The issue of FASB Liability and Required Reserves for CGA programs is an advanced one but I encourage newcomers to the field to read this post anyway (I will try to explain it well and this will give you solid background info that will help you further understand gift annuity programs).
The question hit me last week. One of my client's requested a FASB liability report for their auditors and something struck me as wrong in the report given by the investment/administration provider.
Firstly, what is FASB and what is this liability report?
FASB stands for Financial Accounting Standards Board. Basically, auditors and finance/accounting staff of all types of entities try to follow their standards (they are not actually legal standards - a discussion for another post - but we try to play nice with them anyway).
The FASB liability report? In regards to charitable gift annuities, FASB has standards for institutions to determine the value of the "liability" of each gift annuity contract. In other words, the estimated amount needed to pay the donors for the rest of their life expectancies.
This needs explanation because it is a crucial point in understanding gift annuities and the various calculations involved (charitable deduction, booking value, reserves, etc...).
Ask yourself (out loud and slowly) this question: How much money do I need today to pay this annuitant his/her gift annuity for the rest of his/her life (assuming the money is invested and growing at a fixed rate)? We know how much has to be paid: the fixed annuity payment. We know for how long: the rest of his/her life expectancy. The only question is how much investment growth will their be?
Let's make this very practical. 72-year-old donates $10,000 today (Sept. 2009) for a one-life, immediate payment gift annuity of 5.9% (according to the ACGA recommended rate) for his/her life. This imaginary donor will be entitled to receive $590 a year for the rest his/her life - 14.5 years according to the life expectancy table. Without any investment return in the picture, we will pay this donor $8,555. (Don't get side tracked with questions like what if this person gets sick or alternatively eats lots of yogurt - all the accountants want is a projection of what the cost may be TODAY of this gift - who knows what will really happen)
Ask yourself this next question: Do I really need the full $8,555 in the bank to pay this annuity over 14.5 years? Well, if we can assume an investment rate of return - a fixed rate, of course, because anything else would be too difficult to deal with - we really don't need the full $8,555 in our investment account.
If we assume a fixed rate of investment return of, let's say, 3.4%, you would only need $5,671.60 in the bank today (earning 3.4% per year) to pay our annuitant his $8,555 over the next 14 years.
I chose 3.4% because it happens to be the current "Discount Rate" of the month (otherwise known as the Applicable Federal Rate - AFR - issued monthly which charities use for these calculations/assumptions). So, $5,671.60 is the actual FASB liability of this gift, as of today.
As an aside, your planned giving software simply subtracts the liability from the gross gift amount to give you the charitable deduction. In other words, the charitable deduction is the gross gift amount minus the money needed to cover the payments to the donor (based on the assumptions we discussed). Additionally, you should note that the lower the Discount Rate, the more money you need to cover the payments since your you are, in theory, earning less on the investments needed to pay the annuitant.
Now that we have these concepts done, back to my issue.
My question on the FASB liability report, that came from standard planned giving administration software, was this: the report showed that it used the AFR/Discount Rate/assumed rate of investment return of the month that each gift was originally created (not the current rate of assumed returns).
This confused me. I had assumed that a FASB liability report would want to show us what the liability is TODAY (using today's life expectancies and using today's investment assumptions). It turns out, FASB itself apparently lets auditors choose whether they want to calculate the total liability using the original AFRs of the gift annuities or the current AFR, at least this what people tell me.
Problem #1: the liability will be very different between the two "options." Today's rates are very low - 3.4% to be precise. But many gifts in the pools I work with were created when the AFRs were 6% or higher. My thought is this: if you want to make a projection into the future, knowing what we all now know (but didn't dream of a few years ago), I would say the lower expectation of 3.4% makes sense. And, the lower expectation would mean a greater amount of money is needed in the bank to ensure that you have the funds needed to make these payments.
Problem #2: I had assumed that the standard required reserve (for New York in particular) was the FASB liability plus a percentage above it as a further cushion required by New York. Could it be true that we have a choice on how we calculate the FASB liability when we do our New York annual report?
A quick call to the New York State Department of Insurance's head actuary solved this quandary pretty quickly. The answer to the question of whether New York requires you to calculate your reserve by using either the AFR of the original gift date or the current AFR was....NEITHER.
New York State actually has their own assumed rate of return depending on the year of the gift. It has ranged between 5.25% and 5.5% for the past few years. Why? The actuary told me the logic: they are assuming that you (the charity) are purchasing long-term treasury type assets (20 year treasuries), therefore the assumed rate of return should really be based on the typical type of long term bonds you should have purchased in the year of the gift.
This actually made a lot sense a few years ago when New York basically required that the required reserves be invested strictly in things like treasuries. The problem is this: the New York legislature actually changed the investment requirements to a prudent investor standard a few years ago. Now, it is up to the investment manager to invest as they feel appropriate. (for a time in 2008 and 2009, 20 year treasuries dropped below 4% - not great for CGAs - but they are now back over 4% since April and do make sense). See my post on CGA risk for further discussions on investments and risks to CGA programs: http://plannedgift.blogspot.com/2009/06/gift-annuity-risk.html
If New York didn't require an additional percentage of reserves, I would be saying that charities following New York's reserve requirements were under-reserved! They are requiring charities to use relatively high assumed rates of return for their reserve requirements (and artificially lowering the amounts of funds needed to cover the payments - assuming more realistic returns).
Back to FASB and to bring this discussion to a close. Apparently the accounting board doesn't really have an opinion on whether one should base their liability calculations on the assumed rates of investment returns when the CGAs were created or on current rates of return. My thought is that since we use the new life expectancy of the donor, why not use the new investment return assumptions (seems more realistic to me).
In any case, I have been providing accountants and auditors with various reports and calculations for years upon years, and I have no memory of any of them ever coming back to me with a question. In other words, I don't believe the auditors really understand this stuff so they just take what we give them and move on. And, maybe FASB has an opinion on the topic but no one seems to know it.
