Archive for March, 2013

It seems that everyone in the world knows about TED except me.  (If you don’t know about it either, I’m glad – it makes me feel better!)  Anyway, TED is a nonprofit devoted to, in its words, “Ideas Worth Spreading.” It started out in 1984 as a conference bringing together people from three different worlds:  Technology, Entertainment and Design.  Over the years, it has grown tremendously in scope and in so doing, has embraced the Internet as a way to leverage its reach.  I urge you to check it out.

Viewing a recent TED talk by Dan Pallotta entitled “The Way We Think About Charity is Dead Wrong” is well worth investing the requisite 18 minutes out of your otherwise busy life.  Dan is best known for creating the multi-day charitable event industry, including the AIDS Rides and Breast Cancer 3-Day events, which raised $582 million in nine years. He is president of Advertising for Humanity, which helps foundations and philanthropists transform the growth potential of their favorite grantees.

We recently explored one of Dan’s theses in Charitable Nation, that being that charitable overhead is not inherently bad if it helps the organization become more effective.  However, Dan goes into far greater (and, dare I say, more interesting) detail, examining how philanthropy has historically been relegated to a second or even third class position vis-à-vis the for-profit world and is routinely criticized when overhead costs appear “excessive” – criticism that would never occur in the for-profit world where the accepted economic maxim is that a dollar of marginal cost is worth incurring when more than a dollar of marginal benefit is anticipated.  Dan dares to dream big dreams and he challenges us to do so as well.

On the one hand, Dan’s talk is somewhat depressing, presenting this Sisyphean vision of a philanthropic world doomed to failure for lack of proper investment and understanding by society.  On the other hand, it makes the point that real change is possible if we abandon some of our outmoded ideas and look to invest in philanthropy in the right ways.  Some of the subsequent TED commentary surrounding Dan’s talk questions his math, which is understandable and fair and should be read in context with the video. I have not yet had a chance to review these thoughts but intend to do so (after the tax busy season, of course!)

If our collective goal is to try to solve some of society’s most pressing problems and, as philanthropists, truly move from success to significance, then it behooves us to listen to Dan’s words.

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The New York Jewish Week, a publication that does not generally appeal to readers who are not, well, Jewish, nevertheless has an interesting article in its current edition called the Ten Commandants of Smart Philanthropy.  Although written with a smattering of Judaic references, this article should appeal to a wider range of readers because it contains a secular wisdom that is easily applied to one’s portfolio of charitable commitments.  Some of the “commandments” are somewhat self-evident while others require serious thought.  Following more or less all of them should increase the efficiency of your charitable portfolio, enabling you to more securely move from success to significance.  I encourage everyone to read it.


Today, I want to focus on one particular commandment discussed in the article, number 5, which states:  “Fund (good) overhead and capacity building.”  This seems to fly in the face of the generally accepted cold, hard accounting maxim that organizations should keep overhead to an absolute minimum. The Better Business Bureau (BBB), in its Standards for Charity Accountability, actually quantifies acceptable overhead standards (standards # 8 and 9) which state that a charitable organization shall:


  • (8) Spend at least 65% of its total expenses on program activities.


  • (9) Spend no more than 35% of related contributions on fund raising.


So, in the jargon of the Jewish Week article, what is funding “good” overhead and capacity building?


The author of the article, Andres Spokoiny of the Jewish Funders Network makes the point:


“…..While there have been some abuses and some organizations are unnecessarily bloated, overhead — or operational costs — is what allows an organization to work with proper tools; to have good and trained professionals; to have contingency plans for emergencies, etc. “Good” overhead is not useless administrative circuits. Rather, it’s what allows an organization to function.”


