Rich stock­pil­ing wealth in black-box char­i­ties

The Palm Beach Post - - BUSINESS - By Suzanne Wool­ley Bloomberg

It’s all the rage in char­i­ta­ble giv­ing — and it’s ac­tu­ally got some char­i­ties wor­ried.

Donor-ad­vised funds — money that grows tax-free in in­di­vid­ual ac­counts — are re­shap­ing the land­scape of U.S. phi­lan­thropy. Af­ter cre­at­ing their ac­count, donors choose how it’s in­vested, and the money com­pounds until they de­cide where to dole it out. DAF as­sets mush­roomed to more than $85 bil­lion at the end of 2016 from $30 bil­lion in 2010.

Not ev­ery­one thinks that’s good news. Crit­ics say the ap­proach may slow the flow of money di­rectly into non­prof­its that serve the needy on a daily ba­sis. More­over, it in­jects char­i­ta­ble af­fil­i­ates cre­ated by for-profit fi­nan­cial play­ers such as Fidelity In­vest­ments and Charles Sch­wab deep into the big busi­ness of phi­lan­thropy — a boon for them and their clients, but, some worry, not so clear a win for the causes.

The Sal­va­tion Army is grate­ful for DAF con­tri­bu­tions, said Jeff Hes­sel­tine, di­rec­tor of gift plan­ning for the not-for-profit’s western ter­ri­tory. But “the best op­tion is for donors to work di­rectly with a Sal­va­tion Army fundraiser who can as­sess their char­i­ta­ble in­tent, de­cide on a giv­ing strat­egy” and have gifts put to good use im­me­di­ately.

The fi­nan­cial-ser­vice in­dus­try’s in­ter­est in giv­ing is tied to a loom­ing gen­er­a­tional wealth trans­fer — and a de­sire not to see as­sets walk out the door. (A com­mon DAF mar­ket­ing theme is the abil­ity to leave a legacy of giv­ing for heirs.)

The money in many of these ac­counts started out as highly ap­pre­ci­ated, pub­licly traded stock and illiq­uid “com­plex as­sets” such as shares in closely held busi­nesses, re­stricted stock, oil and gas roy­al­ties, and real es­tate in­ter­ests. Then there’s the art, the cruise ship, the bit­coin and bushels of wheat and soy­beans DAFs have liq­ui­dated to fund ac­counts.

If the donor sold them, those as­sets could pro­duce huge tax bills. If they’re do­nated to a DAF, they bring huge tax ben­e­fits and a big­ger pool of char­i­ta­ble funds than if they’d been sold and the pro­ceeds do­nated.

This tax-pow­ered alchemy has been called “phi­lan­thropic frack­ing” — a way to tease out more dol­lars from rich peo­ple’s port­fo­lios. Fidelity Char­i­ta­ble took in $1 bil­lion last year in com­plex as­sets and will prob­a­bly get an­other bil­lion this year, said Pres­i­dent Pam Nor­ley. At Van­guard Char­i­ta­ble, more than 80 per­cent of 2017 con­tri­bu­tions came from non­cash as­sets in­clud­ing se­cu­ri­ties, re­stricted stock and real es­tate.

DAFs of­fer ad­van­tages over pri­vate foun­da­tions. Donors who con­trib­ute pri­vately held stock or real es­tate to their foun­da­tion must value it at cost ba­sis — likely to be low for de­pre­ci­ated prop­erty or busi­nesses started in a garage. The in­cometax de­duc­tion is capped at 20 per­cent of ad­justed gross in­come (AGI), which can be car­ried for­ward five years.

If in­stead that as­set is con­trib­uted to a DAF, an ap­praiser de­ter­mines its fair mar­ket value be­fore it’s do­nated. That yields a big­ger de­duc­tion, which can off­set as much as 30 per­cent of AGI (and can also be car­ried for­ward five years). Since the DAF is a pub­lic charity, the donor pays no cap­i­tal gains tax — and nei­ther does the DAF when it sells the as­set.