Wednesday, September 30, 2009
Thursday, September 17, 2009
Comments on ponzi scheming CGA promoter case
I am somewhat surprised that the recent federal appeals court running that I reported on about Robert Dillie (http://plannedgift.blogspot.com/2009/08/important-legal-ruling-impacting.html) hasn't been discussed (besides the republishing of my post on OnPhilanthropy.com and the Planned Giving Design Center).
One of the comments I heard from a colleague was that "it was an old case." Of course, I wanted to scream.
True, the actual facts of the case were old news but the facts have nothing to do with the problems that might be caused by the ruling (published just this summer). It is the ruling that matters; the level of the court (just below the Supreme Court) and their approach to analyzing whether gift annuities are investments or not. It is not even whether the court was correct in its approach or not(it may very well have been wrong).
You have to put yourself into the mind of a plaintiff's attorney. I should know - I was one and I spent several years making people feel miserable (especially older attorneys resting on their laurels). I didn't always need the law or logic on my side - all I needed was an inch. Something to give us standing to start the case, negotiations, etc.. Admittedly, we bluffed our way into many situations. Sometimes we "won" on air - sometimes we got crushed, but we always caused trouble for someone.
One thing that I have learned since joining the non-profit world full time in 1998, charities sit in an extremely weak legal position. Law suits (or even threats of law suits) never go well for them - even with top pro-bono counsel. I can't tell you how many litigation situations I have been involved with where the charity had the better case but opted to settle or not pursue a rightful claim. Maybe it was the potential public relations fallout, maybe charitable executives who didn't want the entanglement, maybe it was fear over costs or staff time.
No matter the reason, charities are sitting ducks in general when faced with potential litigation. Here comes a U.S. Court of Appeals which flat out says that most of the standard gift annuity marketing is our proof that gift annuities are investment products. It is just nice and dry firewood for attorneys of unhappy CGA donors, or worse yet, unhappy children or other beneficiaries of CGA donors.
One of the comments I heard from a colleague was that "it was an old case." Of course, I wanted to scream.
True, the actual facts of the case were old news but the facts have nothing to do with the problems that might be caused by the ruling (published just this summer). It is the ruling that matters; the level of the court (just below the Supreme Court) and their approach to analyzing whether gift annuities are investments or not. It is not even whether the court was correct in its approach or not(it may very well have been wrong).
You have to put yourself into the mind of a plaintiff's attorney. I should know - I was one and I spent several years making people feel miserable (especially older attorneys resting on their laurels). I didn't always need the law or logic on my side - all I needed was an inch. Something to give us standing to start the case, negotiations, etc.. Admittedly, we bluffed our way into many situations. Sometimes we "won" on air - sometimes we got crushed, but we always caused trouble for someone.
One thing that I have learned since joining the non-profit world full time in 1998, charities sit in an extremely weak legal position. Law suits (or even threats of law suits) never go well for them - even with top pro-bono counsel. I can't tell you how many litigation situations I have been involved with where the charity had the better case but opted to settle or not pursue a rightful claim. Maybe it was the potential public relations fallout, maybe charitable executives who didn't want the entanglement, maybe it was fear over costs or staff time.
No matter the reason, charities are sitting ducks in general when faced with potential litigation. Here comes a U.S. Court of Appeals which flat out says that most of the standard gift annuity marketing is our proof that gift annuities are investment products. It is just nice and dry firewood for attorneys of unhappy CGA donors, or worse yet, unhappy children or other beneficiaries of CGA donors.
Monday, September 14, 2009
Commissions for "selling" planned gifts?
A reader of this blog submitted a question to me looking for "examples of compensation agreements that are based on other factors besides the amounts contributed, but still reward success and provide incentives for competence and performance?" In other words, he is looking for one of the shangri la's of planned giving - gazillions of motivated and aggressive professional financial salesmen "selling" planned gifts for your organization (albeit with commissions).
The questioner also mentioned that he represented a non profit that issued charitable gift annuities ("CGA") and paid small commissions based on the amounts contributed. It wasn't clear if his question only involved CGAs or all types of fundraising (for this post - I am focusing only on CGAs and planned gifts).
The email was missing another important fact, which we can make an educated guess at: Who are the "salesmen" of CGAs for the non-profit? If the "salesmen" are in-house fundraisers, the answer could be a bonus system (regardless of the general ethical problems inherent with any bonus system in fundraising). We are forced to assume that the "salesmen" are non-employees - most likely financial advisors.
Instead of vilifying the questioner or the org he represents (which many in the planned giving world might do), let's think about it.
Firstly, if you read my pieces on Robert Dillie - the Ponzi schemer CGA issuer (click here http://plannedgift.blogspot.com/search/label/ponzi%20schemes), one thing you should have noticed is that this guy (through his Mid-America Foundation) issued over $55 million in CGAs to over 400 donors over 5 years. Few charities can come anywhere near that production - and the gifts were to a new foundation with no history of anything!
On the flip side, the Pension Protection Act (PPA) of 2005 very specifically states that for CGAs issuers to be free from SEC regulations, CGAs can not be issued with commissions to salesmen (The practical legal implications of the PPA will be the topic of an upcoming blog post. My wonder while reading the Dillie case was why didn't the court just look at the PPA to determine that the CGAs in question - all sold with commissions - weren't afforded PPA exemptions and were automatically considered investment products? Why the whole analysis in the case when the answer was in a statute?)
Ok, I have to admit, as a consultant, it has crossed my mind that should I ever find myself on my own (I work for a large fundraising consulting firm and previous worked in-house in planned giving after leaving law practice), is there any way I could be compensated based on the gifts closed? This is not about greed on my part, more out of a practical consideration: many charities have actually approached me and wondered if I could help them (but they couldn't afford to pay out of existing cash flow). In other words, charities looking for a "contingency fee agreement" in lieu of standard planned giving consulting fees.