Fair enough.  But I would add to that.  Let’s say that you are involved in grassroots philanthropy in your community.  Should you immediately write off a promising startup charity that may, in its first few years, incur overhead costs that far outstrip it actual program expenditures?  By knowing the people involved and understanding their mission, goals, approaches to building the charity, etc. you may be able to determine that the investment is well worth the risk.  On the flip side, should you cut off support for an old line, established, and fabulously wealthy charity just because its CEO is paid a seven figure salary?  Perhaps you bristle at giving money to such organizations but take the example of the well-known and well respected American Cancer Society.  It meets all 20 of the BBB’s Standards, including spending at least 65% of total expense on program (actually 80%) and no more than 35% of related contributions on fundraising (in fact, a meager 11%).  Yet in the same year the CEO John Seffrin was paid in excess of $2.4 million.  Does such seemingly generous compensation bother you?  What about when you consider the organization’s income in that year:  $396 million?


When it accredited the charity, the BBB obviously came to the conclusion that this was money well spent, at least in a financial sense.  Now, it is up to the donors to decide how effective the charity is in meeting its stated purpose “to eliminate cancer as a major health problem by preventing cancer, saving lives from cancer, and diminishing suffering from cancer through research, education, advocacy, and service.”


I wouldn’t be true to my CPA license if I did not believe that metrics are helpful in evaluating charitable organizations.  But one has to put all numbers in context.  The BBB, along with other rating and information aggregating services helps you gather the relevant data and analyze it alongside your own values and philanthropic vision.  The decision to support a charitable organization should be made the same way you decide to invest in a for-profit venture – by determining if the mission of the organization is realistic, attainable, and in synch with your own world vision and by satisfying yourself that the organization is internally efficient and focused on its goal.   By themselves, measures of efficiency and raw expense numbers can be misleading.  It is always best to look at the whole picture before making a commitment.

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As I tell my students at Baruch College, tax deductions are a matter of legislative grace.  Congress giveth and Congress taketh away.  Allowable deductions of all types are claimable, but subject to later scrutiny and possible disallowance by the IRS.  If your documentation is inadequate, then bye-bye deduction!  Charity is no exception.  In fact, charitable contributions may be one of the touchiest subjects of all.  A cranky agent may really chafe at a taxpayer who tries to scam the system – “Look at what a good person I am!  I gave $800 to the Human Fund this year and you’re not letting me deduct it?”  Believe me, such an approach doesn’t play well on the sympathy meter. But scenes like that are so avoidable – once you make the contribution, all you need to do is make sure you have the proper documentation and you’re all set.  Properly papering your file is essential, particularly now as you prepare to meet with your tax advisor to file your 2012 return.


The following information is a start.  Your tax advisor does not necessarily need to see all this paperwork because, at the end of the day, you are the responsible party for gathering, organizing, and retaining this documentation in the event of an audit. (Exception – definitely pass on the qualified appraisals of noncash contributions to your advisor).  If you have any questions about any of this information be sure to check with him/her.  And, of course, for some helpful online information check out the IRS’ excellent publication Charitable Contributions – Substantiation and Disclosure Requirements.


But for now, some basics:

  1. First of all, verify that your contribution is in fact deductible.  Not every tax exempt is a charity, and not all charities are in good standing with the IRS.  The best place to verify this information is through the IRS’ online searchable database (formerly known as Publication 78).  This database will help you determine the status and allowable deductibility for most charities.  The one exception is churches and synagogues, which are not typically listed in Publication 78.
  2. Gather the required documentation from the charities and your own files.  Remember, while the charity bears some responsibility for following these rules, you as the donor are ultimately responsible for ensuring that the documentation you receive is adequate to support your deduction. And it has to be contemporaneous, which means you must receive it before you file your tax return.    Biggest source of errors:  identification of quid pro quo contributions, valuation of the goods or services received, and the required adjustment of the deduction for this value.
  3. Qualified appraisals are absolutely required for larger value non-cash contributions (see table).  Don’t skimp – and if you don’t believe me, just ask Mr. Mohamed, a taxpayer who recently lost out on a $19MM deduction because he skimped on the appraisal.
  4. Relatively low-value non-cash contributions of items such as clothing, furniture, and household effects should be valued piece by piece based on fair market value, which is usually interpreted to mean “thrift shop value.”  A percentage of cost is not permitted unless it approximates the thrift shop value, nor is a “group valuation” such as “5 bags of clothing worth $X.”  In addition, deductions are allowed only for such property that is in good condition or better.  A good starting point is the Valuation Guide published by the Salvation Army.
  5. Vehicles such as automobiles, airplanes, and boats are subject to special rules depending on how the charity uses the donated property.  See my previous blog “Car Donations – Under the Right Conditions, What’s Old is New Again” for more details.

