As frustrating as it can be, Democracy has accountability built in – ultimately through elections but also along the way through transparency, public comment, media scrutiny and rules of ethics.
Philanthropy has virtually none of those guard rails except as willingly self-policed by the ultra-wealthy and their advisors. If a wealthy donor starts a private foundation, they’ll be able to operate in large part under the radar if they wish. They don’t have to be (re-)elected – they are in charge by virtue of their donation. They don’t have to have anyone except themselves as board members. They can donate to organizations they belong to and benefit from, like their own church or synagogue. They can even hire their kids or friends to run the organization and pay them a salary – as long as they follow some pretty soft guidelines laid out by the IRS.
Now, there is a tax return filed every year that is a public document, and if you know how to read it you can learn a lot about how the foundation is operating, but few watchdogs are paying attention to this corner of the yard: the IRS is over-taxed (LOL, #sorrynotsorry), the press is mostly focused on big dollar gifts, and the public allows a “halo effect” of charitable intentions to keep them from asking tough questions.
And if a donor is really concerned about keeping their activities private, they can set up a Donor Advised Fund (DAF) housed at a financial services company like Fidelity or Schwab, which provides complete anonymity along with a better tax deduction – all the way up to 50% of Adjusted Gross Income instead of the 30% deduction for contributions to their own private foundation. Even better (for them), DAFs do not have the same 5% minimum distribution requirement that private foundations must follow, you can just let it sit there and grow tax free for as long as you’d like without actually giving it away.
And here’s a dirty little secret: a private foundation can meet its 5% minimum distribution requirement by giving it out as a grant to their own DAF. Where it can sit until they decide to do something with it, theoretically growing tax-free and untouched forever.
Tax benefits are driving wealthy donors to put money in foundations and DAFs in several ways (at their advice of their savvy financial and tax advisors):
- They get an immediate tax deduction, up to 50% of their AGI for a DAF and 30% for a private foundation;
- They can avoid capital gains taxes on property contributed to the foundation or DAF that is subsequently sold, such as highly appreciated stock;
- They reduce their estate and therefore estate taxes, but the control of the assets and benefits associated with the charitable entity passes to their designated successors, so it’s a way to “pass down” the assets to heirs without paying taxes.
In short – donors get a host of financial benefits up front when they make the donation, but can easily avoid actually using the money to do good things, which is supposed to be the point. And let’s not forget – avoiding taxes means avoiding paying for communal goods, like roads, schools, emergency relief and public health. In providing those tax deductions, we the public have given up our say in the use of funds for our collective priorities through the democratic process.
In this system, the point of leverage is to change the rules about tax deductions for charitable gifts. What if the donor did not receive a deduction for putting it INTO a vehicle such as a private foundation or a DAF, but only when it was distributed OUT of that vehicle to a public charity operating actual programs in the community? And putting funds into that charity’s endowment wouldn’t count either (I’m looking at you, Harvard), it would have to be actually spent.
I am inclined to believe that there would be significant changes in donor behavior, both positive and negative. A few examples:
- More donors would give gifts directly to operating charities like schools, workforce development programs, libraries, etc., bypassing the foundations and DAFs altogether.
- More donors would give the funds away to operating charities during their lifetimes, instead of establishing a foundation or DAF in their will or one that is intended to last in perpetuity.
- More donors who have a “liquidity event” that generates taxable income (such as the sale of their business or an appreciated asset such as real estate) would seek out large organizations they feel could handle a major gift, which could further concentrate large donations in already well-resourced institutions like Ivy League universities, or major international charities like TNC, EDF, Doctors Without Borders, etc., over small local organizations.
- More donors would set up an LLC-type structure like the Chan Zuckerburg Initiative or Emerson Collective – this allows for privacy and control but they don’t receive any deductions until funds are granted to actual charity and must pay for expenses associated with their giving (staff, offices, travel, etc.) from non-exempt funds.
- Fewer donors would set up a foundation and staff it with professionals and costs year after year, meaning they are less likely to have long-term, strategic visions for social change which seems like a bad thing but might be a good thing, I’m honestly not sure.
- The field of philanthropic advisors may switch from long-term employment to short-term consultants to design grants on an “as-needed” basis driven by donors’ major income events.
- The tax planning and financial management industry would lobby hard for additional loopholes or deductions to replace this one.
It’s time for the public to demand that the tax dollars we forfeit actually be used for the public good. If this reform is too big – two others that would make an immediate impact:
- Require each individual Donor Advised Fund to give away at least as much as private foundations at 5% of their average annual balance.
- Do not allow private foundations to meet their own 5% minimum distribution requirement by donating to a DAF over which they have control. Make them give it to an operating charity.