Notes - Managing Foundations and Charitable Trusts

November 22, 2024

Chapter 1: The Basics of Charitable Giving

Introduction

This chapter introduces the different ways individuals can give to charity. Charitable vehicles are the legal structures that make philanthropy effective, especially for those who want to have an impact, take advantage of tax breaks, and maintain control over their giving. The chapter examines four main approaches:

• Direct Gifts: This simplest form involves giving directly to a public charity. It is straightforward but offers less control and fewer tax advantages.
• Supporting Organizations: These are hybrid structures, somewhat more complex and offering more control than direct gifts but less than private foundations.
• Donor-Advised Funds: These funds offer a balance of administrative simplicity, tax benefits, and some control but do not provide the same level of legal control as a private foundation.
• Private Foundations: The most comprehensive option, providing complete legal control to the donor, along with tax benefits and flexibility in giving.

Direct Gifts

Direct gifts are the most common form of giving, but they have some disadvantages.

• Lack of Control: Once a gift is given, the donor has no say in how it's used.
• Limited Tax Benefits: While deductible, deductions for direct gifts may be limited based on the donor's income and the type of asset donated.
• Large Endowments: Creating large endowments through direct gifts can lead to issues with the recipient charity. There is the potential for mismanagement, excessive administrative costs, and a shift in focus away from the intended beneficiaries.

Supporting Organizations

Supporting organizations are more complex but offer greater control than direct gifts, though less than private foundations. They must have a relationship with one or more public charities, operating in connection with or under their supervision.

Donor-Advised Funds

Donor-advised funds offer administrative simplicity, tax benefits, and some control, but they don't provide the same legal control as a private foundation. They can be appealing for those who prefer a less hands-on approach to managing their charitable giving.

Private Foundations

Private foundations are independent, legal entities created to make grants to other charities. They offer the greatest control, flexibility, and tax advantages.

• Making a Difference: Private foundations are a powerful tool for enacting the founder's philanthropic vision. Examples include the Arthur Schultz Foundation, the Russell Sage Foundation, and the James S. McDonnell Foundation.
• Control: Donors have full control over the foundation, including its name, board members, investment strategy, and grantmaking decisions.
• Tax Benefits: Foundations offer a range of tax benefits, including an immediate income tax deduction for contributions, exemption from capital gains tax, and only a minimal excise tax on investment income.
• Flexibility: Private foundations allow for tailored giving strategies, targeting specific areas of interest and achieving long-term impact.
• Family Legacy: They can be used to involve future generations in philanthropy and transmit values.

Chapter 2: Tax Incentives and Limitations

Four Powerful Tax Incentives

• The chapter begins by emphasizing the four substantial tax incentives associated with charitable giving in the United States: income tax deductions, estate tax deductions, gift tax deductions, and the avoidance of capital gains taxes.
• The most straightforward benefit is the income tax deduction, where donors can deduct a portion of their charitable contributions from their taxable income.
• The chapter illustrates these benefits with an example: Bill, a 55-year-old with assets of $12.5 million, contributes 30% of his annual income to his foundation. Over 27 years, his foundation grows to $20.8 million, leaving his son Joe with a significantly larger inheritance and foundation compared to his twin brother Bob, who did not utilize a foundation for his charitable giving.
• Estate and gift tax deductions offer donors unlimited deductions for charitable contributions, allowing them to significantly reduce their tax burden.

Details on Tax Deduction Limits

• The chapter then outlines the specifics of charitable income tax deduction limits, which vary based on the type of charity and the nature of the contribution.
• For public charities, the annual deduction limit is 50% of adjusted gross income (AGI). Donors can deduct cash contributions up to this limit, while deductions for appreciated long-term capital gain property are limited to 30% of AGI.
• For private foundations, the annual deduction limit is 30% of AGI, with a 20% limit for contributions of appreciated publicly traded stock.
• The chapter explains that unused deductions can be carried forward for up to five years, allowing donors to maximize their tax benefits over time.

Finding the Best Giving Strategy

• The authors present two key giving strategies: maximizing contributions to charity and maximizing the amount left to heirs, recommending annual contributions to a foundation as the most effective approach for both.
• For maximizing charitable contributions, donors should aim to contribute the maximum deductible amount each year, which is 30% of their income for private foundations.
• For maximizing inheritance while maintaining the same level of charitable giving, donors should contribute approximately half the percentage of their estate they plan to leave to charity.

The $1.6 Trillion Loss

• The authors highlight a significant finding: most wealthy families are not taking full advantage of private foundation tax benefits, resulting in a projected $1.6 trillion loss for charities over the next 30 years. This estimate is based on data suggesting that only a small fraction of families with assets over $5 million utilize foundations for their charitable giving.
• This substantial loss underscores the importance of encouraging wealthy individuals to establish and fund foundations during their lifetime, maximizing both their tax benefits and their charitable impact.

Estate Taxes

• The chapter briefly addresses estate taxes, noting that the amount going to charities from estates is expected to continue to grow due to the increasing size of estates and the tendency of larger estates to allocate a larger percentage to charity.

Chapter 3: Charitable Planning and Taxes

Giving Approach

This section of Chapter 3 of Managing Foundations and Charitable Trusts by Roger D. Silk and James W. Lintott discusses different approaches to charitable giving. The authors examine the tax implications of each approach, using various examples to illustrate the potential benefits.

Fixed-Dollar Amount

Many donors give a fixed dollar amount each year. The authors discuss an example in which a taxpayer/donor makes a fixed donation of $10,000 to charity every year. The authors consider whether it makes sense for this taxpayer to instead make one large donation of $30,000 every three years.

The authors explain that the tax benefits of this strategy will depend on the donor's income. If the donor's income is $200,000 each year, it doesn't matter if they make three donations of $10,000, or one donation of $30,000 every three years. This is because their total charitable deduction will be the same over the three-year period.