chart(Click to enlarge)

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Many charities and big donors feel that we dodged the philanthropic bullet in January when the American Taxpayer Relief Act of 2012 was signed into law by President Obama.  True, for wealthy individuals, the bad news was that the top tax rate increased from 35% to 39.6%, the annoyingly-named and applied “Pease” and “PEP” limitations were restored to their full strength, and all of these changes were introduced concurrently with the Obamacare provisions taxing compensation income by an additional .9% and investment income at an additional 3.8%.  BUT, HALLELUJAH, THE CHARITABLE DEDUCTION WAS PRESERVED!


Important, yes, particularly with tax increases a reality, but more importantly from a psychological standpoint than a purely rational/financial one.  The question is, do the tax incentives really matter?


The single most interesting behavioral thing I have learned about taxes over the course of my career is that, no matter how large or small our marginal tax rate, as long it is positive, taxpayers will look for ways to avoid paying it.  It is simple human nature.  So take with a grain of salt any talk about tax collections increasing when rates decrease – the fact is, the American Taxpayer (taxpayersaurus Americanus)   will go to enormous lengths to avoid paying tax — any tax — whenever and wherever possible.  Think about those sales tax holidays we occasionally enjoy in some of the high tax states around the country.  States will temporarily cancel their sales tax for a short period of time in order to encourage retail sales.  The results are often incredible.  You would think they were literally giving things away at the mall the way the consumers flock in to save, what, 8%?  It’s not the amount, it’s the principle of the thing, man!  Ok, it actually IS the amount, but no amount is too small.


Understanding this basic premise about taxpayersaurus Americanus explains much about why our tax system is so opaque and inefficient.  Everyone wants to beat it and Congress delights in putting in “incentives” to stir the pot – and to make us THINK we are beating it.  Take our current (permanent) tax policy debate.  Many folks worry that a cap may be imposed on itemized deductions, including charitable contributions, limiting their deductibility to a maximum of 28%.  Psychologically, this is troubling.   But from a purely economic point of view it is nowhere near as bad as it seems for most taxpayers, even high income ones.  Why?  Well, for one thing, before anyone even tries to limit the deduction, the alternative minimum tax (AMT) will most likely kick in and do its damage, particularly for taxpayers in high tax states like New York, New Jersey, and Connecticut.[i]    The AMT can impact taxpayers with income from the high five to the low seven figure range, a large group of people indeed.  And what is the top marginal rate for the AMT for these folks?  Interestingly, 28%!  So effectively, the charitable contribution for these folks is already capped at the magic 28%.  It is a very effective use of smoke and mirrors and one that would not change even if itemized deductions are limited.


The math works perversely in other ways as well, even when the taxpayer is deep into the 39.6% bracket and has broken through the shackles of the AMT.  In such a case, the so-called Pease limitation (extensively derided in a previous blog) can cut down the value of the charitable deduction to almost nothing.  Pease reduces total itemized deductions by 3% of excess adjusted gross income (AGI), i.e., AGI in excess of a magic number ($250,000 for singles and $300,000 for married couples filing jointly), but only to the extent of 80% of total deductions.  So using just percentages, let’s take this example to the extreme — our taxpayer’s itemized deductions consist solely of charitable contributions and are fully reduced by 80%.  Effectively, what this means is that only 20% of his contributions will be deductible at a rate of 39.6%.  Bottom line?  The true tax savings is only 7.9% (20% x 39.6%), a far cry from 28%.   More smoke, more mirrors.


Even so, I do not endorse limiting the charitable deduction.  Its existence sends a message that we, as a society, value charity and players in the “marketplace of philanthropic impulses” and its psychology is very powerful indeed.   But, I also believe that the true financial and incentivizing value of the deduction is overstated.  Psychologically, donors appreciate a deal, especially when the tax break lowers the overall cost of their contribution.  But true philanthropists will continue to give regardless of tax breaks.  For them, the reality is stronger than the psychology.  Giving is the right thing to do and consistent with their goal to move from success to significance.


