Madoff Wants Even More From Private Foundations
Boston College’s Ray Madoff is not related to Bernie. The headline is just a giant blog Ponzi scheme for more clicks.
Two notable opposite events happened in the world of private foundations, and viewed together they demonstrate the stark policy contrasts and perhaps the unjustified subsidies enjoyed by wealthy folk. In Baltimore, the Lillian Holofcener Foundation gave away all of its assets to an operating charity:
In a rare move for philanthropy, Adam Holofcener and his family emptied their foundation’s coffers and gave $1 million — nearly all the money it had left to give — to support Lisa Snowden-McCray’s dream: a free newspaper staffed by Black editors and writers in Baltimore to provide news primarily for the city’s Black residents. Snowden-McCray, a journalist who worked at the city’s major daily, the Sun, and the now-shuttered alternative weekly, the Baltimore City Paper, knew Holofcener, a lawyer-activist who represented artists, from the progressive orbit they both inhabited. She and Brandon Soderberg, a former Baltimore City paper editor, had tried to launch a new paper, the Baltimore Beat, but the publishing company that supported it pulled the plug. In 2020, Holofcener casually asked the two if they had any plans to resuscitate the publication. After some more conversation, he surprised the two with an offer. The foundation, which he says had been making a “hodge-podge” of unfocused grants for decades, would essentially go out of business after giving the Beat $1 million.
His family’s Lillian Holofcener Charitable Foundation joins a growing number of grant makers that have put time limits on their existence so they can direct more money immediately to charities. Not only did the Holofcener foundation decide to give away just about every cent it had but Adam Holofcener, 36, executive director of Maryland Volunteer Lawyers for the Arts, and the other relatives on the board did something even more rare by dedicating almost all of its remaining assets to a single project.
In New York, by contrast, Peter Buck the late co-founder of Subway Sandwiches, donated his half of Subway to The Buck Foundation. The donation is worth $5 billion, generates significant tax advantages, and will be managed by the foundation on which the Bucks — Topher, Andrew, Diane, David, Douglas, Nina and Leland, and Zoe — compose the Board of Directors:
Buck formed the Peter and Carmen Lucia Buck Foundation with his wife, Carmen, in 1999 to manage the couple’s philanthropic efforts. The foundation’s mission is to give “motivated people the tools they need to help themselves,” according to the foundation’s website. This bequest has been in the works for more than a decade, according to the foundation. Notably, its largest donations went toward education. The foundation in 2022 donated $1.5 million to Capital Prepatory Schools, $1 million to Columbia University, $2.4 million to Elevate Charter Schools, $1 million to Excellence Community Schools, $1.2 million to Doctors Without Borders, $1.25 million to Northeast Charter Schools Network and $1.6 million to Third Sector New England. “This gift will allow the foundation to greatly expand its philanthropic endeavors and impact many more lives, especially our work to create educational opportunities for all students, work Dr. Buck cared so deeply about,” Carrie Schindele, the foundation’s executive director, said in a statement. The foundation reported its fair market value of all assets at $592.5 million in its Form 990-PF to the Internal Revenue Service in 2021. It reported just over $27 million in donations. Notably, its largest donations went toward education. The foundation in 2022 donated $1.5 million.
So lets go back to the future. Here is old Section 504 under the 1950 Revenue Act:
“SEC. 3814. DENIAL OF EXEMPTION UNDER SECTION 101(6) IN THE CASE OF CERTAIN ORGANIZATIONS ACCUMULATING INCOME.
“In the case of an organization described in section 101 (6) to which section 3813 is applicable if the amounts accumulated out of income during the taxable year or any prior taxable year and not actually paid out by the end of the taxable year-
“(1) are unreasonable in amount or duration in order to carry out the charitable, educational or other purpose or function constituting the basis for such organization’s exemption under section 101 (6); or
. . . exemption under section 101 (6) shall be denied for the taxable year.”
Its pretty much agreed that old 504 didn’t force meaningful minimum payouts. A 1965 Treasury Department Report determined that the provision didn’t ensure that what Congress intended — that private foundations pay their incomes to charity currently.
Contributions to nonoperating foundations, however, are often neither devoted to an active charitable program nor distributed to operating charities. Instead, such contributions are often retained by the foundation as principal, to be used to generate income which is to be distributed to operating charities as it is received. In such cases there is usually a significant lag between the time of the contribution, with its immediate effect upon tax revenues, and the time when the public benefits by having an equivalent amount of funds devoted to charitable activities. Where, however, a nonoperating foundation invests its funds in assets which do not generate a reasonable amount of current income or retains the income generated by its investments (except, for situations in which income is accumulated for a specific charitable purpose), the justification for the present treatment does not apply. In such a case the need for corrective action is evident.
