Philanthropy, Assets Under Management and the Business Case for Investment Advisors

Often investment advisors are held back in serving the client's philanthropic inclinations by the fear – partly justified – that significant gifts to charity will come at the expense of overall assets under management (AUM). However, today’s advisors are on the cusp of a major historical opportunity: to help baby boomer business owners in transition move from success to significance while, at the same time, greatly increasing and retaining AUM.

A Case in Point: Todd, a Day Late

An advisor we’ll call Todd sold his business, a C corporation with zero basis, for $100 million. His capital gain was $100 million. The tax due on the sale was $20 million. The day after he made the sale, he came to a wealth transfer firm and said, “Help me wipe out my $20 million tax bill.”

Todd got as much help as he could get, but the truth is he came asking for help just one day too late.

Business men shaking hands

Simplified Solution

Charitable planning for non-cash assets, particularly for closely held business interests and commercial real estate, is one of the most complex, intertwined areas of the tax code. Proper planning requires a team with many players: a tax attorney, a CPA, a business valuation expert, an investment advisor, and perhaps an insurance professional.

To see the value of proper planning, consider how Todd might have fared better had the wealth transfer firm been consulted earlier in the game. For example, let us assume Todd sold half his firm inside a Donor Advised Fund (DAF) and half outside. What would be the effects? 

Note the effect on taxes:

  •  No capital gains tax due on the $50 million made on the half sold inside the DAF.
  •  A charitable deduction of up to 30 percent of his Adjusted Gross Income, with a five-year carry forward, subject to whatever limitations may apply under the phase out of itemized deductions. (Be thankful CPAs are happy to do these calculations.).
  •  For the half sold outside the DAF, the $50 million gain would be offset partly by the deduction for the part given to the DAF.

Note the effect on AUM:

  •    $50 million new dollars under management in the DAF.
  •    $50 million (minus whatever residual tax is due) new dollars under management outside the DAF.

Yet, an advisor might wonder if the $50 million in the DAF will soon be headed to charity and, if so, will it deplete what the advisor might otherwise been able to manage? Actually, having an advisor hold on to the assets in a DAF and just trickle out the dollars to charity may well be exactly what an informed donor, getting first-rate charitable advice, will do.

Lessons Learned From Donor Lawsuits Against Charity for Non-Performance

Two examples of disputed donor intent follow for consideration:

Robertson vs. Princeton

In a famous case, Princeton University settled a lawsuit with a donor family, in a case where the family said the school had drifted from the donor's intent. A total of $35 million in A&P stock had gone to Princeton in 1961 to create a supporting organization to fund the Woodrow Wilson School of Public and International Affairs for the education of future diplomats. The fund grew to $900 million used for the Woodrow Wilson School and other items as well. The donor was concerned that the school was not educating enough diplomats and wrote a note to that effect. Upon the deaths of the donor and the spouse, the heirs filed a lawsuit to redirect any remaining funds to other schools. Princeton paid $40 million in legal costs and eventually settled, giving $90 million back to go to a different foundation.

Newcomb and Tulane University

Between 1886 and 1901, Josephine Newcomb gave $3.6 million to create Newcomb College within Tulane University for “female education in Louisiana.” After Hurricane Katrina, trustees merged Newcomb College into Tulane, and Tulane absorbed the endowment. The heirs, Parma Howard and Jane Smith, sued. The case was settled in favor of Tulane.

Slippage: The Importance of Planning for Donor Intent

When a donor makes a big gift to a charity in order to make something happen, like a new program or a chair or even a new school, there should be a gift agreement that specifies the obligations of the parties. While these are often very specific about what the charity gets, they leave a great deal of wiggle room for what the charity is actually expected to do. The agreements are generally written by the charity and signed in an atmosphere of mutual good will. Over time, for good reasons or bad, the charity may drift from the original intent of the donor. Will the agreement be enforceable in court? Do the donors or their heirs have any standing to sue, since dominion and control were relinquished as a precondition of getting an income tax deduction? Does the State Attorney General have standing to sue, even if the donor does not? Will the State Attorney General take the case? Does the Office of the Attorney General have a stack of such cases pending and only limited staff to prosecute them? Most importantly, for the client's professional advisors, how did we get our clients into this mess, in which a lawsuit against the donor's most beloved charity is their only recourse?

Staged Payments

At the leading edge of gift planning are what are variously termed "blended gifts," "virtual endowments," and "personalized philanthropy." All of this simply means that, instead of making a huge gift in one big chunk for an endowed program and having the charity hold the principal and spend the income ("the spend rate") on the program, the newer idea is for you, the advisor, to hold the money and dole it out in stages as the work is performed. That is simply business common sense. Rather than give the charity the whole lump and trust them in perpetuity, we pay them as they go along. This will lead to nuances. For example, can a DAF make a binding pledge? The DAF is not allowed to fulfill a donor’s pledge; however, the DAF sponsor may make a multi-year commitment, and some will. What will the charity be willing to do? What pattern of payments will they demand? They may not set up a new program for only one annual payment, but might for a pledge of the first three payments, or the first five. On the back end of the payment stream might be a bequest, to fulfill the principal amount. That might come from the client's will, or from highly taxed ordinary income assets (like an IRA), or from life insurance. In the meantime, an "umbrella gift agreement" keeps donor and charity in synch. The money keeps coming if, and only if, the charity is faithful to the donor's intentions and performs accordingly.

Todd Again

Back to Todd, the $100-million-dollar C corporation owner who could have transitioned half of his business on a sale inside a DAF and half in an outright sale. He wanted, let us say, a $50 million dollar Center for Religious Studies at a college (He had not gone to college, so this was his way of leaving his mark.).

If he gives the $50 million outright to the university, the donation will go into an endowment fund. The school will invest the funds and use the "spend," say, at 4 percent to fund the Center's annual expenses. So, $2 million is spun off and spent. In that plan, Todd trusts the school. His recourse might be a lawsuit if they fail to perform.

On the other hand, he could keep the $50 million in the DAF and spin off the $2 million each year against a gift agreement that lays out his expectations. If the school negotiates it, and if the DAF provider is willing to do it, and if the attorneys agree, his DAF sponsor (like Fidelity, Schwab, Vanguard, National Philanthropic Trust, American Endowment Foundation, Jewish Foundation, or a local community foundation) might commit to the first three years or five years. He might even give the first three- to five-year payment up front, as a sign of good faith, and give the charity time to pull it all together.

But give it all up front? Knowing what you know now, would you do that?

Motivation and Collaboration

Business owners in transition represent a huge and potentially profitable market for advisors. The most successful advisors in charitable planning do not just want to make a living, they also want to make a difference. They see that, by working together across the sectors to help business owners in transition, we can each leverage our time, talent, and treasure to leave a better community for those who come after us. That is what motivates me and that is what drives the Chartered Advisor in Philanthropy® (CAP®) curriculum I teach at The American College of Financial Services. This is a huge and greatly underserved market.  It is also a very complex area, requiring special training and expertise. Please step up to serve this population of investors and business owners with a heart and financial ability to positively impact the world.

This article was first published in March 2017. It was updated February 2019.