The wealth­ier one is, the more illiq­uid and highly ap­pre­ci­ated as­sets one prob­a­bly owns, en­hanc­ing the ap­peal of these ac­counts.

“One rea­son for the ex­tra­or­di­nary growth of DAFs is their abil­ity to pro­vide max­i­mum tax ben­e­fits for com­plex as­sets: prop­erty other than pub­licly traded stock,” said Ray Mad­off, a Bos­ton Col­lege Law School pro­fes­sor and founder of its Fo­rum on Phi­lan­thropy and the Pub­lic Good.

DAF have an­other ad­van­tage: Even though donors yield le­gal con­trol of as­sets they con­trib­ute, their fi­nan­cial ad­vis­ers may be al­lowed to di­rect how the money is in­vested and earn man­age­ment fees. The big­gest ac­counts also may be al­lowed to in­vest out­side a DAF spon­sor’s usual menu of op­tions.

DAFs have ad­van­tages for fi­nan­cial-ser­vices com­pa­nies, too. Some 60 per­cent of the $21.2 bil­lion in Fidelity Char­i­ta­ble, for ex­am­ple, is in Fidelity funds. Fidelity In­vest­ments par­ent FMR LLC is the DAF’s largest in­de­pen­dent con­trac­tor and re­ceived $46.3 mil­lion for the year ended June 30, 2017.

An­nual ad­min­is­tra­tive fees for DAF ac­counts can be 0.6 per­cent, on top of in­vest­ment man­age­ment fees. Nor­ley said Fidelity Char­i­ta­ble’s “com­plete over­all fees” av­er­age 0.6 per­cent.

“Given the po­ten­tial for phi­lan­thropic dol­lars to grow through in­vest­ment in a DAF, the work we are do­ing creates a net pos­i­tive in funds made avail­able,” she wrote in an email.

Fidelity Char­i­ta­ble’s 2018 giv­ing re­port noted that in­vest­ment growth in its DAFs since in­cep­tion cre­ated $6 bil­lion more for giv­ing.

Some have crit­i­cized DAFs be­cause the money they ac­cu­mu­late far out­strips funds flow­ing in, prompt­ing a re­cent re­port to la­bel them “ware­houses of wealth.” Pri­vate foun­da­tions must pay out at least 5 per­cent of as­sets an­nu­ally, but DAFs don’t have a le­gal re­quire­ment for min­i­mum pay­outs, and the big providers cite an­nual ag­gre­gate grant­mak­ing of about 20 per­cent.

Pay­outs are “the big pub­lic pol­icy ques­tion,” said Roger Colin­vaux, a pro­fes­sor at Catholic Uni­ver­sity of Amer­ica’s Colum­bus School of Law. “DAFs are set up to treat money like it’s still the donor’s money. It’s like hav­ing your own mu­tual fund at Fidelity: You get state­ments and watch it grow. You feel like if you spend it, you lose it.”

If the pace of grant­mak­ing doesn’t in­crease, DAFs risk reg­u­la­tion, said Bryan de Lot­tinville, founder of Benevity, a cor­po­rate giv­ing plat­form that part­ners with DAFs. “There’s this big cor­pus grow­ing to no real ben­e­fit of any­one other than the peo­ple earn­ing fees for man­ag­ing it.”

Also, if non-cash con­tri­bu­tions keep mount­ing, the rules should change so donors’ tax de­duc­tions equal the amount avail­able for giv­ing, Colin­vaux said.

Now, a donor con­tribut­ing an as­set ap­praised at $1 mil­lion gets an im­me­di­ate $1 mil­lion write-off. When a DAF sells the as­set, it may fetch $900,000 and af­ter car­ry­ing costs and fees, leave $800,000 for the DAF.

Even with the money in DAFs ex­plod­ing, to­tal char­i­ta­ble do­na­tions re­main around 2 per­cent of dis­pos­able in­come, so it may be too early to judge whether they pro­vide a so­ci­etal ben­e­fit equal to the donors’ tax breaks. What is clear: The busi­ness of sup­port­ing char­i­ta­ble giv­ing has never been so prof­itable.

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