November 11, 2012

Tax Laws Should Discourage Giving to Funds That Waylay Help for Charities

It’s a sad and troubling sign for America’s charities that the No. 2 spot on The Chronicle’s annual ranking of the 400 nonprofits that had raised the most money was snared by Fidelity Charitable.

Fidelity Charitable is not like most of the other nonprofits at the top of the list: United Way, Salvation Army, and CARE. Fidelity is what we might call a NINO—Nonprofit in Name Only. It provides no services to the community other than to gather and manage money in accounts that the donors can eventually distribute to charities of their choice.

That money can stay locked up in a Fidelity account indefinitely, because the federal government doesn’t set any rules for how much should be distributed annually from the over 50,000 donor-advised funds that Fidelity Charitable manages.

At a time when, according to “Giving USA,” overall inflation-adjusted charitable giving is flat, that means a great deal of money is being diverted from human-service organizations, schools, arts programs, and conservation groups, essentially to be warehoused for future use.

Nonprofits of all kinds must recognize that Fidelity’s growth is coming at their expense—and start to push for changes in the tax code that encourage people to give directly to nonprofits that are providing vital services and advocacy in their communities.

It would be worrisome enough if Fidelity were alone in taking such a big piece of the giving pie.

But other donor-advised funds are also growing far faster than virtually any other kind of nonprofit in America. In 2011, contributions to the three largest commercial gift funds rose 77 percent, The Chronicle noted in its annual study of such entities.

Donor-advised funds are gaining popularity because they are such a good deal for the donors, who get a charitable deduction upfront and can then designate the money to individual charities at their leisure.

The tax benefits—particularly for contributions of real estate, business holdings, and other complex assets—are more generous than for private foundations. And the structure is far simpler than creating one’s own private foundation.

But donor-advised funds are gaining rapidly for other reasons, too. One is the financial incentive for the donors’ brokers.

Though commissions in the financial world can be opaque, the truth is that financial advisers frequently draw fees when they persuade clients to create a donor-advised fund. That’s obviously not the case when a donor makes an outright gift to a charity.

And because the adviser often continues to draw fees based on the balance in the donor-advised fund, he or she has little incentive to encourage donors to give money away at a rapid clip.

The marketing savvy and technological sophistication of commercial donor-advised funds have also fueled their growth.

Clients of financial institutions see marketing messages for advised funds when they go online to make their regular business transactions. And because the commercial gift funds make it so easy to disburse grants—one click and the check is on its way—it’s easy to understand why donors are so easily seduced.

The whole idea that a company would offer donor-advised funds is relatively new.

For several decades, the primary organizations that housed donor-advised funds were community foundations and religious denominations. But in 1992, Fidelity Investments established the Fidelity Charitable Gift Fund.

Now known as Fidelity Charitable, the organization is considered a charity under Section 501(c)(3) of the Internal Revenue Code, a status that many of us in the nonprofit world questioned from the start.

It has a board of directors distinct from Fidelity Investments, though all of the money is invested in Fidelity mutual funds (and thus earns Fidelity Investments fee income).

Dozens of other for-profit corporations soon followed Fidelity’s example and got into the donor-advised-fund business.

Today the three largest are Fidelity, Schwab, and Vanguard. They are huge: Schwab ranks No. 12 on The Chronicle’s Philanthropy 400, while Vanguard is No 22. To put this in perspective, Harvard University ranks No 20, and Yale is 21.

By 2011, gifts to donor-advised funds grew to the point at which, according to figures from “Giving USA” and the National Philanthropic Trust, they captured 4.4 percent of all charitable giving from individuals, and the trend is pointing upward.

The commercial gift funds are becoming increasingly aggressive in soliciting contributions. For example, Fidelity is now pitching directly to estate planners about the fund’s ability to accept assets such as real estate and closely held stock. Will donor-advised funds soom account for 10 percent of annual giving? 20 percent?

Defenders of donor-advised funds say they are a boon for charitable giving and nonprofits. They say that donor-advised funds promote philanthropy by making it easy. They point out that, on average, donor-advised funds distribute a higher percentage of their assets annually than do private foundations. But the fact is that more money is going into donor-advised funds than is going out. They’re a net drain to nonprofits.

Above all, what’s most disturbing is that federal tax policy doesn’t require the funds to distribute even a single penny in a given year.

I’m a relatively lonely voice in publicly criticizing donor-advised funds, but I’m in a chorus of millions singing for an overhaul of the tax system. If that happens, Congress should tighten the rules for deductions to encourage gifts that provide immediate benefit to society.

Perhaps the full deduction should be offered only for donations to groups providing direct services, while people who give to donor-advised funds or their own foundations would receive only a partial deduction. Also, lawmakers could demand that each fund be required to distribute a significant sum each year, or perhaps spend all their money over a specific time period.

For example, Ray D. Madoff, a Boston College Law School professor who has been a prominent critic of donor-advised funds, advocates a seven-year window for spending funds.

These ideas will no doubt agitate many people in philanthropy, particularly those at the commercial gift funds. But if revised public policies produce additional badly needed money to relieve hunger, homelessness, illiteracy, poverty, and environmental disaster, then this is a fight worth having.

Alan M. Cantor is a consultant to community-based nonprofits and donors.