Putting aside the PPA (which basically forbids commissions with CGAs and possibly with other planned giving vehicles), is there any way for someone to get paid for closing planned gifts for an institution on some sort of contingency?
When it comes to planned gifts (CGAs and CRTS in particular), there are options outside of "dreaded" commissions.
CGAs: There are two ways a third party can be paid for helping an organization receive CGAs.
1. Administrative/investment management fees - if a third party provides administrative and/or investment management services for a CGA program, it is perfectly reasonable for the issuing charity to pay a fee out of the CGA pool for those services. Mind you, there needs to be legitimate "services" provided (not just uncovering CGA prospects) and fees for administrative services can not be based on the size of the gifts (rather the fee should be commensurate with the services provided). Not being an expert in SEC regs or investment law, I would throw out a word of caution to those non-investment managers trying to get a piece of the annual basis point fees traditionally taken by investment firms. What I have seen is third party administrators providing real administrative services and charging flat fees per annuities. I have also seen licensed stock brokers providing "free" planned giving consulting services in exchange for investment management fees they will receive when funds come in that the broker manages. As an aside, this is one of the knocks I have on those investment providers that claim to offer free planned giving consulting services: they have no interest in future bequests (no investment management fees from future bequests) but that is where 80% or more of planned giving revenue lies.
2. Reinsurance - If you read my earlier post about CGA risk (http://plannedgift.blogspot.com/2009/06/gift-annuity-risk.html ), you should understand that I loathe the idea of taking any principal out of a CGA pool because I believe charities generally don't understand the long term investment risks and they need to have as much cushion as possible in their CGA pools. That being said, I have become much more attuned to reinsurance. I actually think it should work for most charities, especially smaller and less sophisticated ones. And, reinsurance does open the possibility for commissions on the purchase of the reinsurance contract to a salesman. What the Hartford told me (and they are the only ones that I have found that handle New York CGA reinsurance properly) was that a "consultant" who has a valid life insurance license could receive a commission from the sale of the reinsurance contract. They said there was a percentage range (I can't remember the percentages), not so high, that the charity would see tacked on top of Hartford's own standard sales commission. In the case of reinsurance, at least the long term risk has been mitigated so giving a piece of the pie to a "salesman" isn't that bad.
CRTs: As for charitable remainder trusts ("CRT"), investment management fees are much easier to arrange. CRTs are stand alone vehicles so your charity can choose to let the investment advisor who "sold" the idea to the donor of a CRT manage the investments of the CRT. A word of caution - I have seen many cases where the donor's investment manager kept control over the newly created CRT assets and botched it royally. So again, your investment manager can still receive fees for managing a CRT, whether the charity is trustee or someone else.
Outside of investment management fees, trusteeship is the last refuge for potential fees for a "salesman." Individuals can be appointed trustee of a CRT and most states allow for a trustee to receive a fee for his or her services (usually subject to state law limitations). What if your "salesman" is appointed trustee? Depending on the size of the CRT and state law, that could be a great deal of annual "trailing commissions" for the salesman/trustee.
But the challenges of being CRT trustee are several-fold: 1. A trustee has a fiduciary duty to both the charitable remaindermen and the income beneficiaries - a legal standard of care/responsibility which sane individuals usually would want to avoid except for close relatives; 2. Managing the administration (payouts, tax returns, etc...) for CRTs are not everyday tasks, even for accountants and other financial people, and typically those not specializing in them mess them up miserably (with potential personal liability due to problem #1 in this paragraph); and 3. Overseeing the investment of CRTs, which may sound easy for financial salesmen, is in actuality not so easy and can also land the trustee a big fat law suit. Of course, as trustee, you can do what most charities do when they trustee CRTs - have a bank or trust company do all of the lifting (admin. and investing) for their fees and you sit back and take your fee - but as trustee, you are still legally responsible at the end of the day if there are problems.
In truth, the idea of an individual "salesman" serving as a CRT trustee is plain old nuts - not a good idea unless you are a bank or trust company or a charity with financial expertize in-house.
Back to the questioner's original point - how about rewarding your "salesmen" for the amounts they can bring in. I have no answer because I don't think it works (outside of the investment management fees, administrative fees or reinsurance commissions). Unfortunately for the charitable world, they are missing out on the financial industry's sales-force - which Robert Dillie tapped into and made a mint(and then went to jail). On that thought, maybe it's better to stay away from the whole "financial incentive" push that would come along with a "professional" sales-force.
If you realize that Robert Dillie received $55 million in "gifts" to his fraudulent foundation, you have to wonder how this happened. My guess: hundreds of financial salesmen - with commission incentives in hand - unknowingly pushed a bogus foundation on their clients. It makes me wonder if those salesmen had any duty to their clients to do any due diligence before recommending the "investment"/"gift" to the Mid-America Foundation? Charities are obligated to provide whoever asks a copy of their most recent 990 tax return - so finding out information about the foundation should not have been very difficult. Did these salesmen think to double-check the solvency of the "company" behind the "product" they were selling? If I were someone who lost my gift annuity in the Dillie fraud, I would be looking closely at those salesmen who probably did no due diligence before pushing a fraud on their clients. Of course, the Mid-American Foundation was probably the only one offering commissions to outside sellers of their gift annuities.
The point I am making from the previous paragraph is this: despite the "good" (i.e. dollars) a professional sales-force could do for generating more CGAs and other planned gifts, the "bad" (i.e. unethical practices that lead to law suits) far outweighs the idea. Planned gifts are already ripe for law suits from disgruntled donors - and that is where you have a generally highly ethical "sales-force" in your in-house fundraisers. I can only imagine the problems caused by having the "snake-oil" insurance sales-guy world out there hawking your planned gifts.
Sorry questioner - the commission idea is not a good one for planned giving. There is no magic answer for selling planned gifts with incentives for financial sales professionals.
