Think of it this way – if income is held constant, each and every dollar of allowable charitable contribution will reduce taxable income by one dollar.  If my income is $X and I am in the 39.6% tax bracket and I decide to make a $10,000 to the Human Fund on December 31, 2013, I will save $3,960 in federal income tax.  Period.  Assuming that my charitable contributions are not constrained by the income limitation rules that have long existed for these deductions, I don’t lose ANY value of the additional deduction because of an increase in deductions.  However, if my income increases, I absolutely will lose the benefit of some of my deductions because of the “Pease limitation.”  The decision to increase or decrease charitable contributions or any other deductible expenses can and should be made independently of the decision to increase or decrease taxable income.


The bottom line is that additional deductions will always do you some good in saving taxes while additional income may end up being taxed at a rate higher than you would like.  Decisions about one versus the other should be made independently of one another.

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