However, if the donor's income is only $100,000, it might make more sense for them to bunch their deductions into one year. The authors explain that this is because, in the year the donor makes the $30,000 donation, they will be able to deduct the full amount, even if it exceeds the deduction limit for that year. The remaining deduction can then be carried forward and used in subsequent years.

Fixed-Percentage Gifting

Instead of giving a fixed-dollar amount each year, some donors prefer to give a fixed percentage of their income. The authors note that there is a long tradition of giving 10 percent of one's income to charity. They cite the Bible, which is sometimes interpreted as prescribing a 10 percent tithe to charity. The authors also cite the Talmud, which specifies that people must give a minimum of 10 percent and a maximum of 20 percent.

The authors then review the percentage limits on charitable income tax deductions under the Internal Revenue Code. These rules specify that the maximum deduction in a single year is 50 percent of adjusted gross income (AGI). The limit is 30 percent of AGI for gifts of noncash assets to public charities, and for gifts of cash to private foundations. The limit is even lower, 20 percent of AGI, for gifts of appreciated publicly traded stock to private foundations.

The authors note that most donors give less than 20 percent of their AGI to charity each year. They recommend that these donors consider “gift-bunching,” which is the strategy of making a large donation every few years instead of a smaller donation every year.

Tax Planning Complexity

This section of Chapter 3 explores some of the complexities involved in tax planning for charitable giving.

Timing Considerations

The authors note that the tax benefits of charitable giving can vary depending on when a donation is made. For example, if a donor knows their income is going to be higher next year, it might make sense for them to delay their donation until then.

This is because their donation will be worth a larger deduction in the year they have a higher income. Similarly, if a donor knows they're going to realize a capital gain, it might make sense to time their donation to offset the tax liability from the gain.

Guidelines for Analytical Expenditure

Given the complex rules involved in charitable giving, the authors recommend donors conduct a detailed analysis of their tax situation before making a donation. However, they acknowledge that this can be a time-consuming and expensive process. As a result, they offer some guidelines to help donors decide if tax planning is worth the cost.

The most important factor, according to the authors, is income. The more income a donor has, the more likely it is that tax planning will be worthwhile. This is because even a small percentage reduction in their tax liability can result in significant savings. For donors with lower incomes, the potential savings may not justify the cost of analysis.

What to Do When Tax Rates Are Uncertain

This section of Chapter 3 discusses how donors can plan for charitable giving when tax rates are uncertain. The authors note that tax rates can change over time, making it difficult to predict what the tax implications of a donation will be in the future.

One strategy the authors recommend is to use a charitable remainder trust (CRT). A CRT is a type of irrevocable trust that allows donors to make a donation to charity and receive an income stream for life. The tax deduction for a CRT is based on the present value of the remainder interest that will go to the charity after the donor's death.

The authors note that CRTs can be beneficial for donors who are concerned about future tax rate increases. This is because the tax deduction is determined at the time the CRT is created, even if tax rates increase in the future.

Chapter 4: Planning with Charitable Lead Trusts and Charitable Remainder Trusts

This chapter of "Managing Foundations and Charitable Trusts" focuses on Charitable Lead Trusts (CLTs) and Charitable Remainder Trusts (CRTs), explaining how these "split interest" vehicles can be used to benefit both charities and a donor's children.

Charitable Lead Trusts (CLTs)

A CLT is a trust designed to provide an income stream to a charity for a set period, with the remaining assets eventually passing to the donor's heirs. This arrangement can be beneficial for tax planning purposes, especially when attempting to reduce estate taxes.

Charitable Remainder Trusts (CRTs)

A CRT, conversely, is structured to provide income to the donor or a designated beneficiary for a specified term, with the remaining assets ultimately going to charity. This setup can offer tax advantages, particularly when donors want to receive income from appreciated assets while also making a substantial charitable contribution.

Comparing CRTs and Private Foundations

The authors compare donating highly appreciated, publicly traded stock to a CRT versus a private foundation. Both a CRUT and a donation to a private foundation generate an equivalent upfront tax deduction and irrevocably set aside assets for charity. However, there are important differences.

• Tax Deduction: With a CRT, the donor receives a tax deduction for the present value of the remainder interest, the amount the charity expects to net after annuity payments. With a private foundation, the donor can deduct the full amount of the appreciated stock donated.
• Control: A CRT offers limited donor control, as the charity manages the assets. A private foundation gives the donor complete control over investment and grant-making decisions.
• Flexibility: CRTs are generally less flexible than private foundations.
• Privacy: CRTs offer more privacy than private foundations, which have public disclosure requirements.
• Complexity: CRTs can be more complex to set up and administer than private foundations.

Flexibility and Irrevocability

CRTs are generally irrevocable, meaning they cannot be changed after they are created. This can be a disadvantage if a donor's circumstances change, although there are certain exceptions and strategies for modifying CRTs in some cases.

Chapter 5: Foundations and Children

This chapter examines how private foundations can be used to help children in a family. It begins by discussing how children can be harmed by wealth. It then describes how foundations can help to transmit values, provide valuable skills, and bring families closer.

Affluenza

A large inheritance can make children lazy and entitled. Many wealthy philanthropists like Andrew Carnegie and Bill Gates believe that it is better for society if wealth is used for good causes rather than left to heirs. One study showed that adult children who get more money from their parents accumulate less wealth. Children who are given less money from their parents tend to accumulate more. Many parents worry that their children will focus more on the external signs of wealth than the character traits that create success.

Psychologist Suniya Luthar says that wealthy children can suffer from "affluenza." This can lead to anxiety, depression, and substance abuse. Luthar suggests that wealthy children are better off when they are taught to help others in need. Warren Buffet and Bill Gates are two famous examples of wealthy philanthropists who have chosen to give relatively little of their wealth to their children. Other wealthy families wrestle with how much is enough to leave to their children.

It's important for parents to explain their charitable plans to their children so that there are no hurt feelings or unmet expectations.

