Tax-smart without smart tax(es)

The phrase “close the tax loopholes” has recently re-entered political discourse. Leaders on the right use the phrase to advocate for simplified structures (e.g., FairTax), while those on the left use the phrase as an argument for increasing tax rates on the “1%.” Much less talked about, however, are the implications that “closing tax loopholes” would have on charitable individuals and institutions that have effectively exploited these loopholes for philanthropic purposes.

In last week’s Wall Street Journal, Laura Saunders’s article “Tax-Smart Philanthropy Made Easy” outlined the growing phenomenon of charitable-gift funds (also referred throughout the article as “donor-advised funds”). This “fastest-growing charitable vehicle” provides donors an opportunity to put funds aside, taking advantage of the tax deduction, while delaying actual disbursement.  

Saunders writes:

Here's how they work: A person opens an account with a fund sponsor and makes an irrevocable gift of an asset, which can range from cash to stock to a ‘complex’ asset such as shares of a private business or an ownership interest in a racehorse (which the Fidelity fund once accepted). Because the donor can't get the asset back, he gets an immediate tax deduction for the gift.

By doing so, Saunders explains, donors can “concentrate on boosting the value of their gifts with smart tax planning.” Using data from the four largest sponsors, the Journal shows that charitable gift funds have been growing for the past five years, and assets have tripled to $26 billion, new contributions have gone up to $7.4 billion, and grants have doubled to $4.1 billion, comparing FY09 and FY14 figures.

Curiously, the article also points out that, according to the Chronicle of Philanthropy, Fidelity Charitable’s gift fund (the largest of the charitable gift fund sponsors) ranked as the second largest U.S. charity by contributions. According to the Chronicle, “The organization, which promotes donor-advised funds, collected $3.3-billion in 2012, a gain of more than 89 percent over the previous year.”

Saunders’s article closes with five “points to consider” addressed to individuals reviewing donor-advised funds: “consider donating before tax laws change,” “know the different types of sponsors,” “keep an eye on account minimums, fees and other terms,” “consider a private foundation,” and “understand the endgame.” In other words, despite being a seemingly fruitful charitable investment, the details surrounding each charitable gift fund matter a great deal.

The Journal article appropriately points out the viability of charitable gift trusts for philanthropists, but recognizes, particularly given tax reform threats from politicians on both sides of the aisle, that a simple change in tax law could quite easily undo their necessity. Though the article provides a neutral take on such policy changes, the article implies a number of significant questions.

For example: Given the creative solutions offered by these donor advised funds, are “loopholes” necessarily bad? Though proposed changes to nonprofit tax law would raise taxes, should there be subsequent changes to allow the nonprofit industry (i.e., charities) to maintain its current financial support? Should charitable organizations even have tax-exempt status in the first place?

Though this final question, in particular, divides interested parties squarely into two camps, an important follow-up question would explore how any system change would account for transition (considering it would probably be unwise to make an immediate policy change, given the nonprofit sector’s current dependency on tax-exempt status). By answering this question, and exploring the subsequent arguments for each answer, a discussion surrounding the utility (or futility) of tax-exempt status will be revealed, and its merits finally tested.

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