The Report thus recommended that private foundations be required to distribute their income on a reasonably current basis:
(a) Distribution of realized income.-Because of the inadequacy of existing law and the Service’s difficulty in administering the present permissive rules, it would be appropriate to adopt a rule which would give both taxpayers and the Service workable objective standards. It is therefore recommended that all private nonoperating foundations be required to distribute all of their current net income on a reasonably current basis. Such a requirement would insure that the interposition of a private nonoperating foundation between the donor and charitable activities will not result in undue delay in the transmission of benefits to their charitable destination. . . . Under this proposal a private nonoperating foundation would generally be required to expend the full amount of its current net income by the end of the year following the year such income is received.
What we got from this report was IRC 4942, which assumes a minimum return on dormant assets — assets not used in a charitable activity — of 5%, and couples that assumption with a requirement that the 5% be distributed to an operating charity. The law does not explicitly require a distribution of endowment or wealth (the requirement is an imposition on income, not wealth), but I suppose if a private foundation’s return is less than 5% of dormant assets, it might have to distribute some of the dormant assets to meet minimum distribution requirements. Correct me if I am wrong. I gotta blog to write here, ain’t nobody got time for details or pinpoint citations.
Ray argues in a 2020 Pittsburgh Tax Review article that the 5% rule is fairly useless. She calls it a mere “fig leaf” apparently because it does not cover very much at all:
Judging by appearances, the 5% rule is stronger than ever. For at least fifteen years there have been no Congressional proposals or lobbying efforts to change the 5% payout rule.2 Moreover, the 5% payout rule has become widely accepted and widely touted (by the foundation world, among others) as a reasonable compromise that allows private foundations to exist in perpetuity while ensuring that a portion of their funds be put to current charitable use. Even more importantly, the 5% payout rule has served to legitimate private foundations to the public, by giving foundations a readily recognized role of providing steady sources of capital to nonprofits. All of these things make it seem that the 5% payout rule is well established as both a practical and theoretical matter.
However, despite the apparently robust nature of the 5% payout rule, this Article argues that the 5% payout rule operates more as a fig leaf than as a meaningful control on private foundation spending. Analyzing how the rule operates fifty years after its enactment, it has become increasingly evident that the meaning of the term “payout” is so elastic that the rule cannot be relied upon to fulfill its stated purpose of ensuring the current flow of dollars to charitable activities. In particular, the ability to meet payout requirements by: (1) paying unlimited administrative expenses of the foundation (including salaries and travel expenses for family members), (2) making unlimited contributions to donor-advised funds (which themselves have no further payout requirement), and (3) making investments (provided they qualify as “program-related investments”) give private foundations ample opportunity to skirt the purpose, while still fulfilling the letter, of the law governing payout.
Personally, I think there should be a statute of limitations on private foundation payouts, not just for paying income but also regarding endowment, for a couple of reasons. Like the Holofcener Foundation, all foundations should go out of business in the near rather than far term. First, the charitable contribution deduction (or its estate tax equivalent) is based on the entire endowment, not 5% of the yield. The public should get a yield equal to the entire endowment, the total amount deducted. I admit a credible argument that the entire amount is in fact devoted to public good, at least theoretically, so the deduction should be equal to the entire endowment. If present value equals future income, then we are getting full benefit from the endowment if all income must be paid soon. Blah, blah, blah.
My bigger problem is that the entire amount of wealth — the whole hog — is forever devoted to public good, never to return to the market economy. The indefinite dedication to the public good bothers me; I know that sounds crazy, but hear me out. If we really believe that the market provides the most goods for the most people, we should not permanently remove huge chunks of capital from that market where it would otherwise navigate to its highest and best use. At some point, the capital — the endowment — should be expensed (not capitalized) for charitable purposes. Only in that circumstance is there a high probability that the wealth will eventually find its way back into the private economy where it can do the most good for the most people. Maybe make somebody else rich who can recycle the wealth back into charity.
Not only that, but without a statute of limitations on private foundations, one family usually exercises outsized control over a sector designed to spread public policy-making power amongst the grass and the roots, thereby allowing for a wide diversity of [funded] views regarding what is the public good. As it stands, one huge chunk of wealth is forever dedicated towards public good, sure enough. But it is a public good defined by a small group of ultra wealthy charitable oligarchs who can thereby demand a certain conception of the public good. Soon enough, the public good will be funded by reference to small cadre of out of touch folks who like seeing their names on buildings.
By the way, I really hate it when scholars steal my brilliance, thereby depriving me and this blog of a MacArthur Genius grant. Here is what Ray “I’m Not Bernie” Madoff said about my idea when it was her idea long before it was my idea:
Take the topic of taxes, for instance. Yes, Madoff argues, your tax bill could be less if more than $1 trillion of assets weren’t parked in private foundations and university endowments largely protected from Uncle Sam. “It is important that we revisit the rules to see if they are producing the result we want,” says Madoff, who has found that, well, they aren’t. Instead, too much money is locked away, much of it spent for dubious reasons (Leona Helmsley’s $8 billion for dogs, for example), not at all, or on causes dictated undemocratically by the dead or the very wealthy, all tax subsidized.
darryll jones