Philanthropy and AUM
Often investment advisors are held back in serving the client's philanthropy by the fear, partly justified, that the gifts to charity, if significant, will come at the expense of assets under management. As discussed in a prior post, however, we are on the cusp of a major historical opportunity to help Boomer business owners in transition from success to significance, and also greatly increase and retain assets under management.
A Case in Point: Todd, A Day Late
Todd (not his real name) came to our wealth transfer firm the day after he sold his business, a C corporation with zero basis, for $100 million. His capital gain was $100 million. Tax due was $20 million. He said, “Help me wipe out my $20 million tax bill.” We helped him some, but the truth is he came to us at least one day too late.
Charitable Planning for noncash assets, particularly for closely held business interests and commercial real estate, is one of the most complex intertwined areas of the tax code. Proper planning requires a team with at least a tax attorney, a CPA, a business valuation expert, an investment advisor, and perhaps an insurance professional.
To see the value of proper planning, consider how Todd might have done better. Assume he sold half his firm inside a Donor Advised Fund and half outside. What would be the effects?
- No capital gain on the half sold inside the DAF
- A charitable deduction up to 30% of Adjusted Gross Income, with five year carry forward, subject to whatever limitations may apply under the phase out of itemized deductions. (Thank the Lord, for CPAs.)
- Half sold outside the DAF, with the gain partly offset by the deduction for the part given to the DAF.
Note the effect on AUM.
- $50 million new dollars under management in the DAF
- $50 million (minus whatever residual tax is due) outside the DAF
Yet, an advisor might fear that the $50 million in the DAF will be headed soon to charity, depriving the advisor of asset management trails sufficient to educate a child, buy a vacation home, and retire in comfort. Fear not! In fact, some well-respected philanthropic advisors will caution against a massive outright gift to charity for an endowed program. Instead, the leading edge idea is "personalized philanthropy," with staged payments.
Lawsuits: What We Can Learn
Robertson vs. Princeton
In a famous case, Princeton settled a lawsuit with a donor family, where the family said the school had drifted from the donor's intent.
$35 million in A&P stock had gone to Princeton in 1961 to create a supporting org. to fund the Woodrow Wilson School of Public and International Affairs for the education of future diplomats. The fund grew to $900 million and was used for Woodrow Wilson School and other items as well.
The donor was concerned that the school was not educating enough diplomats and wrote a note to that effect. Upon death of donor and spouse, the heirs filed a lawsuit to redirect funds to other schools. Princeton paid $40 mil in legal costs and settled, giving $90 mil back to a foundation.
Newcomb and Tulane
From 1886 to 1901, Josephine Newcomb gave $3.6 million to create Newcomb College within Tulane for “female education in Louisiana.” After Hurricane Katrina, trustees merged Newcomb into Tulane and absorbed the endowment. The heirs, Parma Howard and Jane Smith, sued. Case has been settled in favor of Tulane.
“A wave of unwelcome publicity has engulfed a nonprofit hospital in Yukon, Okla., hometown of the country music singer Garth Brooks, after a jury last month ordered it to return a $500,000 gift from the star—and pay him another $500,000 in damages.” (Chronicle of Philanthropy, Holly Hall, “Hospital Loses to Garth Brooks in Lawsuit Over $500,000 Donation,” Feb.6., 2012.)
When a donor makes a big gift to a charity in order to make something happen, like a new program, or a chair, or even a new school, there is or should be a gift agreement that specifies the obligations of the parties. But often these are very specific about what the charity gets and leave wiggle room for what the charity is expected to do. The agreements are generally written by the charity and signed in an atmosphere of mutual good will. But over time, for good reasons and bad, the charity may drift from the original intent. Will the agreement be enforceable in court? Does the donor or heirs have standing to sue, since dominion and control was relinquished as a precondition of getting an income tax deduction? Does the State Attorney General have standing to sue, if the donor does not? Will the State Attorney General take the case? Does the office have a stack of such cases pending and limited staff to prosecute them? Most importantly, for the client's professional advisors, how did we get our clients into this mess, where a lawsuit against the donor's most beloved charity is their only recourse?
At the leading edge of gift planning, are what are variously termed "blended gifts," "virtual endowments," and "the three killer apps." All of this simply means that instead of making a huge gift, for an endowed program, and having the charity hold the principal and spend the income ("the spend rate") on the program, the newer idea is for you the advisor to hold the money and dole it out in stages and installments, as the work is performed. Is that not business common sense? Rather than give the charity the whole lump and trust them in perpetuity, we pay them as they go along. This will lead to nuances, like, for example, can a DAF make a binding pledge. (Some will, apparently.) And what pattern of payments is needed to make it possible for the charity to agree. They may not set up a new program for only one annual payment, but might for a pledge of the first three, or first five. On the back end of the payment stream might be a bequest, to fulfill the principal amount. That might come from the client's will, or from highly taxed ordinary income assets (like an IRA), or from life insurance. In the meantime, an "umbrella gift agreement" keeps donor and charity in synch. The money keeps coming if and only if the charity hews to the donor's intentions and performs. For more on this, from the nonprofit's perspective, see Dr. Steven Meyers, Personalized Philanthropy.
Back to our $100 million dollar business owner who could have transitioned half in a DAF and half in an outright sale. Todd said to me, "God gave me the money and if I don't give some back, he will take it all back." He wanted, let us say, a $50 million dollar Center for Religious Studies at a college. (He had not gone to college, so this was a way of leaving his mark.)
If he gives the $50 million outright it will go into endowment. The school will invest the funds and use the "spend," say, at 4%, to fund the Center's annual expenses. So $2 million is spun off and spent. On that plan, Todd trusts the school. His recourse might be a lawsuit if they fail to perform.
Or, he could keep the $50 million in the DAF and spin of the $2 million each year, against a gift agreement that lays out his expectations. If the school negotiates it, and if the DAF provider is willing to do it, and if the tax attorneys all agree, he might pledge the first three years, or five years. He might even give the first 3 to 5 year's payment up front, as a sign of good faith, and give the charity time to pull it all together. But give it all up front? Knowing what you know now, would you do that?
What drives me personally? Do I live to get investment advsiors paid? No, what motivates me is to see us work together across the sectors to help people like Todd, business owners in transition, do more for others. For this to be possible we need to pool our best efforts across the disciplines. And, yes, if you are an attorney, CPA, investment advisor, or insurance professional there are many good ways to get paid - while doing the right thing for the client, family, and community. We can learn together and we can perform together. That is what motivates me and the courses I teach