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’Tis the Season for Donating Complex Assets. Yikes!

By Chris Latham December 22, 2014

Charitable donations are a way of life for most wealthy clients. Yet few advisors have mastered the arcane legal and tax rules involved with philanthropy, and holiday time tends to bring a flood of last-minute client inquiries.

High-net-worth and ultra-high-net-worth investors often hold complex assets like private equity or stakes in small businesses, which specialists can fit into giving strategies. Depending on the nature of the gift, donor-advised funds or perpetual trusts may be suitable. These structures can funnel a greater amount to the investor’s charity of choice — as opposed to the IRS — than direct donations can, experts say.

Even though wealthy clients often employ multiple firms to manage their assets, one advisor should be keeping an eye on the big financial picture and coordinating with estate attorneys and accountants, says Ramsay Slugg, the Dallas/Fort Worth-area managing director for U.S. Trust. The Bank of America unit won’t allow its advisors to disclose their individual AUM; altogether, it oversees more than $380 billion.

Most of Slugg’s clients have over $10 million to invest, and he has extensive experience with philanthropic planning. “If two advisors are each telling the client to give large sums from separate accounts, they might not both qualify for tax deductions,” he says. “There are limits on what you can deduct for charity.”

Knowing when to use donor-advised funds and when to use perpetual trusts can affect clients’ finances as well as the scope of their philanthropy, Slugg says.

Ramsay Slugg
Donor-advised funds make sense when clients are more interested in maximizing tax deductions or transferring privately held assets than in directing how nonprofit organizations use their donations, he says. Many financial institutions — including the wirehouses, fund providers and large custodians — offer donor-advised funds to advisors and end clients. Perpetual trusts, by contrast, are a type of private foundation set up by a family or individual to make grants. They can operate long after their founder, and even their founder’s heirs, have died. A perpetual trust allows donors to dictate which social issues it will advocate and who can manage the trust, Slugg says, but rules may differ from state to state.

Advisors inexperienced with gifting private holdings may find it daunting — according to Karla Valas of Fidelity Charitable, which oversees nearly 64,000 donor-advised funds. “We have made the process smooth and not as cumbersome as it may sound,” says Valas. She is a trained tax lawyer and managing director of its complex-asset group, which can work with investors or guide advisors on behalf of clients.

Right now, Valas says, advisors are hustling to make sure clients who want to donate complex assets for a 2014 tax benefit make their gift by Dec. 31. An independent appraiser must assess the value of assets like physical property or interests in limited liability entities, but that paperwork isn’t due until spring, along with income tax returns.

The end of the year is a bad time for clients to find out the governing documents of private shareholder agreements — for example, those involving C-corp or S-corp stock — have wording that makes it difficult for charitable organizations to become shareholders, Valas says. Advisors who coordinate early in the year with clients’ attorneys to review shareholder agreements can form better philanthropic strategies.

A client who wants to sell such shares will probably incur capital gains taxes, and thus may become inclined to donate a portion of the proceeds to charity, she adds. Transferring shares to a donor-advised fund can mitigate those tax liabilities, provided the donation is made before the sale terms are finalized.

Wayward Heirs

The allure of perpetual trusts is that founders can participate in their cherished causes and can use the trust to run organizations like soup kitchens or thrift shops. But unless it’s properly structured, the founder’s heirs may take such an entity far off track. That’s why Michael Whitty of law firm Handler Thayer in Chicago recommends incorporating detailed mission statements into the trust’s bylaws or drafting a stand-alone document that specifies how the trust’s funds should be used over the long term.

Whitty, a CFP, also says a perpetual trust needs a designated “foundation protector” to rein in the board of directors after the founder has died. This person shouldn’t be a family member, as the board is likely to include relatives of the founder — a professional like an attorney or a financial advisor is ideal.

Of course, skipping the “perpetual” part and limiting the trust’s time frame avoids potential problems with future generations. “This means the foundation would have to spend itself out during that time period,” Whitty says. “Several well-known foundations have been set up with a fixed term.”