Monday, July 18, 2016

Donor-Advised Funds: Finance, Politics and the Perversion of Charitable Giving

At one time charity was thought of as aid to the poor and unfortunate.  Over time this quaint notion has been overcome by events as charity became a tax dodge by which the wealthy avoid as much tax on their wealth as possible.  This source estimates that only about a third of charitable contributions are actually targeted at the poor.  Modern finance and generous tax regulations have now created paths by which charitable deductions can be gained without ever actually making a contribution to charity (Yes, that is correct!).  Charitable contributions have also become the vehicle by which the wealthy pursue their private political agendas.  They try to impose their will upon us and we reward them by subsidizing their efforts with a tax deduction.

The topic here will be the recent creation and growth of what are referred to as “donor-advised funds.”  Lewis Cullman and Ray Madoff provided a concise description of this financial entity in an article that appeared in The New York Review of Books: The Undermining of American Charity.  These authors are most concerned that these funds make receiving a charitable deduction easier and more economical for donors but provide a mechanism whereby actual distribution of the funds to a charity can be delayed indefinitely.

“Most Americans have never heard of donor-advised funds and would be surprised to learn that, measured in donated dollars, the second-most-popular ‘charity’ in 2015 (just behind the United Way) was not the Red Cross, the Salvation Army, or Harvard or other universities. It was Fidelity Charitable, an organization created and serviced by Fidelity Investments for the purpose of holding charitable donations. Fidelity Charitable acts as a middleman, attracting its customers’ charitable donations and managing them in separate client accounts. Money in such donor-advised funds is invested and held until the clients give instructions (‘advise’) about distributions to operating charities.”

Fidelity created he first of these funds for the obvious reason that it was another mechanism whereby they could market, manage and collect fees on yet another pile of money.  The donor/investor gains an immediate tax deduction and doesn’t have to bother with how to best use the money until later—or even much, much later.  Fidelity, and others who have produced competing funds, like to advertise them as a means of creating a “charitable legacy” for the donor/investor’s descendents.  The tendency to hoard the contributions rather than distribute them to charities is thus encouraged.  This means fees can be charged for managing these funds forever since there is no deadline imposed on the distribution to an actual charity.

“This tendency to hoard rather than spend DAF [donor-advised fund] funds is borne out by the most recently available statistics from the IRS, which show that the median annual payout rate from all DAFs was 7.2 percent, while nearly 22 percent of all DAF sponsors reported no grants at all.”

Donor/investors love these funds because of the conveniences they provide.  For example, the donation of property rather than cash is greatly facilitated to the financial advantage of the donor.  It is this ability to provide a larger tax deduction than through a direct contribution that has made the donor-advised funds popular.  The authors provide some examples.

“….commercial DAFs make it easy for donors to make contributions of property—including shares of stock—rather than cash. These donations can save an additional 20 percent in the capital gains taxes the donor would otherwise pay. Thus, while a gift of $100 cash by a high-income taxpayer can save that taxpayer nearly $40, a gift of $100 of property can save the taxpayer close to $60 in combined income and capital gains taxes.”

Also facilitated is the contribution of what are referred to as “complex assets.”

“For financial institutions the words “complex assets” refer to property that is not publicly traded stock. Complex assets can include such varied holdings as commercial and residential real estate, art, private business interests, and even mineral rights, yachts, and taxidermy collections. A significant part of the work of commercial DAF sponsors consists of acting as a tax-free clearinghouse for complex assets.”

Donor-advised funds (DAFs) also provide an advantage over private foundations when it comes to garnering tax deductions.  They can value complex assets at current value for tax purposes, while private foundations must use initial value.

“Congress specifically prohibited donations of complex assets to private foundations from being deducted at their market value because it was concerned about problems of valuation. Since there is no ready market for complex assets, the donor must get an appraisal to set the value for the donation. Appraising is not an exact science and the donor has an interest in coming up with as high a value as is legally supportable. In addition, the DAF has little incentive to challenge this valuation.”

“For example, if a donor invested $100,000 in a hedge fund, and it grew to be worth $2 million, the donor would get only a $100,000 deduction if it were given to a private foundation, but would get a $2 million deduction if it were given to a DAF. This ability to provide a larger deduction for donations of complex assets has fostered the growth of DAFs.”

Also, if a donor has an asset assessed at $2 million contributed to a DAF and the object is eventually converted to cash yielding only $1.5 million, the donor is still entitled to a $2 million tax deduction.

Is there any wonder that DAFs have gained popularity?

“According to the National Philanthropic Trust, annual contributions to DAFs hit an all-time high of $19.66 billion in 2014. The increase in contributions, combined with a rising stock market, “drove total donor-advised fund assets above $70 billion for the first time.”3 The leader, Fidelity Charitable, has had particularly strong growth and it is widely expected that in 2016 it will surpass the United Way and receive more donations than any other charity in the country.”

The authors are concerned that depositing funds into an intermediary like a DAF rather than a direct contribution to a charity delays, often indefinitely, access by the charities to the resources they need.  Lewis Cullman is particularly sensitive to this issue.

“Lewis Cullman is a New York philanthropist who, at the age of ninety-seven, has given away over 90 percent of his wealth to charitable causes.”

He has been particularly irate about the role private foundations that were set up to make charitable contributions actually play in extending wealth indefinitely to generations of a wealthy person’s heirs.  He is also unhappy because DAFs are now vehicles to which a private foundation can make a “charitable” contribution to fulfill the obligation to spend 5% of assets annually on charitable activities.

