Hemenway & Barnes AUTHORED LITERATURE
Venture Philanthropists
When it comes to charitable contributions, many newly wealthy give more --
yet expect more from organizations they benefit.
Financial Planning,
June 2000
By Dennis R. Delaney
Are any of your clients suffering from the effects of "affluenza"? One of
the few maladies that people seek to contract, affluenza is easy to diagnose.
The first symptom seems benign -- sudden acquisition of wealth -- but later
symptoms can include familial difficulties, lost or damaged friendships, guilt
and a lost sense of direction. The causes are not a mystery: hard work,
intelligence, entrepreneurship, inheritance and savvy investing can all be
contributing factors.
Affluenza has hammered some of our nation's foremost technology
entrepreneurs and venture capitalists. Although the Nasdaq's wild gyrations may
be the cure for some who have recently contracted affluenza, those who have
already solidified their fortunes may be more seriously afflicted.
Mindful that we are amidst the largest generational transfer of wealth in
recorded history -- to $136 trillion, according to one recent study -- those
of us in the financial and estate planning fields are likely to see the effects
of affluenza for years to come.
Individuals afflicted with affluenza may not immediately recognize the
symptoms, concentrating instead on the wonderful opportunities that wealth can
bring. Still, some clients experience an immediate sense of dread upon
realizing they have become very wealthy. In any event, sooner or later, they
will encounter a host of psychological and emotional challenges in coming to
terms with their new status.
Private foundations are a great way to remove highly appreciated stock from
the donor's estate, but beware of the limitations.
Affluenza can creep in when your clients begin to wonder why they struck it
rich and others did not, and when their children face jealousy at school or on
the playground from playmates who can look up your clients' net worth on the
Internet. Its symptoms may intensify when worries set in that the children
will never acquire the drive necessary to succeed if they lose touch with core
values or become accustomed to a life of luxury. Now, don't scoff at the notion
that sudden wealth may bring burdens as well as blessings; affluenza can be
quite serious for those it strikes. In fact, this scoffing and other subtle
forms of distancing by friends and associates is yet another element of
affluenza.
So, how can you as an adviser help your client? Charitable giving is one
way. In fact, many have become intensely engaged in philanthropy as a way to
combat affluenza. These individuals often follow the lead of the titans of
the "old" economy by setting up their own charitable entities, which in turn
make multiple distributions to different public charities over time.
Why don't clients simply make gifts directly to charities instead of setting
up and funding some sort of entity that distributes to charities? There are a
number of reasons. One is that these entities allow the client and his or her
family to participate in a long-term charitable giving program, helping family
members connect and share a sense of purpose. Another reason is that these
entities allow the donors to put a personal touch on their giving, be flexible
in their philanthropy and interact more with the people who run the benefited
charities, providing the donor with greater degrees of involvement and
opportunity to influence favored organizations and programs.
It isn't too surprising that these donors are interested in procuring more
"bang for their buck" when giving to charity. Having been held to high
standards by venture capitalists -- with good results -- they are quite
comfortable applying the same standards and the same hands-on approach to the
objects of their bounty. These "venture philanthropists" view a donation as a
community investment and want to see a return on their investment in the form
of increased benefits to the community. Being new at large-scale charitable
giving, they are less likely to be bound by a tradition of family giving to
a particular charity than are those with "old" money. The venture philanthropist
seeks to maximize results from his or her giving, hard as those results may be
to quantify, by conducting their philanthropic activities through their own
charitable entities.
Four of these entities - private foundations, donor-advised funds,
supporting organizations and charitable lead trusts - are proving to be
particularly popular with those making charitable gifts with a desired return
on investment in mind. The private foundation is popular because it allows the
donor not only to make decisions with regard to charitable distributions, but
also to decide how to invest the assets that are not yet distributed to
charity. There are limitations on each of these powers, such as the rule that
generally requires a private foundation to distribute at least 5% of the fair
market value of its assets each year, but these limitations rarely pose a
problem for donors with charitable programs in mind. Private foundations are
a great way to remove highly appreciated stock from the donor's estate, but
beware of the limitation that forbids the foundation from holding more than
20% (in some cases 35%) of the voting interest of a corporation or partnership.
For the client looking to leave a lasting legacy, the permanence of a
private foundation will likely be especially attractive as it affords the
donor the opportunity to carry on his or her good work and family name for
generations to come. Also, contributions to a private foundation are
tax-favored, being fully deductible for income tax purposes (but only to the
extent the deductions do not exceed 30% - and in some cases 20% - of the
donor's adjusted gross income) and for gift, estate and generation skipping
tax purposes.
