The Real World of Philanthropic Implementation – Part II
Last week, we discussed the implementation of philanthropic giving plans and the fact that the rote application of conventional wisdom is not always wise. Today, I would like to discuss another “real world” event where the outcome was a bit surprising.
We have a client who is a senior level executive in a firm that is a publicly traded limited liability company (LLC). Over time, he has accumulated a large number of LLC units as part of his compensation package as well as through open market purchases. Because of this, a good deal of his net worth is wrapped up in this one concentrated, highly appreciated investment.
Except for the fact that the security in question is denominated in LLC units rather than shares of common stock, this is not an unusual situation. In the normal case, the executive finds him/herself on the horns of a dilemma, with a diversification problem involving both his/her investments and career path. [1] Diversification is generally called for, but there are numerous issues to consider, especially political (how will the markets react to a senior executive dumping stock) and legal (the timing of any divestment plan). Sell too much and there is the distinct possibility of adversely moving the market. And, more close to home, the capital gain tax on the realized appreciation is not insubstantial [2]. A possible, partial solution to this dilemma, if the executive is so inclined, is to use highly appreciated securities to fund deductible charitable contributions.
The general rule for individuals is that contributions of long term, appreciated securities to public charities are valued at the average fair market value of the securities on the date of contribution, limited in total to 30% of the taxpayer’s adjusted gross income (AGI). This is the case whether or not the securities are publicly traded or privately held. However, in the case of a private foundation (PF), such contributions have further restrictions. Only “qualified appreciated STOCK” (in essence, publicly traded STOCK) qualifies to be valued at fair market value. Any other securities, including LLC units, are valued at tax cost basis.
Therefore, our client, who ideally wanted to give the securities to his PF, was hamstrung by the limitation on the value of the charitable contribution because the securities were not qualified appreciated stock. The loss of the market value deduction made such a choice both uneconomic and irrational.
To maximize the value of the contribution of the LLC units, our client would instead have to make the contribution to a public charity rather than his private foundation. If he had a favorite public charity, let’s say for argument’s sake, the American Cancer Society, then he could contribute the units directly. But in reality, he wanted to fund his PF for use in making future grants to charity, i.e., he wanted to engage in “time shifting” his deductions/grants (the philanthropic equivalent of using the DVR or Tivo on your television set) rather than make a current major gift to one or two public charities. The solution to this problem was to use a donor advised fund (DAF) in place of the PF. DAF’s are, by definition, public charities. They are subject to the larger “30% of AGI” limitation on gifts of long term appreciated securities, and they are not limited to the use of publicly traded stock to get the full FMV valuation. The resulting capital gain from the sale of the LLC units by the DAF escapes taxation, and our client received a full fair market value deduction for his gift while indefinitely postponing the decision about the ultimate disposition of the funds to outside charities. The downside of using a DAF instead of a PF is that there is less flexibility in the DAF as to the ultimate disposition of the assets. Stated another way (and discussed in a previous blog post), the PF enables the client to engage more robustly in the business of philanthropy while the DAF serves as a charitable pocketbook to fund public charities in a more passive way. If this loss of flexibility is not an issue for the client, then the use of the DAF will be a win/win.
This may be a nonconventional solution to the valuation issue of substantial charitable contributions, but it preserves the value of the charitable deduction while not rushing the disbursement of funds to the ultimate charitable beneficiaries.
