Our principal mission at Altium is to help our clients pursue their own personal fulfillment. The planning process we use to do this includes an on-going audit of all aspects of their wealth. We show our clients how to take a high level, comprehensive view of their situation and educate them on the unintended consequences of a lack of coordination between and amongst their various advisors (while many of our clients have excellent advisors, it is a challenge for them to coordinate the advice they get because their advisors, while expert in their own field like the law or the tax code, do not share a common language and rarely meet in the same room). We are also concerned about the efficiency of the advice our clients receive. The following hypothetical example of a client situation, in this case in the area of philanthropic planning, illustrates how we bring coordination and efficiency to the planning process.
Let’s say that our client is a kind, wealthy woman who has just died after a prosperous and happy life, which included a longstanding relationship with our firm. Her will mentions something about being kind to animals and her lawyer, who is the executor of her estate, recommends that a private foundation be established (something he has done for other clients) in our mutual client’s name to honor her philanthropic intentions. Her CPA agrees that a foundation is the right solution for the client’s needs. Our reaction as coordinator of the advice our clients receive is to ask whether or not the cost and administrative burden associated with the establishment of a private foundation is warranted in carrying out the client’s intentions in this case. Perhaps there is a cheaper and less burdensome alternative (hint: there is. It’s called a donor-advised fund (DAF) which we explain below – a DAF is an increasingly well-recognized charitable concept, but is underappreciated in terms of its efficiency and flexibility.)
There are a number of costs associated with the establishment and running of a private foundation. First and foremost are the legal and accounting fees associated with the required IRS filings. IRS Form 1023 is used to establish the foundation’s tax exempt status; it is a “bear” to complete, requiring both time and expertise. Once completed and filed, Form 1023 can take 6 months to a year to be approved. Once the foundation is approved, it must start filing IRS Form 990-PF, which is an arduous annual exercise. In addition to the legal and accounting costs, there are trustees’ fees and possibly the cost of a custodian and an investment manager. There may also be a need for insurance and for on-going expertise in grant making and general administration, which will add to the costs of running the foundation.
In addition to the cost, the administrative burden of complying with the IRS’s rules for private foundations is significant (and so too are the penalties for not complying - including the possibility of having to pay an excise tax equal to 2% of the foundation’s assets). A private foundation is required to make mandatory annual grants equal to 5% of its assets. It is also required to open its books to the public and to abide by the IRS’ very strict “self-dealing” policies.
So given the requirements and conditions outlined above, what is the main advantage of establishing a private foundation (which really isn’t “private”), particularly since there is a less costly and burdensome alternative available? The answer to the question is mainly about having absolute control over the distribution of grants, although there are many special circumstances that lead donors to establishing private foundations.
So what would our client (now deceased) and her advisors give up by establishing a donor- advised fund instead of a private foundation to carry out her testamentary philanthropic wishes?
Before answering this question, a quick review of what a DAF is and how it is established and used may be helpful. A DAF is a charitable account sponsored by a public charity. The donor makes an irrevocable, tax-deductible contribution of cash, securities, or other assets to the charity that sponsors the DAF program. The sponsor charity then establishes a DAF in the donor’s name. The donor can make additional contributions at any time. Donors advise the sponsor charity on how they would like their contributions invested. Any investment growth is tax free. When they wish to, donors recommend grants from their DAF to other non-profit organizations – virtually any qualified public charity. Before making a grant, the sponsor charity conducts due diligence on the donor recommendations to assure that the funds will be used for charitable purposes.