Bringing Families Closer

Working together on charitable projects can help to create a strong family identity.

Transmitting Values

Setting a good example can have more of an impact on a child's character than anything else. By giving to charity and being involved with charitable causes, parents can teach their children their values.

Providing Valuable Skills

Working on charitable projects with family can help children develop valuable skills that will help them later in life. Family foundations provide an ideal environment for children to work with other people, learn to budget money, conduct research, and make decisions. Children who gain experience working with a family foundation are often better at collaborating, leading, and solving problems.

Chapter 6: Benefits of Giving While You’re Still Alive

Procrastination in Philanthropy

Many people procrastinate when it comes to philanthropy. This is especially true for busy, successful people who have the resources to start their own foundations.

While there may be valid reasons to delay funding a foundation until death, tax planning is usually not one of them.

Financial and Philanthropic Advantages of Lifetime Giving

Funding a foundation while alive offers numerous benefits, including the chance to establish a giving pattern for heirs and successors to learn from. This provides a track record that can guide the foundation after the donor's death.

The Importance of a Clear Mission

A well-defined mission statement is essential for guiding a foundation's activities, especially for successor trustees.

Donors who establish foundations during their lifetime have the opportunity to develop a mission statement based on their experiences and refine it over time. This is much more effective than leaving vague instructions in a will.

Examples of Specific and Vague Mission Statements

• James B. Duke, founder of Duke University, left highly specific instructions for his foundation, dictating the exact percentage distribution of funds to various beneficiaries, including Duke University, hospitals, and retired preachers.
• John D. Rockefeller, on the other hand, provided a much broader mission statement for his foundation, simply instructing it to "promote the well-being of mankind throughout the world."

Potential Issues with Overly Specific Instructions

Overly specific instructions can limit a foundation's ability to adapt to changing social and economic conditions. For example, Duke's restrictions on selling Duke Power shares prevented the foundation from diversifying its holdings when the energy industry declined.

The Importance of a Track Record for Vague Missions

Foundations with vague mission statements can still be successful if the founder establishes a strong track record of philanthropic involvement during their lifetime. This provides a tangible example for successors to follow.

For instance, the Rockefeller Foundation thrived under vague instructions because John D. Rockefeller was heavily involved in philanthropy while alive, setting a precedent for future decisions. Conversely, the Ford Foundation initially struggled after Henry Ford's death due to a lack of direction and his minimal philanthropic involvement during his lifetime.

The Value of Precedents for Successors

Founders who give while alive create a coherent set of precedents that help guide their successors in making informed decisions.

Without prior actions to back up the words, it becomes difficult for successors to truly understand the founder's intentions.

Chapter 7: Effective Foundations: The Business of Philanthropy

This chapter focuses on the strategies and methods for running an effective foundation.

The Mission Revisited

The most important element is a clear mission statement, which should outline the foundation's goals and how it plans to achieve them.

• Foundations can model their missions after existing organizations or be inspired by personal experiences.
• A written mission statement is crucial for guiding successors and maintaining the founder's vision. Some founders might write extensive instructions, while others may prefer a more concise approach.
• A good mission statement should define the foundation's purpose, energize stakeholders, and guide resource allocation.

Getting Started

A new foundation should determine if it wants to focus its giving on one area or spread its efforts across various causes.

Know Your Charities

• Donors should research potential grantees thoroughly to ensure their missions align with the foundation's goals. Name recognition alone is not a guarantee of effectiveness. Financial statements, program descriptions, and site visits are crucial for informed decision-making.
• Rankings and celebrity endorsements should not be the sole basis for choosing a charity.
• Donors should focus on effectiveness and consider smaller, local organizations that might lack widespread recognition.
• Key questions to ask when evaluating a charity include the percentage of donations used for programs, the organization's sources of income, and the qualifications and compensation of the staff.

Governing for Effectiveness

Effective governance is crucial for long-term planning and consistency.

• The board should be charged with implementing the founder's vision and mission.
• Key questions include:
  • The chairperson's roles and selection.
  • Establishment and responsibilities of board committees.
  • Duties of board members.
  • Selection and recruitment of board members, including considerations of family and non-family members, term limits, and board size.

Approaches to Grant Making

• If a foundation doesn't receive suitable grant proposals, it can proactively approach potential grantees and collaborate on projects that fulfill its mission.

Stand on the Shoulders of Others

Collaboration and information sharing with other foundations and experts can enhance a foundation's effectiveness.

Outside Experts Can Make the Difference

Experts can provide valuable insights and guidance on specific issues or program areas.

Types of Support: Periodic versus Endowment, General versus Program

• Periodic support offers more control than endowment support as it allows donors to adjust their giving based on changing needs or priorities.
• General support is crucial for covering a charity's overhead and operating expenses, while program support is directed toward specific programs. Donors should consider the importance of both types of support.

Is Measurement Worthwhile?

Measuring a charity's effectiveness helps determine if the foundation's money is making a real difference and if it is being used efficiently.

• Evaluating a charity's cost-effectiveness and comparing it to similar organizations is essential for maximizing impact.
• Measurable goals and performance tracking are crucial for objective assessment.
• Charities that embrace measurement and can demonstrate their success are preferable to those that avoid accountability.
• Foundations should avoid simply repeating the previous year's funding patterns without evaluating effectiveness.

Establishing Measures

Measurable goals should be objective, quantifiable, and relevant to the program's intended outcomes.

Provide Feedback

Donors should provide feedback to charities, both positive and negative, to help them improve their operations and understand donor perspectives.

Give Wisdom in Addition to Wealth

Donors can contribute their skills, experience, and expertise to charities in addition to financial support.

Give Strategically

Donors should consider the long-term impact of their giving and adopt a strategic approach to philanthropy, similar to venture capital, focusing on strengthening a charity's management and sustainability.

