The Foundations of Tax-Efficient Giving

This is my most recent On Philanthropy Column for the Financial Times. You can find an archive of past columns here.

The Foundations of Tax-Efficient Giving
By Sean Stannard-Stockton
May 10, 2008: Link to original story on

Many people think of charitable giving as an item in their annual budget, and measure it as a percentage of income. But if you own financial assets such as real estate or a portfolio of stocks and bonds, you should consider an endowment approach to your philanthropy.

Ultra-wealthy philanthropists have long created family foundations, which they fund with a single, large gift. From then on, their charitable giving is done out of the foundation – typically at a rate equal to about 5 per cent of the assets in it. Today, the falling costs of administering a foundation, or the alternative vehicle known as a donor-advised fund, mean that anyone who gives at least $500 a year to charity should consider taking a similar approach.

The tax benefits of endowing your charitable giving are significant. Donors receive an income tax deduction when they make a gift to a private foundation or donor-advised fund. This means that by “front-loading” your charitable giving by shifting assets equal to multiple years of expected donations into a charitable vehicle, you obtain multiple years’ worth of income tax deductions today.

The concept of present value says money received today is worth more than equal amounts delivered in the future (for instance, you would rather I gave you $100 today than promise to pay it in 10 years). By endowing your charitable giving, you will pull the income tax deduction that you would normally receive in the future into the current tax year.

Once in a charitable vehicle, your assets are shielded from taxation (assets in donor-advised funds owe no taxes on capital gains, dividends or interest and assets in foundations pay only a 1-2 per cent “excise tax”). Just as IRAs and 401ks allow individuals to save for retirement in a tax-advantaged account, endowed charitable vehicles give a similar benefit to philanthropists. But if, instead, you keep your assets in a taxable account and make annual gifts to charity, you will have to pay taxes on the capital gains, dividends and interest generated each year.

Endowing your philanthropy makes it much easier to follow the golden rule of tax-smart charitable giving: always donate with your most highly appreciated asset. When you give cash to a charity, you receive an income tax deduction. But when you give an appreciated asset (shares of stock that have gone up in value, for example, or a piece of real estate bought years ago), you receive the same income tax deduction and avoid capital gains tax on the appreciation.

You can also achieve this advantage simply by replacing your annual cash gifts to charity with transfers of appreciated assets. But if you make numerous charitable gifts each year, or your most highly appreciated asset is not something you can easily give fractional interests in (such as real estate), then using a private foundation or donor-advised fund will make following the golden rule much easier.

Using a charitable vehicle also means that you can separate the tax aspects of your giving from the personal and emotional reasons that drive philanthropy. When endowing your giving, you can work with your accountant and financial adviser to select the assets that make the most sense to fund your donations with and to time the gift for the highest financial benefit.

Once your charitable vehicle is funded, the gifts you make to non-profits will not have tax consequences. You will be free to make your donations in the amounts and on the timeline that does the most good in the world.

For maximum financial advantage, you should fund your charitable vehicle with 20 times the amount of your annual giving. However, if your asset base does not allow for a gift of this size, donating any amount greater than one year of giving will enhance your financial situation.

The suggestion of funding with 20 times annual giving comes from the fact that if the assets in your philanthropic vehicle are invested to achieve 8 per cent annual returns, you will be able to make annual grants of 5 per cent (one 20th) of the assets and increase your giving by 3 per cent each year to keep up with inflation. Barring unexpectedly bad investment performance, your charitable vehicle will be able to sustain this level of giving forever, without any additional funding from you.

Most people find that endowing their giving has many non-tax related benefits as well. With a private foundation, for instance, you can name relatives to join the board and make it part of your family tradition to come together and talk about what charitable causes are important to you and why. By organizing your giving, you may also find that you focus it on a smaller set of causes that are deeply important to you. Focused giving is a trait that most philanthropic advisers encourage their clients to adopt to maximize impact.

While at its core philanthropy comes from the heart, by being financially savvy you can reduce the cost of your giving and do more good in the world.

The writer is a principal and director of tactical philanthropy at Ensemble Capital Management and author of the blog