Deferred charitable giving options.

Among other motivations, a client who is eager to donate to charity also wants to capture a charitable deduction for income tax purposes. Sometimes, the client has not selected the charities or, perhaps, the amount involved is much greater than he or she wants to give in one year. As such, what he or she really needs is a "philanthropic savings account." This item provides a frame work for evaluating the advantages and pitfalls of three alternatives applicable to a client who has no need for additional income or for donated assets to pass to heirs or other noncharitable beneficiaries; thus, it does not discuss charitable gift annuities, charitable remainder trusts or charitable lead trusts.

The Alternatives

The Code provides three different ways to make a current gift (to secure a current income tax deduction), while deferring payments to the ultimate charities:

* Public charity's donor-advised kind;

* Private nonoperating foundation; and

* Supporting organization.

Donor-advised funds: These funds are owned and operated by public charities (including community foundations); public charity affiliates of mutual fund/brokerage firms; and larger charitable organizations (e.g., hospitals, universities and national charities). Donations to these funds qualify for the most generous charitable deductions under Sec. 170(b)(1)(A) (50% of adjusted gross income (AGI) for cash contributions, and 30% of AGI for other contributions). (For a detailed discussion of the charitable deduction limits, see Swift, "Limits on Individuals' Charitable Deductions" (Part I), TTA, May 2004, p.296, and (Part II), June 2004, p. 366.)

Donor-advised hands require very little setup and, thus, are useful for last minute and year-end gifts. They also require very little additional donor involvement. The donor (and often the donor's family) can recommend--but not control--the selection of charitable grantees. Some donor-advised funds "allow donor involvement in the broad investment decisions for donated assets. There are no annual return fillings; fund activities are reported by the sponsoring charitable organization.

Donor-advised funds tend to have comparatively low administrative costs (less than 1%) and facilitate privacy and anonymity. Finally, they have the lowest minimum contributions--sometimes as little as $10,000.

Private nonoperating foundations: These foundations are Sees. 501(c)(3) and 509(a)(1) independent charitable organizations established by donors. They have the most restrictions on the deductibility of charitable contributions (30% of AGI for cash contributions and, generally, 20% of AGI for other contributions, under Sec. 170(b)(1)(B)),and special limits on die types of donated assets (e.g., they have to divest closely held business stock and concentrated positions in publicly held companies; ownership by related parties is taken into account in this determination). Private nonoperating foundations are subject to an annual excise tax under Sec. 4940 (1% or 2% of investment income) and, under Sec. 4942(e), have to grant at least 5% of their assets each year.

Establishing a private foundation and obtaining exempt status can be very costly. There is also a comprehensive annual return filing (on Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Nonexempt Charitable Trust Treated as a Private Foundation) that can be time-consuming and require specialized experience. These returns must be made available to the public, making donor anonymity difficult. Generally, these requirements result in a significantly greater lead time for setup and somewhat higher ongoing administrative costs. As a result, a private foundation is impracticable for gifts under $1 million. However, subject only to meeting IRS operating rules and avoiding prohibited related-party transactions, a donor can have almost total control over the foundation and its assets, as well as the nature of its grants--and control can pass to subsequent generations. This control conies at a price, however; such a foundation cannot accept gifts of closely held stock.

Supporting organizations: These organizations offer a middle ground between donor-advised funds and private foundations. The charitable deduction limits for gifts to supporting organizations mirror those for donor-advised funds. As with private foundations, they are separate charitable organizations established by a donor. However, they must be closely integrated and usually have a controlled relationship with a "supported" organization (a public charity).

The costs of establishing a supporting organization are similar to those for private nonoperating foundations; however, with the involvement of a capable "supported" organization in day-to-day administration, they can be less onerous. An annual return is required and must be open to public inspection. Unlike private foundations, supporting organizations are not required to make minimum distributions and are not subject to excise tax. The donor usually does not have control, but does have influence (as a board member) that can extend to investment policy and organizational operations. The donor's supporting foundation role can pass to subsequent generations. As a supporting foundation tends to have fewer ongoing administrative requirements, it can be established with lower minimum contributions (usually $500,000 to $1 million).

Considerations

In choosing from among these alternatives, a taxpayer should consider the following:

* Type of asset to be given: cash, publicly traded securities, closely held stock;

* The dollar amount to be given: under or over $500,000;

* Timing: current year, a period of years or inclusion of gifts at death;

* Tax deduction: need to maximize this year or prefer to spread it out;

* Administrative costs: pay nothing or willing to pay for quality service;

* Donor involvement in operations: none or participate in day-to-day activities;

* Public recognition: anonymity or desire to be a visible example to others; and

* Control after the donation: none or autonomously managing investments, recipients and distributions indefinitely and passing control to descendents.

Although taxpayers should consider all of the above, the key in choosing among a donor-advised fund, private foundation or supporting organization are (1) the dollar amount given; (2) the control retained; and (3) the tax benefit obtained from the gift.

A small gift often precludes use of a private foundation or supporting organization, regardless of how much control the donor wants to retain. Although the language governing the relationship between a donor-advised fund donor and a public charity is fairly standard, there is some latitude. However, any changes to an agreement are best established before is complete.

A donor who will not give up control or does not want to work with a nonfamily board will be happiest with a private nonoperating foundation, but that choice will be unavailable if the donation is small or funded with closely held stock. In such cases, the donor might be satisfied with a supporting organization that has externally appointed (but compatible) board members. However, the donor still needs a large enough gift to justify setup costs.

When the goal is to maximize the year of-gift tax benefit, a supporting organization or donor-advised fund is preferable, although the donor sacrifices control.

Conclusion

The framework presented is a basic set of guidelines requiring independent evaluation in every case. Some clients with $5 million should and do choose a donor-advised fund. Some donors with well under $1 million successfully follow the private foundation path. Regardless, the alternatives provide sufficient variety to suit the needs of virtually any taxpayer's philanthropic inclination.

FROM KRISTI M. MATHISEN, J.D., CPA, BADER MARTIN ROSS & SMITH PS., AND DANIEL M. ASHER, PRESIDENT, FOUNDATION MANAGEMENT GROUP, LLC, SEATTLE, WA