Exercise of Leverage

Leverage refers to maximizing the impact of each dollar donated. Strategies include:

• Challenge grants and matching funds, which encourage additional contributions from other sources.
• Strategic timing of grants, providing early support to promising initiatives or delaying grants until optimal conditions are met.
• Public relations and publicity to increase awareness and attract support.

Make Foreign Donations Deductible

Donors can structure their giving through intermediary organizations to ensure tax deductibility for foreign donations.

Use Public Relations Effectively

Public relations can raise awareness, attract support, and advance a foundation's mission.

Let Your Foundation Do the Dirty Work

A foundation can support projects or initiatives that might be controversial or politically sensitive for individual donors.

Chapter 8: The Road to Hell: Beware of Unintended Consequences

Charity's Double-Edged Sword

This chapter emphasizes the potential for charitable acts to have unintended negative consequences, despite good intentions. It stresses the responsibility of donors to ensure that their giving does not cause harm. This aligns with the medical principle of "Do no harm."

Maimonides' Hierarchy of Giving

The chapter references Moses Maimonides, a Jewish physician and scholar, who outlined a hierarchy of charitable giving. The highest form, according to Maimonides, is charity that empowers recipients to become self-sufficient, encouraging them to "learn to fish" rather than simply receiving a handout.

Critiques of Large-Scale Philanthropy

The chapter discusses critiques of large-scale philanthropy, particularly directed at the Bill and Melinda Gates Foundation. Some critics, like economist William Easterly and development expert Michael McCannon, argue that massive aid programs can create dependency, distort markets, and hinder genuine development.

Food Aid and Its Unintended Consequences

The chapter uses food aid as a prime example of how well-intentioned aid can have negative consequences. While aiming to alleviate hunger, food aid can depress local food prices, discourage local farmers, and create dependence on external sources.

Fungible Money and Inadvertent Funding of Terrorism

The chapter highlights the risk of fungible money in charitable giving. Fungible money refers to funds that are interchangeable and can be easily redirected. This poses a challenge in ensuring that donations do not indirectly support activities that the donor opposes, such as terrorism.

Restricted Grants and Donor Control

The chapter recommends using restricted grants to mitigate the risk of unintended consequences. Restricted grants specify how the funds can be used, giving donors more control and ensuring that their money is used for the intended purpose.

Poverty and Economic Growth

The chapter revisits the issue of poverty and emphasizes the importance of sustainable economic growth as a long-term solution. It cautions against approaches that might exacerbate poverty and encourages donors to support initiatives that empower individuals and communities to become self-reliant.

Key Takeaways:

• Do no harm: Charitable giving requires careful consideration to avoid unintended negative consequences.
• Focus on empowerment: The most effective charity enables recipients to become self-sufficient.
• Beware of fungibility: Money can be easily redirected, making it crucial to ensure donations are not used for unintended purposes.
• Utilize restricted grants: Specifying the use of funds can enhance donor control and minimize unintended consequences.
• Support economic growth: Sustainable economic growth is essential for alleviating poverty in the long term.

Chapter 9: Developing an Appropriate Foundation Investment Policy

This chapter of "Managing Foundations and Charitable Trusts" explores the crucial aspects of developing a comprehensive investment policy for a private foundation, emphasizing the need for a well-defined strategy to ensure the foundation's long-term financial sustainability and ability to fulfill its mission. The book emphasize that this investment policy should go beyond basic investment considerations, addressing aspects like cash management, risk assessment, asset allocation, and rebalancing.

What to Include in an Investment Policy

A foundation's investment policy should outline its overall approach to managing assets, considering the foundation's mission, time horizon, risk tolerance, and spending requirements. This policy should include clear guidelines for:

• Investment Objectives: This section articulates the foundation's primary investment goals, typically focusing on generating returns sufficient to support grant-making activities while preserving the foundation's capital over the long term.
• Spending Policy: Foundations are required to distribute a minimum percentage of their assets each year (typically 5%). This policy should define how the foundation will determine its annual spending rate, ensuring compliance with regulations and alignment with grant-making goals.
• Cash Management Policy: The policy should address day-to-day cash management practices, outlining how the foundation will manage cash flow, handle short-term investments, and ensure liquidity to meet immediate spending needs.
• Risk Management: This component involves identifying and assessing potential risks, including market volatility, inflation, and fraud. The policy should articulate the foundation's risk tolerance and establish procedures for mitigating these risks.
• Asset Allocation Policy: As highlighted in Chapter 10, asset allocation is a critical aspect of investment management. The policy should define the target allocation of assets across different asset classes (e.g., stocks, bonds, real estate) based on the foundation's risk profile and return objectives.
• Investment Selection and Monitoring: This section outlines the criteria for selecting specific investments within each asset class, considering factors such as diversification, performance, fees, and alignment with the foundation's mission.
• Rebalancing Policy: To maintain the target asset allocation and capture the "rebalancing bonus" discussed in Chapter 10, the policy should establish a systematic approach to rebalancing the portfolio periodically, adjusting the mix of assets to maintain the desired risk and return characteristics.
• Reporting and Review: The policy should outline the frequency and content of investment performance reporting, providing transparency to the foundation's board and stakeholders.

The book stress that many foundations do not have such comprehensive investment policies, often neglecting crucial aspects like risk assessment, long-term projections, and systematic rebalancing.

Chapter 10: Developing and Implementing a Foundation Asset Allocation Policy

Differences between Corporation and Foundation Investment Plans

This chapter of "Managing Foundations and Charitable Trusts" focuses on the importance of developing and implementing an asset allocation policy for foundations, specifically highlighting the differences between investment plans for corporations and foundations. The authors underscore that foundations, typically established with perpetual lifespans, require a unique approach to investment planning compared to corporations.

One key difference is that corporations, unlike foundations, have a defined lifespan and are obligated to distribute their profits to shareholders. This distinction significantly impacts how they approach risk and investment strategies. Corporate pension plans, for instance, must carefully manage their assets to ensure they can meet future pension obligations, while also aiming to minimize risk and volatility to avoid potential financial strain on the company.