The questioner also mentioned that he represented a non profit that issued charitable gift annuities ("CGA") and paid small commissions based on the amounts contributed. It wasn't clear if his question only involved CGAs or all types of fundraising (for this post - I am focusing only on CGAs and planned gifts).
The email was missing another important fact, which we can make an educated guess at: Who are the "salesmen" of CGAs for the non-profit? If the "salesmen" are in-house fundraisers, the answer could be a bonus system (regardless of the general ethical problems inherent with any bonus system in fundraising). We are forced to assume that the "salesmen" are non-employees - most likely financial advisors.
Instead of vilifying the questioner or the org he represents (which many in the planned giving world might do), let's think about it.
Firstly, if you read my pieces on Robert Dillie - the Ponzi schemer CGA issuer (click here http://plannedgift.blogspot.com/search/label/ponzi%20schemes), one thing you should have noticed is that this guy (through his Mid-America Foundation) issued over $55 million in CGAs to over 400 donors over 5 years. Few charities can come anywhere near that production - and the gifts were to a new foundation with no history of anything!
On the flip side, the Pension Protection Act (PPA) of 2005 very specifically states that for CGAs issuers to be free from SEC regulations, CGAs can not be issued with commissions to salesmen (The practical legal implications of the PPA will be the topic of an upcoming blog post. My wonder while reading the Dillie case was why didn't the court just look at the PPA to determine that the CGAs in question - all sold with commissions - weren't afforded PPA exemptions and were automatically considered investment products? Why the whole analysis in the case when the answer was in a statute?)
Ok, I have to admit, as a consultant, it has crossed my mind that should I ever find myself on my own (I work for a large fundraising consulting firm and previous worked in-house in planned giving after leaving law practice), is there any way I could be compensated based on the gifts closed? This is not about greed on my part, more out of a practical consideration: many charities have actually approached me and wondered if I could help them (but they couldn't afford to pay out of existing cash flow). In other words, charities looking for a "contingency fee agreement" in lieu of standard planned giving consulting fees.
Putting aside the PPA (which basically forbids commissions with CGAs and possibly with other planned giving vehicles), is there any way for someone to get paid for closing planned gifts for an institution on some sort of contingency?
When it comes to planned gifts (CGAs and CRTS in particular), there are options outside of "dreaded" commissions.
CGAs: There are two ways a third party can be paid for helping an organization receive CGAs.
1. Administrative/investment management fees - if a third party provides administrative and/or investment management services for a CGA program, it is perfectly reasonable for the issuing charity to pay a fee out of the CGA pool for those services. Mind you, there needs to be legitimate "services" provided (not just uncovering CGA prospects) and fees for administrative services can not be based on the size of the gifts (rather the fee should be commensurate with the services provided). Not being an expert in SEC regs or investment law, I would throw out a word of caution to those non-investment managers trying to get a piece of the annual basis point fees traditionally taken by investment firms. What I have seen is third party administrators providing real administrative services and charging flat fees per annuities. I have also seen licensed stock brokers providing "free" planned giving consulting services in exchange for investment management fees they will receive when funds come in that the broker manages. As an aside, this is one of the knocks I have on those investment providers that claim to offer free planned giving consulting services: they have no interest in future bequests (no investment management fees from future bequests) but that is where 80% or more of planned giving revenue lies.
2. Reinsurance - If you read my earlier post about CGA risk (http://plannedgift.blogspot.com/2009/06/gift-annuity-risk.html ), you should understand that I loathe the idea of taking any principal out of a CGA pool because I believe charities generally don't understand the long term investment risks and they need to have as much cushion as possible in their CGA pools. That being said, I have become much more attuned to reinsurance. I actually think it should work for most charities, especially smaller and less sophisticated ones. And, reinsurance does open the possibility for commissions on the purchase of the reinsurance contract to a salesman. What the Hartford told me (and they are the only ones that I have found that handle New York CGA reinsurance properly) was that a "consultant" who has a valid life insurance license could receive a commission from the sale of the reinsurance contract. They said there was a percentage range (I can't remember the percentages), not so high, that the charity would see tacked on top of Hartford's own standard sales commission. In the case of reinsurance, at least the long term risk has been mitigated so giving a piece of the pie to a "salesman" isn't that bad.
CRTs: As for charitable remainder trusts ("CRT"), investment management fees are much easier to arrange. CRTs are stand alone vehicles so your charity can choose to let the investment advisor who "sold" the idea to the donor of a CRT manage the investments of the CRT. A word of caution - I have seen many cases where the donor's investment manager kept control over the newly created CRT assets and botched it royally. So again, your investment manager can still receive fees for managing a CRT, whether the charity is trustee or someone else.
Outside of investment management fees, trusteeship is the last refuge for potential fees for a "salesman." Individuals can be appointed trustee of a CRT and most states allow for a trustee to receive a fee for his or her services (usually subject to state law limitations). What if your "salesman" is appointed trustee? Depending on the size of the CRT and state law, that could be a great deal of annual "trailing commissions" for the salesman/trustee.
But the challenges of being CRT trustee are several-fold: 1. A trustee has a fiduciary duty to both the charitable remaindermen and the income beneficiaries - a legal standard of care/responsibility which sane individuals usually would want to avoid except for close relatives; 2. Managing the administration (payouts, tax returns, etc...) for CRTs are not everyday tasks, even for accountants and other financial people, and typically those not specializing in them mess them up miserably (with potential personal liability due to problem #1 in this paragraph); and 3. Overseeing the investment of CRTs, which may sound easy for financial salesmen, is in actuality not so easy and can also land the trustee a big fat law suit. Of course, as trustee, you can do what most charities do when they trustee CRTs - have a bank or trust company do all of the lifting (admin. and investing) for their fees and you sit back and take your fee - but as trustee, you are still legally responsible at the end of the day if there are problems.
In truth, the idea of an individual "salesman" serving as a CRT trustee is plain old nuts - not a good idea unless you are a bank or trust company or a charity with financial expertize in-house.
