The Headache Free Philanthropist

Volume 20, No. 11 • November 2010

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The Wealthy Retiree

estate Planning

The Headache-Free Philanthropist

By Baruch S. Littman

With the wealth created over the past 25 years, a generation of recently minted millionaires is now able to contemplate the philanthropic options that come with success.

For many, the prestige of establishing a private family foundation to dispense charitable gifts to their favorite causes is alluring.

They think of it as a dream come true. But is it really?

Along with the hope of becoming a philanthropist and taking their place among names

like Rockefeller, Gates or Buffett, the creators of private family foundations need to be prepared for considerable burdens. They come in the form of administrative and investment management obligations, reporting requirements, minimum gifting of assets required under the tax code and the loss of privacy. The unfortunate reality is that the expense ratios of private foundations holding assets of less than $10 million often make them woefully inefficient as philanthropic vehicles.

According to a 2001 study (the most recent year for which data is available) by the Foundation Management Series on the administrative expenses of private foundations, the mean expense ratios of operating private family foundations rose sharply as net charitable assets declined. Specifically, the study showed that the expense ratio of undistributed assets was 2.79% for private family foundations with assets of $5 million to $9.9 million, with some paying in excess of 40% of assets. For smaller private

family foundations, those with assets below $5 million, the expense ratio averaged 1.1%, but ran as high as almost 13%. While this survey is several years old, it is a fair assumption that those expense ratios have only increased over time.

So given this conundrum, what are the viable alternatives? One answer comes in the form of donor-advised funds. They are charitablegifting instruments that can be established at most community foundations, charitable-fund host organizations and many commercial investment management firms, with as little as $10,000 to $20,000.

For that comparatively small amount, the charitable-minded individual or family can have their personal equivalent of a private family foundation with complete privacy and no back office headaches. There are no tax returns to be completed and no annual meetings to conduct.

In short, the philanthropist leaves the administration to the host organization and is able to experience the pleasure of distributing funds to needy causes through the donor-advised account. The donor receives an immediate tax deduction on assets used to establish the fund and can continue to add to the fund over time and realize further deductions on those contributions.

Of course, there are several zeros between $10,000 and $10 million, and the obvious question is whether a donor-advised fund makes sense for someone with significant charitable assets. The short answer is a resounding yes.

And, in many instances, it actually makes the most sense.

Case-in-point: The Jewish Community Foundation of L os A ngeles, the largest donor- advised fund with a balance in excess of $50 million. Certainly, this philanthropist could create his own private family foundation or family support organization (the community foundation equivalent of a private family foundation), if he wished.

With his charitable dollars, the donor-

advised fund represents the easiest option.

Each year, he contributes additional funds with either low-basis marketable securities or fractional interests in real estate. Unlike private family foundations, community foundations can accept and offer a fair-market-value tax deduction.

There are other reasons why an individual or family should consider establishing a donoradvised fund or a family-support organization to create a private family foundation. We’ll explore four of them.

• Lower costs: In general, the management fee for a donor-advised fund with assets of $1 million to $10 million will never be more than 1.5%. Even better, a comparably sized family support organization will have all-inclusive management fees of approximately 80 basis points, or 0.8%. Consider these fees in contrast to the aforementioned study of private foundations. In that same data, expenses as a percentage of the annual payout were outsized. Private family foundations with assets of $5 million to $9.9 million had a mean expense ratio of a whopping 16.3%.

Private family foundations with less than $5 million still had mean expenses in relation to a payout of 7.2 %.

• Acting as recipient of a private foundation’s required distribution: It’s commonly known that a private family foundation must make charitable gifts of 5% of its total assets annually to maintain tax-exempt status. Less known, however, is that donor-advised funds are ideal repositories for these undistributed assets.

In the eyes of the IRS, once transferred to a donor-advised fund, the assets from the private family foundation have been given away for proper charitable purpose. Once in the donoradvised fund, your client can then take as long as he or she likes to determine how and where to distribute.

• Second-generation family issues: Establishing and maintaining a private family foundation can be a lonely venture. Where does the person turn for resources? How

do they engage their children in a shared philanthropic vision? While counsel can be obtained for private family foundations, consulting fees can be considerable and add to the onerous operating expenses that cut into available funds for good works. By contrast, community foundations and other host organizations offer a substantial array of resources designed to assist donors: programs on issues in charitable giving, inter-generational planning and assistance in tapping philanthropic passions, for example.

• Contributions of C-Corp stock: Private family foundations are prohibited under the tax code from receiving contributions of C-Corp stock, which is regarded by the Internal Revenue Service as self-dealing. With respect to both low-basis and fractional real estate donations to a private family foundation, the donor’s deductibility is limited to the tax-adjusted basis (i.e., the depreciated value). As such, a fully depreciated piece of real estate can be contributed to a private family foundation, but would not qualify for a deduction.

In contrast, a donor-advised fund can accept both of these asset classes.

In addition, it offers your clients fairmarket-value tax deductions, avoidance of all capital-gains taxes on the donated interests and; in the case of real estate, it eliminates the recapture of previously claimed depreciation.

Before a client accelerates full speed into establishing a private family foundation with less than $10 million in assets, advisors would do well to flash the yellow caution light, and consider the full range of options available to the philanthropist-to-be. It is a critical first step in becoming a committed and informed philanthropist. ows

Baruch S. Littman is the vice president

of development at the Los Angeles-based Jewish Community Foundation, a not-for-profit manager of charitable assets and planned giving solutions.

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