In contrast, foundations, due to their perpetual existence and the absence of shareholder distribution requirements, can adopt a more long-term investment horizon, allowing them to assume greater risk in pursuit of higher returns.

The authors also note the discrepancy in accounting requirements between corporations and foundations. Corporate pension plans are subject to stringent accounting regulations set by the Financial Accounting Standards Board (FASB), which dictate how pension obligations and related expenses are reported. These regulations often lead corporations to prioritize lower-risk investments to minimize potential accounting volatility.

Foundations, however, are not burdened by such rigorous accounting standards, giving them more flexibility in their investment decisions and allowing them to focus on maximizing returns over the long term.

The Seven Deadly Sins of Foundation Asset Allocation Policy

The chapter then identifies and examines seven common mistakes that foundations make when developing asset allocation policies:

1. Assuming foundations are just like pension plans. This misconception leads foundations to adopt overly conservative investment approaches that prioritize short-term stability over long-term growth potential.
2. Benchmarking against the wrong index. Foundations often compare their performance to inappropriate benchmarks, such as the S&P 500, which may not accurately reflect their unique investment objectives and constraints.
3. Overemphasizing diversification. While diversification is important, excessive diversification can dilute returns and make it challenging to achieve specific philanthropic goals.
4. Paying too much attention to the short term. Foundations often succumb to the pressure of short-term market fluctuations, leading to reactive investment decisions that can undermine long-term performance.
5. Failing to properly assess and manage risk. Many foundations lack a comprehensive understanding of their risk tolerance and fail to implement effective risk management strategies.
6. Overemphasizing liquidity. Foundations typically require minimal liquidity due to their low annual spending rates. Holding excessive liquid assets can hinder their ability to achieve long-term growth.
7. Trying to save money by skimping on smart counsel. Foundations often attempt to cut costs by avoiding professional investment advice, which can lead to costly mistakes and missed opportunities.

Developing a Good Asset Allocation Policy

The authors emphasize the importance of a carefully crafted asset allocation policy. They recommend a multi-step approach. First, foundations should determine their long-term spending rate, considering factors such as inflation and the 5% minimum payout rule. Second, they should assess their risk tolerance based on their mission, time horizon, and financial resources. Finally, foundations should construct a diversified portfolio that aligns with their risk tolerance and return objectives, considering a range of asset classes such as:

• Cash
• Money market instruments
• High-grade bonds
• High-yield corporate bonds and emerging market debt
• Equities (stocks)
• Real estate
• Timber
• Hedge funds
• Commodity futures
• Venture capital and private equities

Should an Asset Allocation Policy Change over Time?

The chapter addresses the question of whether asset allocation policies should be static or dynamic. The authors acknowledge that some circumstances, such as a shift in a foundation's mission, may necessitate policy adjustments. However, they advise against frequent changes driven by market fluctuations, emphasizing the importance of maintaining a long-term perspective.

Capturing the Rebalancing Bonus

The chapter introduces the concept of the "rebalancing bonus," which refers to the potential gains achieved by systematically rebalancing a portfolio to maintain the target asset allocation. Rebalancing involves periodically selling assets that have performed well and purchasing assets that have underperformed. This process helps to control risk and exploit market volatility to enhance returns, particularly for tax-exempt entities like foundations that are not subject to capital gains taxes.

Active Management Versus Indexing

The chapter discusses the debate between active and passive (indexing) investment approaches. Active management involves actively selecting investments with the goal of outperforming the market, while indexing aims to replicate the performance of a specific market index.

The authors acknowledge that while some active managers consistently outperform the market, many struggle to do so consistently. They caution against relying solely on past performance as a predictor of future success. Indexing, on the other hand, offers a lower-cost, more predictable approach, but it may not be suitable for all foundations.

Who Is Responsible for the Asset Allocation Policy?

Finally, the chapter addresses the question of responsibility for the asset allocation policy. The authors suggest that, while investment managers play a crucial role, the ultimate responsibility lies with the foundation's board of directors. It's their duty to establish the policy, oversee its implementation, and ensure it aligns with the foundation's mission and goals.

Chapter 11: Main Themes in Legal Compliance

This chapter of "Managing Foundations and Charitable Trusts" emphasizes the complexity and significance of legal compliance for private foundations, particularly in light of the extensive regulations introduced in 1969.

Some Compliance Errors May Seem Funny, but They're Not

The chapter begins with examples of seemingly humorous compliance errors that can have serious repercussions for foundations. These errors often stem from a lack of understanding of the intricacies of the tax code and the numerous regulations governing private foundation activities.

It provides an anecdote about a director who unknowingly engaged in self-dealing by purchasing items from a company he owned using foundation funds, highlighting how seemingly innocuous actions can violate regulations and result in significant penalties.

A Fail-Safe System

To avoid these pitfalls, the authors stress the necessity of a "fail-safe system" for ensuring legal compliance. They emphasize that legal compliance is not merely a formality but a critical aspect of responsible foundation management.

The chapter presents a systematic approach to legal compliance, categorizing key aspects into two lists: required activities and prohibited activities. This framework aims to simplify and clarify the complex regulatory landscape for foundation directors and trustees.

Required Activities

This section outlines the essential activities that foundations must undertake to maintain their tax-exempt status and comply with regulations.