Donors may also realize greater tax benefits in establishing a DAF, particularly if they are donating appreciated or closely-held stock. These benefits are available because the sponsors of DAFs are public charities, which are granted more favorable tax treatment than private foundations (charities) by the IRS. These benefits are summarized in the following table:
Type of Donation Private Foundation DAF
Cash Donation limited to 30% of AGI* 50% of AGI
Appreciated Stock Donation limited to 20% of AGI 30% of AGI
Closely-Held Stock Deduction limited to BASIS Deduction at FMV**
*AGI= Adjusted Gross Income **FMV= Fair Market Value
The most important distinction between a private foundation and a DAF involves donor control over his or her grant making activities. The donor’s control over which entities get the grant is complete and absolute in the case of a private foundation, whereas donors can only recommend which entities receive the grant in the case of a DAF (hence the words “donor advised” are used). As a practical matter however, the vast majority of donor recommendations are readily approved by the sponsor charity, particularly if the proposed grantee entity is classified as a public charity. Establishing a private foundation rather than a DAF can provide donors with additional flexibility if their intentions include giving money to individuals (which they cannot do through a DAF) and investing all their money in a particular hedge fund (which they also cannot do through a DAF).
In the case of our client and what we know of her philanthropic intentions, we would recommend the establishment of a DAF vs. a private foundation. Since she has not named specific entities, her family and advisors would in all likelihood be able to recommend grants to animal welfare organizations that would be readily approvable by the charity sponsoring the DAF program. The absolute control advantage of the Private Foundation seems unnecessary in this case. And then there are the many cost and efficiency advantages that the DAF offers.
In our opinion, a DAF is easy and quick to establish. Well-known investment firms, Charles Schwab and Fidelity, have established public charities that sponsor DAF programs. Community Foundations, which are independent philanthropic organizations working in specific geographic areas, also sponsor the establishment of DAF accounts. Since they have an in-depth knowledge of the non-profit organizations in their area, community foundations offer an additional advantage to those donors whose intentions are general in terms of field of interest, but specific in terms of geography. While all these organizations do charge an administrative fee for handling the account in addition to their investment management fees, the costs of setting up and running a DAF are generally much lower than those associated with a private foundation.
And the “rules of the road” for the ongoing management of a DAF are so much easier to live with than those governing a private foundation. DAFs do not have complicated IRS forms to complete and are not subject to the annual payout requirement that a private foundation is. Not being subject to an annual payout requirement is very important in the case of our client in this example. Her wishes are not specific (they involve a field of interest – animal welfare, not specific organizations). Her family and advisors may need time to do the necessary research in order to decide which organizations to support and thus would not want to be subject to an annual payout requirement. A DAF provides the convenience that our client and her advisors need to discuss their grant-making priorities and the sponsor charity has a staff that is available to help them carry out our client’s philanthropic wishes.
The activities of private foundations are critical to the size and success of philanthropy in the U.S. New foundations are created every day for good causes and good reasons. In fact, our firm will be establishing a private foundation to help our employees fulfill their philanthropic ideas and intentions. Yet, in our opinion, the fact remains that these vehicles are costly and administratively burdensome to establish and maintain. That’s why it’s good to know that the DAF is available - it is an efficient and easy to use alternative for those of us who want to be philanthropic, but do not require a private foundation to do so.
Altium Wealth Management LLC (“Altium” or the “firm”) is an SEC registered investment adviser with its principal place of business in the State of New York. Registration does not imply a certain level of skill or training. This newsletter is limited to the dissemination of general information pertaining to its investment advisory/management services. For information pertaining to the registration status of Altium, please contact Altium or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).
This article is provided for informational and educational purposes only, is only a summary of the topics discussed herein, and contains information that is not suitable for everyone. As such nothing herein should be construed as personalized investment advice. Past performance is no guarantee of future results. The information contained herein is based upon certain assumptions, theories and principles that may not completely or accurately reflect your specific circumstances. The hypothetical case study of a client situation described in this article is included to illustrate certain aspects of the firm's approach and methodology with respect to philanthropic planning and should not be considered as typical of the firm's clients' experiences. Your experience may vary according to your individual circumstances. As such, there can be no assurance that the firm will be able to achieve similar results for all clients in comparable situations or that any particular strategy will prove to be successful. Additionally, this article contains information derived from third party sources. Although we believe these third party sources to be reliable, we make no representations as to the accuracy or completeness of any information prepared by any unaffiliated third party incorporated herein, and take no responsibility therefore. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change without prior notice.