Still, private foundations can be costly to set up and administer, and thus
may not be cost efficient for a smaller fund -- generally less than $1 million.
They are also closely regulated by the IRS, with penalties that can be severe
for violations, and are subject to an excise tax on investment income.
Some affluent clients may opt instead to set up donor-advised funds. Under
this arrangement, a public charity, such as a community foundation, sets up an
account for a donor, accepts the donor's gifts to the account, manages the
money and generally makes distributions to whatever charity or charities the
donor recommends. Some donor-advised funds provide additional services, such
as researching charities, staying abreast of work done in certain charitable
sectors and helping to educate the donor and his or her family about
philanthropy. Other funds merely provide a telephone staff to take donors'
calls when they want to make a distribution. As for investing the funds that
are not distributed, the donor typically may select from a group of mutual
funds, whereas the donor of a private foundation enjoys more flexibility over
investment decisions. Donor advised funds offer greater tax advantages than
private foundations because a donor-advised fund is treated as a public charity.
Therefore, cash gifts to donor advised funds may be fully deducted so long
as they do not exceed 50% of the donor's adjusted gross income, as opposed to
30% for gifts to a private foundation. Stock gifts to a donor-advised fund
also enjoy a tax advantage over stock gifts to a private foundation.
Another alternative to a private foundation is a supporting organization,
an entity that supports a particular public charity or charities. For the donor
who wants continuing control over his or her charitable giving, the typical
supporting organization is more limited than the other three entities because
it exists to support a particular charity or charities and may not make any
distributions to any other charities. On the other hand, a supporting
organization may offer more opportunity for regular interaction with those who
run the charity receiving the distributions. Like the donor-advised fund, a
supporting organization is considered to be a public charity, so it offers
greater tax advantages than a private foundation and is not subject to the
voluminous regulations that govern private foundations. Of course, a supporting
organization is subject to its own considerable set of IRS regulations.
Each entity can be used to research charities, allowing the donor to give
the charity that presents the best prospects for strong returns.
A fourth entity that has gained in popularity over the past few years has
been the charitable lead trust. This type of trust "leads" with distributions
to charities for a set period of time -- either a number of years or during
a named individual's lifetime. Ultimately, the trust distributes to
non-charitable beneficiaries, usually the donor's children or grandchildren.
The charitable lead trust can be a powerful estate planning tool, enabling
the donor to make charitable gifts and also to pass assets to descendants at
reduced gift and estate tax rates. It is most effective when interest rates
are low and was a very popular choice last year, but remains quite useful even
at today's somewhat higher rates.
All four of these entities allow venture philanthropists to maintain a high
degree of involvement with their favored charities. Each can be used to
research charities, allowing the donor to give to the charity that presents
the best prospects for strong returns. If the return on this investment does
not materialize, the venture philanthropist can discontinue the funding and
move on to a new public charity. A foundation, charitable lead trust or
supporting organization with enough funding will also enable the venture
philanthropist to develop a constructive relationship with those who run
the benefited public charities. For instance, a college president may join
the donor and the donor's family in serving on the board of a supporting
organization established to support that college. In contrast, a donor who
writes a check to the college directly has relatively little opportunity to
work with that college president; he or she would likely see the president
once or twice a year at banquets.
But how do these entities allow the newly wealthy to help their family cope
with the emotional and psychological challenges that affluenza brings? For one
thing, the entities provide a way for the family to connect in a shared
enterprise to do good. The private foundation, donor-advised fund or
charitable lead trust all can involve using a family committee to choose which
charities will receive distributions, creating an opportunity for members of
the donor's family to get involved with philanthropy and to work together.
Some even make running the entity their career and treat it as a family
enterprise. Donors bring their children to site visits to see where the
money goes or to lend a hand with the charity's work and the children also
conduct research on their own and help make distribution decisions. These
families are also teaming up with donor-services organizations or financial
institutions to help educate their children about the responsibilities of
wealth, to reinforce a strong value set and avoid the dangers that money
can bring.
In short, many who have experienced sudden wealth have found that
philanthropy conducted through their own charitable entity can be just the
right medicine to ease their transition into a new economic order and a
meliorate some of the unpleasant side effects that can accompany wealth.
Dennis R. Delaney is a lawyer at the Boston firm of Hemenway & Barnes, where
he concentrates on matters involving estate planning, probate and taxation.
Reprinted from Financial Planning, June 2000
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