• Annual Disbursements: Foundations are generally required to distribute 5% of their average net assets each year. This "5% rule" ensures that foundations actively engage in charitable activities and do not simply accumulate wealth.
• Grantee Status Verification: Foundations must verify the charitable status of their grantees to ensure that their funds are used for legitimate charitable purposes. Failure to do so can result in significant penalties for both the foundation and the individuals involved in approving the grant.
• Tax Returns: All private foundations must file annual tax returns using Form 990-PF. These returns provide detailed information about the foundation's activities and financial status, ensuring transparency and accountability.
• Annual Corporate Filings: Foundations, like other corporations, must comply with annual corporate filing requirements, maintaining their legal standing and adhering to corporate governance standards.
• Payment of Excise Taxes (if any): Foundations may be subject to excise taxes for various reasons, such as failing to meet the 5% distribution requirement or engaging in prohibited activities.
• Documentation of Gifts Received: Foundations must meticulously document all gifts received, including donor information, gift amounts, and the date of receipt. Proper documentation is essential for ensuring donors receive the appropriate tax deductions and for maintaining accurate financial records.
• Expenditure Responsibility (if applicable): When granting funds to other private foundations, the granting foundation must exercise "expenditure responsibility." This involves monitoring the recipient foundation to ensure that the funds are used as intended and complying with reporting requirements to the IRS.
• Public Inspection: Foundations are subject to public inspection requirements, allowing the public to access certain foundation documents, promoting transparency and public accountability.

Prohibited Activities

This section outlines the activities that foundations are strictly prohibited from engaging in, as they violate tax regulations and jeopardize the foundation's tax-exempt status.

• Self-Dealing: Foundations are prohibited from engaging in transactions that benefit the foundation's founders, directors, or other disqualified persons. Self-dealing includes actions such as selling assets to the foundation at inflated prices or using foundation funds for personal expenses.
• Jeopardizing Investments: Foundations cannot engage in investments that jeopardize their ability to carry out their charitable purposes. This prohibition aims to prevent reckless or speculative investments that could result in substantial losses for the foundation.
• Taxable Expenditures: Foundations are prohibited from making expenditures that are not directly related to their charitable purposes. These include expenditures that influence legislation, support political campaigns, or benefit private individuals.
• Excess Business Holdings: Foundations are subject to restrictions on their ownership of business enterprises. These restrictions prevent foundations from using their tax-exempt status to gain an unfair advantage over other businesses and ensure they focus on their charitable missions.
• Unrelated Business Income: Foundations are prohibited from engaging in business activities that are unrelated to their charitable purposes. Income generated from such activities is subject to taxation, and foundations must take care to avoid engaging in activities that could jeopardize their tax-exempt status.

Chapter 12: Fraud, Inflation, and Market Risk

This chapter of "Managing Foundations and Charitable Trusts" focuses on the risks that charities and foundations face from fraud, inflation, and market volatility.

The Threat of Fraud

• The chapter highlights the vulnerability of charities to fraud, using the example of the Elie Wiesel Foundation for Humanity, which lost $15.2 million to Bernie Madoff's Ponzi scheme. Despite this significant loss, the foundation continued operating and fulfilling its charitable commitments.
• The chapter uses the example of the Baptist Foundation of Arizona to illustrate how fraud can occur within charities themselves. The foundation's executives misrepresented the value of real estate investments, ultimately leading to its collapse and a loss of $590 million for investors, many of whom were elderly church members.
• The chapter cautions that even seemingly simple investments like certificates of deposit (CDs) can be manipulated for fraudulent purposes. The case of Stanford Financial Group demonstrates this, where investors were lured by promises of high returns on CDs that turned out to be part of a massive Ponzi scheme.

Market Risk

• The chapter discusses the collapse of Allied Capital, a business development company that invested in small businesses. Allied's aggressive accounting practices and risky investments eventually led to its downfall in 2010. This example serves as a reminder that even established companies with long track records can be susceptible to market risk.

Inflation Risk

• The chapter shifts focus to inflation, a significant risk for long-term investors like foundations and endowments.
• It notes that inflation has historically averaged 3.7% per year since 1933, when the U.S. abandoned the gold standard. This rate is nearly triple the average inflation rate in periods before 1933, when money was typically backed by gold or silver.
• Inflation indexing is discussed as a means to adjust for inflation's impact on economic data. For example, Social Security benefits are indexed to inflation, ensuring that recipients maintain their purchasing power over time.
• The chapter cautions that the official inflation figures, such as the Consumer Price Index (CPI), may underestimate the actual rate of inflation due to methodological limitations.
• The authors cite former Federal Reserve Chairman Alan Greenspan, who acknowledged the inherent challenges in accurately measuring inflation and emphasized the importance of using a broad range of goods and services to gauge the true cost of living.
• Foundations and endowments are highly exposed to inflation because their assets are typically invested for the long term.

Avoiding Fraud and Mitigating Risk

• The chapter offers advice on how foundations and donors can avoid fraud and mitigate risk.
• It emphasizes the importance of due diligence and thorough research before making any investment, particularly when dealing with complex financial instruments or unfamiliar asset classes.
• The authors recommend seeking advice from qualified financial experts to assess investment risks and develop appropriate strategies.

Chapter 13: Other Planned Giving Vehicles

This chapter explores several lesser-known "planned giving" strategies that can offer tax benefits and support charitable causes. These vehicles are often used for smaller donations or when a donor's needs are not as complex.

Charitable Gift Annuity

• A charitable gift annuity involves two simultaneous transactions: a donation of money or property to a charity and a promise by the charity to pay the donor a fixed annual income for life (or the life of a spouse).
• The amount of the annuity payment is determined by factors like the donation amount, the donor's age, and current market conditions.
• The donor receives an income tax deduction for the present value of the remainder interest that will eventually go to the charity.
• Charities promote gift annuities as a way for donors to receive income, obtain tax deductions, and support a worthy cause. For example, The Salvation Army suggests this arrangement for those who want to make a sizable donation but feel financially constrained.

Gift Annuities versus Regular Annuities

• The authors caution against viewing charitable gift annuities as equivalent to regular annuities.
• Gift annuities typically offer lower payout rates compared to commercial annuities due to the charitable component.
• Donors considering gift annuities should carefully compare payout rates and tax benefits with other options, such as private foundations or charitable remainder trusts.

Partial Exclusion of Annuity Payments from Income Tax

• A portion of each annuity payment is considered a tax-free return of the donor's original principal, while the remaining portion is treated as taxable income.
• The exclusion ratio, which determines the tax-free portion, depends on the donor's age at the time the annuity is created.