Back to the questioner's original point - how about rewarding your "salesmen" for the amounts they can bring in. I have no answer because I don't think it works (outside of the investment management fees, administrative fees or reinsurance commissions). Unfortunately for the charitable world, they are missing out on the financial industry's sales-force - which Robert Dillie tapped into and made a mint(and then went to jail). On that thought, maybe it's better to stay away from the whole "financial incentive" push that would come along with a "professional" sales-force.
If you realize that Robert Dillie received $55 million in "gifts" to his fraudulent foundation, you have to wonder how this happened. My guess: hundreds of financial salesmen - with commission incentives in hand - unknowingly pushed a bogus foundation on their clients. It makes me wonder if those salesmen had any duty to their clients to do any due diligence before recommending the "investment"/"gift" to the Mid-America Foundation? Charities are obligated to provide whoever asks a copy of their most recent 990 tax return - so finding out information about the foundation should not have been very difficult. Did these salesmen think to double-check the solvency of the "company" behind the "product" they were selling? If I were someone who lost my gift annuity in the Dillie fraud, I would be looking closely at those salesmen who probably did no due diligence before pushing a fraud on their clients. Of course, the Mid-American Foundation was probably the only one offering commissions to outside sellers of their gift annuities.
The point I am making from the previous paragraph is this: despite the "good" (i.e. dollars) a professional sales-force could do for generating more CGAs and other planned gifts, the "bad" (i.e. unethical practices that lead to law suits) far outweighs the idea. Planned gifts are already ripe for law suits from disgruntled donors - and that is where you have a generally highly ethical "sales-force" in your in-house fundraisers. I can only imagine the problems caused by having the "snake-oil" insurance sales-guy world out there hawking your planned gifts.
Sorry questioner - the commission idea is not a good one for planned giving. There is no magic answer for selling planned gifts with incentives for financial sales professionals.
Friday, September 11, 2009
Bigger the gift - bigger the scrutiny
Not every attorney will agree with my approach. Here is the theory: the bigger the gift, the more precautions you take. (The question you are supposed to ask is: aren't the precautions the same for all size gifts - at least ones over $500 or $5,000?)
Hear this story and you'll understand.
I received a call from a colleague the other day about accepting a work of art. A university but one that does not have a museum or an art program or even art classes. But, it does have places where it displays art and has regularly accepted works of art as donations in the past (presumably professing a "related use" program so that the donors were entitled to full fair market value deductions for their gifts).
Sounds like they are good to go as far as "related use" (will be discussed below), the first hurdle in accepting a work of art. One fact I left out though: the proposed art donation involves very, very valuable works of art - relatively famous, too. I don't want to give any more details because this one is still in the works. Let's just say a real value of multiple millions - we'll just call it a "Picasso" to give us some perspective.
When the conversation started, I knew enough about the institution to assume that related use would not be a problem and that they could move on towards other complications in dealing with a proposed art gift of any magnitude (which are many).
But, when he said it was a Picasso, I started churning in my mind. And, of course, he also had an art museum expert telling him that it wasn't related use to this institution. (Topic for another blog post - non-lawyers playing lawyer and reaching the wrong conclusions.)
Well, here are some of the IRS private letter rulings on related use mentioned in Tax Economics of Charitable Giving:
Porcelain art related to retirement home's exempt purpose because the objects enhanced the residents' living environment. PLRs 8143029 and 8247062.
Wildlife etchings on public display in state office buildings, ok, too. PLR 8301056.
Displayed stamp collection in University's art gallery plus use in school's art program, ok, too. PLR 8208059
This university in question has some sort of art appreciation or therapeutic thing (not a formal program but something).
Of course, the IRS tells us to rely on private letter rulings at your own risk (like beaches without lifeguards) - the IRS always has the option of ruling any which way they want when they get to your case.
If this had been a run of the mill gift of less than a million, I might have made a different suggestion. But, since this was a "Picasso", I couldn't shake the thought of the IRS art panel reviewing the deduction and somehow this issue of related use coming up.
My suggestion was to hire the best attorney in the area of art contributions you can find before moving forward with the donor. Besides, related use is only an initial issue. Even more daunting is the qualified appraisal (subject of an upcoming blog post). Anything less than having the best counsel reviewing the entire proposed gift would be foolish in this case. Not with a multi-million dollar donor involved and several sticky issues that really could come back to haunt everyone (especially the charity).
The point of this post is this: size and magnitude of a gift makes a big difference in how I advise someone. This institution clearly never ran into issues with accepting art in the past but they also have never had anything of this magnitude. Millions of dollars are at stake in charitable deductions and even though the IRS has never taken issue with art contributions to this institution in the past, nothing is stopping them from taking a hard line this time - especially since it can easily be described as a stretch to claim related use. The private letter rulings seem to point towards this stretch being within reason but you better have an attorney on your side who has been through this before guiding you.
I hope to post updates on this one as it moves forward if my colleague reports back on how it is proceeding.
Just a reminder about what the "related use" rule is (according to the IRS):
A donor is only entitled to a deduction of the "cost basis" (usually the original purchase price) for gifts of "tangible personal property" (i.e. art or collectibles) when "use by the donee is unrelated to the purpose or function constituting the basis for its exemption under section 501." IRS Code Sec. 170(e)(1)(B)(i).
And, let's not forget IRS Code Sec. 170(e)(7) which effectively says that if the charity sells the "related use" tangible personal property gift within three years of the contribution, the gift is retroactively presumed to be "unrelated use" and your donor retroactively loses his or her deduction over the cost basis.
Here are the relevant IRS Regulations on related use, Reg. 1.170A-4(b)(3)(i)and (ii):
Hear this story and you'll understand.
I received a call from a colleague the other day about accepting a work of art. A university but one that does not have a museum or an art program or even art classes. But, it does have places where it displays art and has regularly accepted works of art as donations in the past (presumably professing a "related use" program so that the donors were entitled to full fair market value deductions for their gifts).
