The Seven Corporal Works of Mercy
Originally published on Forbes.com.
The New York Review of Books article The Undermining of American Charity is a good example of a somewhat arcane tax story that really deserves to break out of the tax ghetto. What the authors, noted philanthropist, Lewis B. Cullman and Boston College law professor, Ray Madoff think is undermining American charity is “donor advised funds”. The thing that surprised me most about this article was the reference to donor advised funds being a “still largely unknown charitable vehicle”. I mean really, Paul Streckfus is writing about them in his EO Tax Journal all the time. That is where I got the word that this article, which I had been looking forward to, had finally come out. It’s not like I subscribed to the New York Review of Books. (Well I do now)
What Is A Donor Advised Fund? – The Good
The way I think about donor advised funds is what they are good for. Say you have a client who is basically charitable and has a great year. She has a lot of long term charitable goals for small charities that don’t have the infrastructure to handle relatively large donations prudently. She can count on making $250,000 per year which is plenty for her to live on, but this year she made $1,500,000. So she wants to give away $750,000, but wants its receipt by her target charities to be spread over five years.
I know what you are thinking. Set up a private foundation. But right off the bat, you know the problem. There is 30% limitation for gifts to a private foundation, so she would not be able to deduct the whole $750,000. And then there is the expense and the tsoris of running the private foundation. The 990-PF, etc., etc.. Don’t get me started.
A donor advised fund is a program run by an entity that is classified as a public charity. I recall first running into them as “community foundations”. The idea is that you make a donation to the organization and it sits on the assets you donate in a separate fund. Then you make “suggestions” (i.e. donor advice) as to which qualified charities should receive donations. There is no legal requirement that the organization follow your “advice”, but the understanding is that they will. And somebody running donor advised funds who ignores donor advice will not have much of a brand.
The technique also allows anonymity. People who worry about “dark money” have concerns about that, but there are also good reasons. One is so that the charity uses your donation on its mission rather than asking you for more money. The other is a spiritual precept about detached generosity. The Christian version is “Take heed that ye do not your alms before men, to be seen of them: otherwise ye have no reward of your Father which is in heaven.”
The Bad
When I spoke with Professor Madoff, she did not dispute that there were positive aspects to donor advised funds, but the focus of the article is on the downside. It is something that would never have occurred to me. Private foundations are required to make distributions every year, but there is no such requirement for donor advised funds. So apparently a lot of people are, in effect, advising the sponsors to just sit on their assets. The article discusses the psychological dynamic behind that phenomenon.
Instead of the donor thinking of this transfer as a charitable gift that has been made (the way one would feel about an outright transfer to a museum, for example), the donor now thinks of the DAF as a charitable asset in which he has a continuing interest. To the extent that donors think of DAFs this way, they are less likely to spend DAF funds. Behavioral economists refer to this desire to keep property in which one feels one has ownership interest as the “endowment effect.”
The Ugly
The ugly part is that the big sponsors of donor advised funds are not community foundations, but rather organizations ginned up by financial management firms. In 2015 the second most popular charity, measured by donated funds, was Fidelity Charitable. According to its 2015 Form 990, $4.6 billion came in and only $2.8 billion went out to actual charities. In business since 1991 it has over $15 billion more or less sitting on the sidelines of American philanthropy. And after all isn’t having assets under management more important than, you know, feeding the hungry and giving drink to the thirsty. As the article explains it:
DAF sponsors encourage the endowment effect by building up the donors’ sense of ownership in the DAF. They do this by granting the donors the ability to manage the investment and by providing regular statements about how their investment is doing. Donors are also encouraged to pass these accounts on to their children and grandchildren, creating a “charitable legacy.” The combined effect is to subtly encourage donors to hoard, rather than distribute, their DAF funds. Of course, this approach benefits the financial companies representing the DAF as well; the longer the property is held in the DAF, the greater the management fees.
And remember that rule about private foundations having to make distributions to regular charities. Well donor advised fund qualify.
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.
Little Known?
I spoke with Professor Madoff about the odd observation that donor advised funds are little known. She said that there is a “very big divide” on this. DAFs have been in my bag of tricks for a while, but public awareness remains light. I had some evidence from the way I was made aware that this article would be coming out. My covivant and I were spending a day being tourists in New York and during a long subway ride, I listened to three attorneys in my age bracket talking about this and that. The conversation leader seemed to have the managing partner personality, kind of like Donald Trump without the modesty. One of the others had heard about the article coming out and was amazed and astounded by it. Managing partner type had never heard of donor advised funds. Something obscure enough for a guy like that to not just not know about, but admit not knowing about is pretty obscure. Go figure.