Bargain Sale

• A bargain sale involves selling an asset to a charity for less than its fair market value, resulting in a partial charitable donation.
• Donors can claim a charitable deduction for the difference between the asset's fair market value and the sale price.
• The book explain that current bargain sale rules, revised in 1969, can be complicated and require careful consideration of the donor's basis in the asset.

Charitable Gift Annuity versus CRT

• The authors compare charitable gift annuities with charitable remainder trusts (CRTs), noting that CRTs offer several advantages:
  • Potential for higher payout rates.
  • More flexibility in terms of payout structures and investment options.

Remainder Gifts with Retained Life Estate

• A remainder gift with a retained life estate allows a donor to transfer an asset's future interest to a charity while retaining the right to use the asset for life.
• This arrangement offers a charitable deduction for the present value of the remainder interest.
• Two key caveats apply:
  • Irrevocability: These agreements cannot be easily reversed, even if the donor's circumstances change.
  • Potential Bargain Sale Issues: Transferring debt-financed property under a life estate agreement can trigger complex bargain sale rules, potentially negating tax benefits.

Pooled Income Funds

• A pooled income fund combines contributions from multiple donors into a single investment pool managed by a charity.
• Donors receive a lifetime income stream based on their share of the pool's earnings, with the remainder going to the charity upon their death.
• Pooled income funds offer a simple way to make a charitable gift while receiving income, but payout rates may be lower than other options.

Chapter 14: Donor-Advised Funds

History

Donor-advised funds (DAFs) originated in the 1930s, initially established by community foundations. However, it wasn't until the 1990s that DAFs experienced significant growth, driven by the emergence of commercial providers like Fidelity, Schwab, and Vanguard.

Guidelines—Highlights

The IRS provides guidelines governing DAFs, highlighting key aspects:

• Contributions: Donors receive an immediate income tax deduction for contributions to their DAF accounts, even if the funds are not distributed to charities right away.
• Investment Growth: Assets in DAF accounts can grow tax-free until they are granted to charities.
• Donor Recommendations: While donors can recommend which charities receive grants from their DAF accounts, the sponsoring organization retains ultimate control over grant-making decisions.

Fees and Costs

Donor-advised funds typically assess fees for their services:

• Setup Fees: Most DAFs do not charge setup fees.
• Annual Fees: DAFs generally have higher annual fees compared to private foundations, averaging around 1.5% of assets. These fees encompass administrative expenses (approximately 1% of assets) and investment management fees (roughly 0.5% of assets).

Chapter 15: Building Assets with Charitable Planning

This chapter shifts focus to investment professionals and how they can utilize private foundations as a tool to increase their clients’ assets.

Private Foundations as an Asset Growth Tool

While previous chapters discussed the benefits of private foundations, this chapter emphasizes those benefits specifically for investment advisors seeking to enhance client wealth.

The chapter highlights seven specific advantages of utilizing a private foundation to build a client’s assets.

1. An immediate increase in a client’s total assets, both personal and through the foundation.
2. Substantial long-term growth of total client assets.
3. Valuable opportunities to diversify a client’s holdings in highly appreciated stock.
4. The ability to avoid capital gains taxes on appreciated assets.
5. The potential for significant tax savings when donating appreciated assets.
6. Estate planning advantages, particularly minimizing or eliminating estate taxes.
7. The ability to make a larger charitable impact.

The authors provide a table illustrating the immediate income tax savings a client could experience by contributing to a private foundation. For a client with a gross income of $1,000,000, establishing a private foundation and contributing $300,000 resulted in a 25% increase in net assets available for management.

Another table shows how the total asset increase becomes even more significant over the long term.

Professionally Managed, Turnkey Private Foundations

While the benefits of private foundations are compelling, the authors acknowledge that the compliance and accounting requirements can appear daunting. They suggest that by offering comprehensive private foundation management services, professional advisors can make it easier for clients to establish and manage their own foundations.

Foundation Manager’s Role

The chapter then outlines the key responsibilities of a foundation manager. These include:

• Helping the client develop a mission statement and grant-making guidelines.
• Working with financial advisors to ensure adequate cash flow and fulfillment of client requirements.
• Handling administrative tasks such as annual meetings, reports, and corporate filings.
• Maintaining all necessary foundation records, including grant documentation.
• Providing donation acknowledgments to founders.
• Verifying the charitable status of grant recipients.
• Managing bookkeeping and accounting.
• Calculating the required minimum distribution each year.
• Preparing and filing federal and state tax returns.
• Ensuring compliance with self-dealing and excess business holdings restrictions.
• Confirming the fiduciary duty against jeopardizing investments.
• Monitoring changes in IRS regulations.
• Preparing letters to grant recipients with the required language.
• Ensuring ongoing IRS compliance.

Chapter 16: How to Select a Foundation Manager

Choosing A Foundation Manager

This chapter outlines factors donors should consider when choosing a manager for their private foundations. Donors must first decide how much they want to be involved in their foundation's operations. They can choose to manage it themselves, using attorneys and accountants as needed. Alternatively, they can retain a full-service foundation management firm to handle all aspects of the foundation, excluding asset investment. Finally, they can work with a bank trust company that will manage both administrative and investment tasks.

Full-service foundation management companies offer the most comprehensive services for foundations, handling all necessary tasks. Partial service firms also exist, specializing in specific areas like accounting or grant assistance. These may be useful for donors who choose to manage their foundations themselves, but won't be suitable for those seeking full service.

Factors to Consider When Choosing a Manager

Donors should consider several factors when choosing a manager for their private foundation:

• Time required to create a foundation: Some managers can establish foundations more quickly than others.
• Range of services: Managers offer different service packages, so it's important to understand what's included.
• Administrative systems: Robust administrative systems are vital to ensure smooth foundation operation and compliance.
• Experience: Donors should assess a manager's experience level and track record.
• Philanthropic expertise: Consider the manager's familiarity with various philanthropic strategies and approaches.
• Reputation: A manager's reputation reflects their professionalism and reliability.
• Educational resources and attitudes: Managers who provide educational resources and are receptive to a donor's questions can be valuable partners.