Sounds like they are good to go as far as "related use" (will be discussed below), the first hurdle in accepting a work of art. One fact I left out though: the proposed art donation involves very, very valuable works of art - relatively famous, too. I don't want to give any more details because this one is still in the works. Let's just say a real value of multiple millions - we'll just call it a "Picasso" to give us some perspective.
When the conversation started, I knew enough about the institution to assume that related use would not be a problem and that they could move on towards other complications in dealing with a proposed art gift of any magnitude (which are many).
But, when he said it was a Picasso, I started churning in my mind. And, of course, he also had an art museum expert telling him that it wasn't related use to this institution. (Topic for another blog post - non-lawyers playing lawyer and reaching the wrong conclusions.)
Well, here are some of the IRS private letter rulings on related use mentioned in Tax Economics of Charitable Giving:
Porcelain art related to retirement home's exempt purpose because the objects enhanced the residents' living environment. PLRs 8143029 and 8247062.
Wildlife etchings on public display in state office buildings, ok, too. PLR 8301056.
Displayed stamp collection in University's art gallery plus use in school's art program, ok, too. PLR 8208059
This university in question has some sort of art appreciation or therapeutic thing (not a formal program but something).
Of course, the IRS tells us to rely on private letter rulings at your own risk (like beaches without lifeguards) - the IRS always has the option of ruling any which way they want when they get to your case.
If this had been a run of the mill gift of less than a million, I might have made a different suggestion. But, since this was a "Picasso", I couldn't shake the thought of the IRS art panel reviewing the deduction and somehow this issue of related use coming up.
My suggestion was to hire the best attorney in the area of art contributions you can find before moving forward with the donor. Besides, related use is only an initial issue. Even more daunting is the qualified appraisal (subject of an upcoming blog post). Anything less than having the best counsel reviewing the entire proposed gift would be foolish in this case. Not with a multi-million dollar donor involved and several sticky issues that really could come back to haunt everyone (especially the charity).
The point of this post is this: size and magnitude of a gift makes a big difference in how I advise someone. This institution clearly never ran into issues with accepting art in the past but they also have never had anything of this magnitude. Millions of dollars are at stake in charitable deductions and even though the IRS has never taken issue with art contributions to this institution in the past, nothing is stopping them from taking a hard line this time - especially since it can easily be described as a stretch to claim related use. The private letter rulings seem to point towards this stretch being within reason but you better have an attorney on your side who has been through this before guiding you.
I hope to post updates on this one as it moves forward if my colleague reports back on how it is proceeding.
Just a reminder about what the "related use" rule is (according to the IRS):
A donor is only entitled to a deduction of the "cost basis" (usually the original purchase price) for gifts of "tangible personal property" (i.e. art or collectibles) when "use by the donee is unrelated to the purpose or function constituting the basis for its exemption under section 501." IRS Code Sec. 170(e)(1)(B)(i).
And, let's not forget IRS Code Sec. 170(e)(7) which effectively says that if the charity sells the "related use" tangible personal property gift within three years of the contribution, the gift is retroactively presumed to be "unrelated use" and your donor retroactively loses his or her deduction over the cost basis.
Here are the relevant IRS Regulations on related use, Reg. 1.170A-4(b)(3)(i)and (ii):
(3) Unrelated use--(i) In general. The term unrelated use means a use which is unrelated to the purpose or function constituting the basis of the charitable organization's exemption under section 501 or, in the case of a contribution of property to a governmental unit, the use of such property by such unit for other than exclusively public purposes. For example, if a painting contributed to an educational institution is used by that organization for educational purposes by being placed in its library for display and study by art students, the use is not an unrelated use; but if the painting is sold and the proceeds used by the organization for educational purposes, the use of the property is an unrelated use. If furnishings contributed to a charitable organization are used by it in its offices and buildings in the course of carrying out its functions, the use of the property is not an unrelated use. If a set or collection of items of tangible personal property is contributed to a charitable organization or governmental unit, the use of the set or collection is not an unrelated use if the donee sells or otherwise disposes of only an insubstantial portion of the set or collection. The use by a trust of tangible personal property contributed to it for the benefit of a charitable organization is an unrelated use if the use by the trust is one which would have been unrelated if made by the charitable organization.
(ii) Proof of use. For purposes of applying subparagraph (2)(ii) of this paragraph, a taxpayer who makes a charitable contribution of tangible personal property to or for the use of a charitable organization or governmental unit may treat such property as not being put to an unrelated use by the donee if:
(a) He establishes that the property is not in fact put to an unrelated use by the donee, or
(b) At the time of the contribution or at the time the contribution is treated as made, it is reasonable to anticipate that the property will not be put to an unrelated use by the donee. In the case of a contribution of tangible personal property to or for the use of a museum, if the object donated is of a general type normally retained by such museum or other museums for museum purposes, it will be reasonable for the donor to anticipate, unless he has actual knowledge to the contrary, that the object will not be put to an unrelated use by the donee, whether or not the object is later sold or exchanged by the donee.
Wednesday, September 9, 2009
Editorial on Barry Kaye
I missed this editorial in the Palm Beach Post on the Barry Kaye story while on vacation:
http://www.palmbeachpost.com/opinion/content/opinion/epaper/2009/08/24/a12a_fau_edit_0825.html
It is a short piece but it really hits at the heart of the problem with Mr. Kaye and others like him. Just another reason to be cautious when the next "can't miss" deal is presented to your charity.
http://www.palmbeachpost.com/opinion/content/opinion/epaper/2009/08/24/a12a_fau_edit_0825.html
It is a short piece but it really hits at the heart of the problem with Mr. Kaye and others like him. Just another reason to be cautious when the next "can't miss" deal is presented to your charity.