“Finally, DAFs are also detrimental because they disrupt the flow of money from private foundations to operating charities. Private foundations are required to distribute 5 percent of their assets each year and these distributions typically go to operating charities. However, according to current tax rules, contributions to donor-advised funds qualify as required distributions for private foundations. This means that a private foundation can meet its payout requirement by giving funds to a DAF, which itself has no payout requirement.”

There is another perversity about DAFs that seems to leave the authors a bit puzzled.  The managers of a donor-advised fund are not required to follow the requests of the donors when it comes to utilization of the funds.  They can legally do pretty much anything they want with them.

“Despite such references to control, legal agreements between donors and DAF sponsors in fact provide that the donor cedes all legal control over donated funds.  Although a donor is given the right to make recommendations (sometimes referred to as ‘advisory privileges’), this is not much of a ‘right.’ DAF sponsors are legally allowed to ignore donors’ advice about the disposition of their DAF funds.”

“For most donors, this will have little practical effect; donors will advise and the DAF sponsor will follow the donor’s advice. This is because the business model of commercial DAF sponsors is to profit from the fees they secure and not from appropriating donor funds. However, not all donors have been so lucky. In one case, a DAF sponsor went bankrupt and the donated funds were seized to pay its creditors. In another case, the DAF sponsor used donated funds to pay its employees large salaries, hold a celebrity golf tournament, and reimburse the cost of litigation when a dissatisfied donor sued. In both cases, courts ruled against the donors and upheld the rights of the fund sponsor to exert full legal control over DAF funds.”

Why would Fidelity and other fund managers construct an entity that could potentially act quite differently from how it was advertised to its customers?  Perhaps the Fidelities of the world knew more about how the wealthy choose to spend their money than those who focus only on charitable contributions.

Let us now see how a DAF appears to someone who is concerned about political spending.  Jane Mayer has written about the way in which the wealthy use charitable contributions to impose their views on the general public in her book Dark Money: The Hidden History of the Billionaires Behind the Rise of the Radical Right

Those who would wish use their money to influence public opinion have the nearly perfect vehicle available: private foundations set up to contribute to charitable activities.

“By 1930, there were approximately two hundred private foundations….By 1950, the number had grown to two thousand, and by 1985 there were thirty thousand.  In 2013, there were over a hundred thousand private foundations in the United States with assets of over $800 billion.  These particularly American organizations, run with little transparency or accountability to either voters or consumers yet publicly subsidized by tax breaks, have grown into 800-billion-pound Goliaths in the public policy realm.”

“Private foundations have very few legal restrictions.  They are required to donate at least 5 percent of their assets every year to public charities—referred to as ‘nonprofit’ organizations.”

It was this designation of “nonprofit organizations” as the legal equivalent to charitable organizations that would allow what Mayer refers to as the “weaponization of philanthropy.” When Congress created this interpretation of nonprofits as “social welfare” entities early in the twentieth century it was not expected that the wealthy would use them as a means of propagating personal political agendas while hiding the source of funds.

It is quite easy for a non-profit organization of any kind to be designated as a vehicle for tax exempt contributions.

“….to qualify as tax exempt, such groups had to certify that they would be ‘operated exclusively for the promotion of social welfare.’  The IRS later loosened the guidelines, though, allowing them to engage marginally in politics, so long as it wasn’t their ‘primary’ purpose.  Lawyers soon stretched the loophole to absurd lengths.  They argued, for instance, that if a group spent 49 percent of its funds on politics, it complied with the law because it still wasn’t ‘primarily’ engaged in politics.  They also argued that one such group could claim no political spending if it gave to another such group, even if the latter spent the funds on politics.  Experts likened the setup to Russian nesting dolls.  For example, at the end of 2010, the Center to Protect Patient Rights reported on its tax return that it spent no money on politics.  Yet it granted $103 million to other conservative groups, most of which were actively engaged in the midterm elections.”

Many hundreds of millions of dollars were distributed by wealthy individuals through their private foundations to organizations that were set up to counter global warming science, defeat the Affordable Care Act, kill environmental regulations, and promote the continued use of fossil fuels and other pollutants.  And they were also used to elect appropriately conservative Republican politicians.  With these vehicles the wealthy could confuse those who might wish to learn who was providing all this money by shuffling funds back and forth between multiple organizations.  However, the system was complicated to manage and not perfectly opaque.  Then along came donor-advised funds.

Mayer introduces us to a DAF named DonorsTrust that explicitly advertises its ability to protect donors from any public connection between themselves and any of the organizations to which they contributed.

“Founded in 1999 by Whitney Ball, an ardent libertarian from West Virginia who had overseen development of the Koch-funded Cato Institute, DonorsTrust boasted one key advantage for wealthy conservatives.  It made their contributions appear to be going to Ball’s bland-sounding ‘donor-advised fund,’ rather than to the far more controversial conservative groups she distributed it to afterword.  The mechanism thus erased the donors’ names from the money trail.”

“Between 1999 and 2015, DonorsTrust redistributed some $750 million from the pooled contributions to myriad conservative causes under its own name.”

For an outfit like DonorsTrust, and for its investors, the ability to pool funds and expend them in a coherent, targeted fashion is critical.  If a donor-advised fund had to explicitly wait for donor advice on spending, this political use would not have been possible. 

One has to wonder what exactly Fidelity had in mind when they created this type of vehicle that provides so much flexibility to its managers.

Recall that only about 30% of “charitable” contributions are charitable in the Biblical sense—providing aid to the poor.  Note also that those who make charitable contributions but are not in a position to itemize deductions on their tax returns receive no financial benefit from their contributions.  The tax deduction for “charitable” contributions benefits mostly the wealthy who often are engaged in some form of self-aggrandizement or are trying to promote or impose a personal agenda.  It is rather dumb to provide a tax system that subsidizes these latter activities.

The interested reader might find these articles informative:

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