Evaluating a Manager's Expertise and Approach

Donors should evaluate a manager's experience with both grant-making and grant-seeking, as this dual perspective provides valuable insights for managing a foundation.

When assessing philanthropic expertise, look for a manager with a versatile approach that can be applied across diverse areas. While deep expertise in a specific field is helpful, adaptability is crucial for effectively navigating various philanthropic domains.

The Importance of Administrative Systems

Sound administrative systems are essential for managing a foundation's administrative and compliance requirements, which often involve strict deadlines. Systems should encompass various areas, including due diligence on grants, proposed transactions with disqualified individuals, and investment monitoring.

Evaluating Reputation

Donors should check a manager's reputation through referrals from trusted sources, professional organizations, or regulatory bodies. This research helps to ensure that the manager is reputable and adheres to ethical standards.

The Value of Educational Resources

Look for a manager who provides educational resources and encourages donors to ask questions. This demonstrates a commitment to transparency and helps donors make informed decisions.

Chapter 17: What Can You Donate to Charity?

Donating Assets Other Than Cash

This chapter explores various non-cash assets that individuals can donate to charity, outlining key considerations, tax implications, and potential challenges associated with each type of donation.

Publicly Traded Securities

Donating publicly traded securities, like stocks or bonds, offers several advantages:

• Tax Benefits: Donors can deduct the fair market value of the securities at the time of the donation, avoiding capital gains tax on appreciated assets.
• Simplicity: Donating securities is relatively straightforward, involving a simple transfer to the charity.

Nonpublicly Traded Business Interests

Donating nonpublicly traded business interests, such as interests in limited partnerships, closely held corporations, or LLCs, involves more complexity:

• Deduction Rules: Donations to public charities can typically be deducted at fair market value if held for over a year. Donations to private foundations are limited to the lesser of basis or fair market value.
• Valuation Challenges: Determining the fair market value of privately held businesses requires a qualified appraiser, adding time and expense to the process.
• Bargain Sale Rules: Privately held businesses with debt may be subject to bargain sale rules, impacting the tax deduction and potentially making the donation less advantageous.

Tangible Personal Property

Donating tangible personal property, like artwork, collectibles, or vehicles, requires careful consideration:

• Valuation and Appraisal: Accurate valuation is crucial for tax purposes and may necessitate a qualified appraiser for items exceeding $5,000 in value.
• Related Use Requirement: For donations to private foundations, the charity must use the donated property in a way that is related to its charitable purpose.
• Substantiation Requirements: Donors must maintain records and documentation to support the valuation and related use of donated property.

Intangible Personal Property

Donating intangible personal property, such as patents, copyrights, or royalties, involves specific complexities:

• Valuation: Establishing the fair market value of intangible assets can be challenging and typically requires expert appraisal.
• Transferability: Ensuring the clear and legal transfer of ownership rights for intangible assets is essential.
• Tax Implications: The deductibility and tax treatment of intangible property donations can vary depending on the specific asset and recipient organization.

Qualified Retirement Plans

Donating assets from qualified retirement plans, like 401(k)s or IRAs, offers unique opportunities:

• Tax Advantages: Directly donating to charity from a retirement plan avoids income tax on the distribution, maximizing the charitable impact.
• Estate Planning Benefits: Naming a charity as a beneficiary of a retirement plan can reduce estate taxes and ensure assets are used for philanthropic purposes.
• Considerations for Partial Donations: If only a portion of the plan is donated, careful planning is needed to address minimum distribution requirements and potential tax liabilities.

Real Estate

Donating real estate to charity can be complex due to various ownership structures and tax rules:

• Outright Gifts: Donors can donate real estate outright to charity, receiving a tax deduction for the fair market value.
• Bargain Sales: Real estate with debt may be subject to bargain sale rules, affecting the tax deduction.
• Life Estate Agreements: Donors can retain a life estate while gifting the remainder interest to charity, providing a current tax deduction and potential property tax benefits. However, these agreements are irrevocable and may limit the donor's flexibility.
• Retained Use: Donors can donate real estate while reserving the right to use it for a specified period, providing a current tax deduction but reducing its value based on the retained use.

Chapter 18: When the Shoe No Longer Fits: What to Do If You Get Tired of Your Private Foundation, Donor-Advised Fund, Charitable Remainder Trust, or Charitable Gift Annuity

This chapter addresses situations where donors may want to modify or dissolve their existing charitable giving vehicles, acknowledging that circumstances and priorities can change over time. The book provides insights into the challenges and opportunities associated with winding down or restructuring charitable structures like private foundations and charitable remainder trusts.

Private Foundations

The book acknowledges that while private foundations offer substantial benefits, there can be instances where maintaining a foundation might become burdensome or no longer align with the donor's goals. The decision to dissolve a private foundation should involve careful consideration of the foundation's assets, liabilities, and ongoing commitments.

Charitable Remainder Trusts

The chapter highlights the complexities associated with modifying or terminating charitable remainder trusts (CRTs). CRTs are irrevocable, meaning they cannot be easily changed once established. However, The book illustrate, through an example, how strategic approaches can help donors and beneficiaries navigate challenges and potentially unlock value within the constraints of CRT structures.

Example: A donor, Marta, established a CRT years ago, naming her son Chuck as the income beneficiary. As Marta's circumstances changed, she explored options for modifying the CRT. Chuck, facing financial pressures, considered options like selling his income interest in the CRT. The book suggest that a collaborative approach, involving financial analysis and legal expertise, can help identify the most advantageous course of action. In this example, analysis revealed that both Marta and Chuck could potentially benefit financially from a sale of the CRT, as opposed to other options like splitting the trust.