Another gift planning quandry: real estate, the 3 year rule and donor control
As my friends in the planned giving world are finding out, the cost of sharing your "war stories" with me to see a post about your story. This one reminds us about the current post-gift reporting rules but more importantly, finding out the "donor's" real intentions and whether there really is a "gift" here.
This story involves an offer of vacant land where the potential donor says he already has an appraisal for over $500,000. This is a straight gift (no retained income or retained life estate or split interest). Sounds good barring any unforeseen environmental or title issues (not the subject of this post because we are still far away from those issues on this one).
What's the catch?
The "donor" (mind you, this "donor" has actually never given anything to this organization but does profess some admiration) told the development officer that he wants some sort of guarantee that the charity will not undersell the property. In fact, this was why he came to this organization (a message that he will go to another if need be). In my mind, new donors generally don't make first time gifts for $500,000 or more - so this is the catch.
Rule number 1: donor wants a deduction, donor needs to give up control of the property.
My first question is: why does he want a guarantee?
We only speculated but our thoughts turned to the post-gift reporting requirements. For a gift like this (real estate over $5,000), the donor will need a qualified appraisal (a subject for future posts) and the charity will have to sign form 8283 acknowledging receipt of the property and the appraised value.
What is the charity's responsibility when it sells the gifted property? If it is sold within 3 years (yes, 3 years not 2 years - extended in the Pension Protection Act of 06), here is the rule (as quoted directly from "Planned Giving Answers Online" a plug for my friends at EDS):
"Charitable organizations must file Form 8282 (the so-called "tattletale" form) to report to the IRS any sale or other disposition of donated property (other than publicly traded securities) within three years after the contribution if the property was valued at $5,000 or more. When required, Form 8282 must be filed with the IRS within 125 days of the disposition, and there are penalties on charities who fail to comply (up to an annual maximum of $250,000). Charities also must provide a copy of Form 8282 to donors, and additional penalties apply to charities who fail to do so."
Maybe this donor is concerned about his deduction being questioned?
At this point in the conversation, I started getting confused with the special rule for tangible property sold within in 3 years of a gift (an automatic loss of related use and retroactive deduction reduced to cost basis - see http://plannedgift.blogspot.com/2009/07/art-and-other-tangible-property-gifts.html).
Chalk it up to end of day sugar lows. This morning, I scoured my sources and confirmed that real estate gifts do not require "related use" and a sale within 3 years only means that form 8282 has to be filed by the charity - a possible red flag with extreme discrepancies in the valuation verses the actual sale price.
Lastly, we did the obvious and most easily overlooked step: we googled the "donor" and found that he was in the business of real estate. Makes me think he might just have a business motive to see that the property doesn't sell for too low - maybe he's involved in developing the land and doesn't want to see his "gift" undercut the value of the other vacant lots in the area.
At this point, my advice was to get some local volunteers (in the real estate business in the area of the property) to scout the property, do some independent research, and give an informal report as to its marketability.
In the meantime, I would want to meet this donor face to face to get a better feel for the donor. If he really wants to benefit organization, he will have to understand that the charity has to play by the rules (and no legal guarantees of the sale price can be made in writing or otherwise). Business reasons for not seeing the property sell too low can be addressed with split interests or CRTs or other creative arrangements but intent on taking an excessive deduction from a compliant charity is probably not fixable. If the informal real estate committee comes back with a resounding report that the property is worth taking and its likely sale price range makes sense, maybe this goes to the next level (environmental, qualified appraisal, title, etc.).
Stay tuned for part II!
This story involves an offer of vacant land where the potential donor says he already has an appraisal for over $500,000. This is a straight gift (no retained income or retained life estate or split interest). Sounds good barring any unforeseen environmental or title issues (not the subject of this post because we are still far away from those issues on this one).
What's the catch?
The "donor" (mind you, this "donor" has actually never given anything to this organization but does profess some admiration) told the development officer that he wants some sort of guarantee that the charity will not undersell the property. In fact, this was why he came to this organization (a message that he will go to another if need be). In my mind, new donors generally don't make first time gifts for $500,000 or more - so this is the catch.
Rule number 1: donor wants a deduction, donor needs to give up control of the property.
My first question is: why does he want a guarantee?
We only speculated but our thoughts turned to the post-gift reporting requirements. For a gift like this (real estate over $5,000), the donor will need a qualified appraisal (a subject for future posts) and the charity will have to sign form 8283 acknowledging receipt of the property and the appraised value.
What is the charity's responsibility when it sells the gifted property? If it is sold within 3 years (yes, 3 years not 2 years - extended in the Pension Protection Act of 06), here is the rule (as quoted directly from "Planned Giving Answers Online" a plug for my friends at EDS):
"Charitable organizations must file Form 8282 (the so-called "tattletale" form) to report to the IRS any sale or other disposition of donated property (other than publicly traded securities) within three years after the contribution if the property was valued at $5,000 or more. When required, Form 8282 must be filed with the IRS within 125 days of the disposition, and there are penalties on charities who fail to comply (up to an annual maximum of $250,000). Charities also must provide a copy of Form 8282 to donors, and additional penalties apply to charities who fail to do so."
Maybe this donor is concerned about his deduction being questioned?
At this point in the conversation, I started getting confused with the special rule for tangible property sold within in 3 years of a gift (an automatic loss of related use and retroactive deduction reduced to cost basis - see http://plannedgift.blogspot.com/2009/07/art-and-other-tangible-property-gifts.html).
Chalk it up to end of day sugar lows. This morning, I scoured my sources and confirmed that real estate gifts do not require "related use" and a sale within 3 years only means that form 8282 has to be filed by the charity - a possible red flag with extreme discrepancies in the valuation verses the actual sale price.
Lastly, we did the obvious and most easily overlooked step: we googled the "donor" and found that he was in the business of real estate. Makes me think he might just have a business motive to see that the property doesn't sell for too low - maybe he's involved in developing the land and doesn't want to see his "gift" undercut the value of the other vacant lots in the area.