[i] This has to do with the calculus of AMT – certain expenses including  but not limited to state and local income, property and sales taxes may be deductible for regular tax purposes but not for AMT.  So taxpayers in high state and local tax jurisdictions whose deductions will be significantly impacted by AMT will be subject to the AMT more often than taxpayers from low tax jurisdictions.

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Politicians love the concept of the sound bite.   They are short, pithy, digestible, and easy to grasp and accept at face value.  Non-thoughtful people are stirred by sound bites and often moved to action (vote) because of the attractiveness and brevity of what is said.  When a politician seeks to go into further depth, s/he is accused of being elitist and unduly professorial.  So, in this concentration-challenged and Twitter-obsessed society, we end up with a watered-down and vitriolic political discourse that consists of “5 point plans” that say nothing and culminate in the level of dysfunction we currently see in Washington.  It’s a pretty pathetic situation.


charity2So, indulge me while I craft my own sound bite:  “Charity is good.”[1]  Who can argue that?  But at the risk of sounding elitist and professorial, I’m going to take that sound bite and dissect it.  First of all, define “charity”.  According to the website dictionary.com, charity includes “(1) generous actions or donations to aid the poor, ill, or helpless or; (2) something given to a person or persons in need; alms.”  It is a pretty broad definition.  The Internal Revenue Code defines charity in a more legalistic yet similarly broad manner.  The basic 501(c)(3) organization, or charity, is one that is “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes, or to foster national or international sports competition…or for the prevention of cruelty to children or animals……”


So, even though we have extensive regulations to flesh out the IRC and rulings galore to further interpret it, we are still left with definitional loopholes broad enough to drive a truck through – and charities that conceivably stretch the definition to the breaking point.  In a recent article, the online magazine Slate.com cited the Renegade Roller Girls of Oregon (Bend, OR) as an example of a “questionable” charity.  I’m not so sure about this and frankly, I think it deserves a bit more investigation.  (While I did find it in the IRS’ charitable organization search engine listed as a public charity, I was unable to locate it in the charitable database www.guidestar.org.)  Certainly, on its face, the Renegade Rollers sounds like an organization that “fosters national sports competition” so what could be bad?  One person’s philanthropic passion is another’s “what, are you kidding me?” example of bad public policy.  But the Renegade Roller Girls are small potatoes.  In that same article, the author goes on to cite a 2006 study by the Congressional Budget Office (CBO) that compared for-profit hospitals and charitable hospitals and found only small differences between them, leading one to question the need for any sort of tax exemption for hospitals at all, particularly since charitable hospitals represent only 1% of all US charities but garner a whopping 43% of all donations.  On the other hand, they do provide more than two thirds of the Medicare beds across the country, so weigh the public good against the tax cost.  Then there is the perennial argument about private schools and colleges – while they are indeed organized for “literary or educational purposes” do they go about it at the cost of draining resources from the public education sector where greater numbers of students are served?  And even if they do, is that a reason to strip their charitable status from them?  Doesn’t the fact that major scientific breakthroughs have come from some of these schools make an argument for keeping that tax exemptions?


My point is simple yet highly complex – yes, charity is good, but try defining charity first and you realize that the argument stretches far beyond the sound bite.  I have long maintained that the “marketplace of philanthropic impulses” will direct capital to the pet causes of the contributors and that this is not necessarily a bad thing.  But like all marketplaces it can be prone to excess and needs a certain amount of regulation to keep it honest and working for the public good.  As the tax debate in Washington continues to weigh the possibility of limiting itemized deductions to 28% (including the charitable deduction), perhaps a secondary debate should occur about a more realistic definition of “charity” for purposes of that deduction.

[1] Not to be confused with the 1987 Oliver Stone movie “Wall Street,” which left us with the enduring and ultimate sound bite of that generation:  “Greed is good.”

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