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Case History: the Charitable-Giving Blunder
By Roger D. Silk, PhD, CFA
and CEO of Sterling Foundation Management
April 10, 2002 6:30 am ET
Walt, a high-net-worth client, wanted to make a charitable contribution that would offset his taxes. His accountant steered him wrong. Could you have done better?
Will Rogers once said, "It's not the things we don't know that get us into trouble. It's the things we know that ain't so." And sometimes, the simpler the fact, the easier it is to "know" the wrong thing.
The rules writ wrong
Recently, a client, whom I'll call Walt, enjoyed a tremendous income year: he sold a large amount of stock in his company and realized on the order of $50 million. Committed to giving a large sum to charity, Walt consulted his accountant as to the best way to make a charitable contribution.
Apparently, however, Walt's accountant failed to study Will Rogers; the accountant assured Walt that, if he contributed money to his private foundation, his deduction would be limited to 20% of the amount of his donation. Instead, he advised Walt to give the money to a public charity, which would enable him to deduct 50%.
Heeding his accountant's advice, Walt (who became a client only after these events took place) gave $10 million to a donor advised fund. Only later did Walt discover that what his accountant knew, "ain't so."
Walt's accountant, evidently, is not well versed in the rules that apply to charitable deductions. While the full extent of the rules are complex enough to confuse even experts at times, the basics are quite clear. The 20% and 50% limitations do exist. They just don't apply in the way the accountant thought.
The real rules
In any year, an individual can deduct up to a total of 50% of his adjusted gross income (AGI). (Technically, the limit is based on something called the "Contribution Base;" in almost all cases, however, this is the same as AGI.)
For example, with Walt's gross income of $50 million, he could have deducted a maximum of $25 million that year.
What confused Walt's accountant was the fact that two sets of limitations exist: one for public charities, and one for private foundations. In addition, one set of limitations applies for gifts of cash, while another applies for gifts of appreciated property. For public charities, the overall limit of deductibility is 50% of AGI. Of this amount, up to 30% of AGI may be in the form of long-term capital gains property (such as stock held for more than a year).
The deduction limit for contributions of cash to a public charity is 50% of AGI. For gifts of cash to a private foundation, the limit is 30%. So Walt could have donated up to $15 million of cash to his private foundation before a deduction limit kicked in.
So where does the 20% limitation come from? The 20% limit applies for gifts of appreciated publicly traded stock to a private foundation. Therefore, Walt could have deducted his entire $10 million contribution even if he had made it to his private foundation, and even if he had made it in the form of appreciated stock.
It turns out that in Walt's case, there is no scenario under which his deduction would have been limited, given his $50 million AGI and his $10 million gift.
The fallout
Again, the full details of the rules are complex. But the basic rule is that deductions are limited only to the extent that they exceed a given percentage of AGI. And when they are thus limited, they can be carried forward for up to five more years.
In practice, only the most generous philanthropists-or those following bad advice-lose charitable deductions to which they are entitled.
As it happened, Walt got all the tax deductions to which he would have been entitled, so he wasn't really out of pocket. By giving his money to a donor advised fund instead of his own private foundation, however, he lost control without any compensating benefit. Fortunately for Walt's accountant, Walt is generous of mind, and does not plan on exploring whether his accountant committed malpractice.
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