At this point, my advice was to get some local volunteers (in the real estate business in the area of the property) to scout the property, do some independent research, and give an informal report as to its marketability.
In the meantime, I would want to meet this donor face to face to get a better feel for the donor. If he really wants to benefit organization, he will have to understand that the charity has to play by the rules (and no legal guarantees of the sale price can be made in writing or otherwise). Business reasons for not seeing the property sell too low can be addressed with split interests or CRTs or other creative arrangements but intent on taking an excessive deduction from a compliant charity is probably not fixable. If the informal real estate committee comes back with a resounding report that the property is worth taking and its likely sale price range makes sense, maybe this goes to the next level (environmental, qualified appraisal, title, etc.).
Stay tuned for part II!
Tuesday, September 8, 2009
Through the eyes of the gift planner (part 2)
If you didn't see my previous post about a typical gift planning situation click here: http://plannedgift.blogspot.com/2009/07/through-eyes-of-gift-planner.html
Part 2 of the story. Where we left off, we had an attorney asking me to help his client set up both a $1 mil+ CRT and an ILIT (Irrevocable Life Insurance Trust), and there was confusion between who would trustee the gift and so on.
For those experienced in planned giving, the next part should sound familiar. Donor in his mid-60s can not do a charitable remainder annuity trust for much more than 5% due to the low AFR (applicable federal rate). Problem is, the donor wants more (not sure how much more but definitely more than what an annuity trust could offer). And, the donor doesn't want to do a charitable remainder unitrust either. Somewhere in this story, I suspect an insurance salesman (behind the ILIT part) was promising a wonderful plan based on a 6% or higher annuity trust.
So, I ran a calculation to see what a charitable gift annuity would give the donor. Maybe a slightly higher rate and some guaranteed tax free income would help close this $1 million+ gift. The attorney responded to this proposal and was interested. Now my work was cut out for me. I had to somehow get this small organization to agree that it would be better off if its bigger parent org would accept a large CGA on its behalf. Then, I had to somehow get the big org to really understand what it means to accept a $1 million+ CGA and to consider reinsurance over a certain amount. After several calls, emails and memos, I finally thought we had everything set up to go until the last phone call with the CFO (of the smaller charity).
I thought the CFO should know that the larger, parent org would accept the CGA, take on the liability, maybe reinsure part of the gift, and that they should just know what's going on. Then he tells me that he needs to have his own board approve this plan (even though legally there is no liability on their part as they would not be the issuer of the gift annuity). Oh boy. Now I am waiting for the donor's attorney to get back to me and let us know if the donor wants to make the gift and I have a CFO of a related org (and ultimate beneficiary) saying he needs board approval for us to do this gift.
This story just shows you some of the challenges planned giving professionals can face in getting gifts closed. You might need multiple CFOs, Executives, VPs of Development on board and understanding a complex gift - but wavering all along the way. In the meantime, you have a donor and/or the advisor also wavering. And, I wonder what happens when the donor finally says that he/she is ready to make the gift and the intended beneficiary says they still need board approval.
Stay tuned for part 3, if the advisor ever gets back to me.
Part 2 of the story. Where we left off, we had an attorney asking me to help his client set up both a $1 mil+ CRT and an ILIT (Irrevocable Life Insurance Trust), and there was confusion between who would trustee the gift and so on.
For those experienced in planned giving, the next part should sound familiar. Donor in his mid-60s can not do a charitable remainder annuity trust for much more than 5% due to the low AFR (applicable federal rate). Problem is, the donor wants more (not sure how much more but definitely more than what an annuity trust could offer). And, the donor doesn't want to do a charitable remainder unitrust either. Somewhere in this story, I suspect an insurance salesman (behind the ILIT part) was promising a wonderful plan based on a 6% or higher annuity trust.
So, I ran a calculation to see what a charitable gift annuity would give the donor. Maybe a slightly higher rate and some guaranteed tax free income would help close this $1 million+ gift. The attorney responded to this proposal and was interested. Now my work was cut out for me. I had to somehow get this small organization to agree that it would be better off if its bigger parent org would accept a large CGA on its behalf. Then, I had to somehow get the big org to really understand what it means to accept a $1 million+ CGA and to consider reinsurance over a certain amount. After several calls, emails and memos, I finally thought we had everything set up to go until the last phone call with the CFO (of the smaller charity).
I thought the CFO should know that the larger, parent org would accept the CGA, take on the liability, maybe reinsure part of the gift, and that they should just know what's going on. Then he tells me that he needs to have his own board approve this plan (even though legally there is no liability on their part as they would not be the issuer of the gift annuity). Oh boy. Now I am waiting for the donor's attorney to get back to me and let us know if the donor wants to make the gift and I have a CFO of a related org (and ultimate beneficiary) saying he needs board approval for us to do this gift.
This story just shows you some of the challenges planned giving professionals can face in getting gifts closed. You might need multiple CFOs, Executives, VPs of Development on board and understanding a complex gift - but wavering all along the way. In the meantime, you have a donor and/or the advisor also wavering. And, I wonder what happens when the donor finally says that he/she is ready to make the gift and the intended beneficiary says they still need board approval.
Stay tuned for part 3, if the advisor ever gets back to me.
Tuesday, September 1, 2009
More on Charitable Insurance Fiascos
As early readers of this blog have seen, I have a vendetta against the whole scheming charitable-insurance world (for more on this topic, check out posts under Insurance Schemes).
Here is a blog post from from anther site going through how one of the older "can't miss" fads in charitable planning blew up (about 10 years late) on a sorry university:
http://taxprof.typepad.com/taxprof_blog/2009/08/charitable-splitdollar.html
Here is a blog post from from anther site going through how one of the older "can't miss" fads in charitable planning blew up (about 10 years late) on a sorry university:
http://taxprof.typepad.com/taxprof_blog/2009/08/charitable-splitdollar.html
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