Wealthy individuals and families looking to devote time, energy and significant resources to philanthropy frequently assume that forming a charitable foundation is the best - or only - path available.
A foundation provides a potentially perpetual structure to organise giving and allows for tax efficiency on contribution, and during the life of the foundation. A donor may be presented with the alternative of giving to a charitable donor advised fund or community foundation, but this is not the only choice; there is a growing trend for considering non-charitable nonprofit structures as an alternative to either of these choices. This article looks first at the role of tax incentives in philanthropy, then examines how, and why, a philanthropist might forego, or delay, those incentives by creating a non-charitable philanthropic structure.
Philanthropy And Giving Incentives
Many jurisdictions seek to incentivise philanthropy as a matter of public policy.[i] Incentives and reliefs may look a bit different from jurisdiction to jurisdiction, but as a high-level generalisation, a donor who irrevocably gifts an asset to an organisation that their taxing jurisdiction privileges with 'charitable' status may enjoy some relief against the tax they would otherwise pay had they retained the asset, or else gifted it to a non-charitable beneficiary. In the US, individual donors of cash may take an income tax deduction up to applicable annual limits when gifting to a US tax-exempt organisation; in the UK, the Gift Aid scheme gives relief from UK income and/or capital gains tax for an individual donor of cash, effectively splitting the relief between a higher/additional rate UK donor, and a recipient organisation that is a 'charity' for UK tax purposes.
It should be remembered, however that charitable giving incentives do not improve the donor's net position. Leaving aside abusive schemes cooked up from time to time by the unscrupulous, a donor who benefits from tax relief on a contribution has still, at the end of the day, given away the donation principal itself. If this seems self-evident, it is nevertheless worth emphasising since it is commonplace for press coverage of philanthropy to refer suspiciously to donor 'tax-breaks' as if they somehow enhanced the donor's net worth. If a donor gives to a tax-privileged organisation, they will never be better off, at least financially, than if they had not given at all.
Foundation Vs DAF/CF
A philanthropist who expresses a desire to commit a significant amount to charity, perhaps after the sale of a business, or an inheritance, will often be steered by advisors or peers towards forming a charitable foundation.[ii] If a donor has little appetite for the administration, legal responsibility, or the relative transparency of the foundation option, they may be presented with the alternative of contributing to a charitable structure such as a Donor Advised Fund (DAF) or a Community Foundation (CF). If the decision between a charitable foundation and a DAF/CF is made with the help of a skilled advisor, it will be a multi-factor analysis covering donor preferences across a number of areas, including but certainly not limited to the value a donor has available to commit to philanthropy.
As a simplification, DAFs and CFs are charitable grant makers. They operate by accepting irrevocable contributions from donors, tax-efficiently, and then permit them to make non-binding recommendations as to what charitable causes and projects should be supported in due course. They may also permit donor recommendation as to how the funds should be invested until they are applied in charitable grants. While DAFs are generally cause-and locality-neutral, CFs often operate to benefit a specific locality, identifying local charitable organisations and in many cases helping them to develop capacity for the benefit of the local community.
Tax relief is generally not a point of distinction between forming a foundation on the one hand or contributing to a DAF or CF on the other; both options permit the tax 'event' of the relieved contribution to be separated in time from the philanthropic activity of identifying worthy projects to support. This is contrasted with the position a donor would find themselves in if they were making ad hoc gifts directly to various charities from time to time, choosing the project and then enjoying tax relief at that point in time, and for that particular contribution only.
Alternatives To Charitable Structures
Jurisdictions that incentivise giving invariably impose additional regulation on the organisations to which they grant tax-privileged status. The trade-off is fairly simple in concept, with clear policy underpinnings that most readers would recognise as reasonable – if the public purse is to forego tax revenue as a means of encouraging donors to give to public benefit projects, there must be some way to ensure that the public actually benefits. In the past 40 years however, the level of regulation has grown substantially, particularly in the US, where philanthropic foundations are subject to additional regulation as 'private foundations'.
Over the past decade there has been increasing interest in non-charitable structures. In the US in particular, it is becoming more common to consider the formation of a Limited Liability Company (LLC) as an alternative to forming a private foundation, or in some cases to supplement one. A noncharitable structure may also be used to 'house' a variety of activities, including grant-making, investment, social investment, and advocacy. The donor's vision of 'doing good' may not stop at the boundaries of what is charitable, or they find that the tax relief on offer is too high a price to pay for the increased regulation.
The US 'philanthropy LLC'
As described above, the uncoupling of the tax 'event' from the philanthropic event of determining what to support is generally thought to be one of the chief advantages of a charitable foundation or charitable DAF or CF. However, some prominent examples of philanthropists foregoing the benefits of the foundation structure provide an interesting challenge to the assumption that tax-efficiency at the point of contribution is a priority for all.
When Facebook founder Mark Zuckerberg and his wife, Dr Priscilla Chan, announced the creation of the Chan Zuckerberg Initiative the announcement took the form of a heartfelt letter to their new-born daughter and contained a staggering commitment of their wealth to doing good. However, there was immediately some puzzlement about what exactly had happened, and this turned to criticism in some quarters when it became clear that they had not formed a charitable foundation, but instead had formed an LLC.[iii]
An LLC is a legal vehicle used to organise activities with the benefit of a legal personality and limited liability, like corporations generally, but treated as effectively transparent to its owners for tax purposes. Not all jurisdictions have such a structure - they are notably absent in the UK. For the purposes of philanthropic LLCs, the transparency means that assets can be organised towards giving without claiming any tax relief, and therefore without making the relief/regulation trade-off. Another way to look at this is that the moment where charitable tax relief is enjoyed is delayed – it is not when assets are contributed to the structure as it would be for a foundation; it is later, when assets are disbursed by the LLC in due course to a US tax exempt organisation.
To a certain extent, critiques were inevitable regardless of structure; generous gifts routinely attract sceptical response from the press in relation to the power inherent to being the person who may decide what benefits, and even the reputational uplift that philanthropy has for the donor. Mark Zuckerberg, as a famous, young and inexperienced philanthropist, was always going to be criticised. However, in the case of the Chan Zuckerberg Initiative, there was criticism first that the LLC was some sort of tax dodge (it wasn't), and then far more perceptively, that the structure did not afford any immediate tax relief, but afforded the considerable advantage of freedom – freedom from charitable regulation, freedom to give to political causes, freedom to distribute to any party, or to not distribute at all; freedom from transparency and reporting. The main criticism – the only criticism that makes much sense – is that Zuckerberg benefitted from the 'halo effect' of making a huge and public philanthropic commitment while relinquishing no control over the wealth he committed.
The philanthropist is in something of a no-win situation in the realm of public perception - they either form a traditional foundation and are accused of giving 'to get the tax break', or they give to an LLC, are clear that they are enjoying no tax break on contribution, and are instead accused of sidestepping regulation.
Outside the US: Embracing the non-charitable
At its simplest, a philanthropic LLC is just a means of organising things, and one of its great advantages is the almost unlimited nature of what those 'things' might be. Outside of the US context, while the LLC structure itself might not be available, there is nevertheless interest in setting up structures that are able to do more than a traditional foundation might. A philanthropist in the UK may wish to set up a foundation or a DAF for the portion of their giving that is squarely within the definition of what is charitable, and to give beyond this to projects which they feel are beneficial - advocacy, impact investing, socially beneficial activities that are outside the scope of what is recognised as tax-privileged. One UK option is the Community Interest Company (CIC), a non-charitable corporate legal vehicle with a legal personality and limited liability. It is not tax transparent as an LLC is, and indeed it is taxed like any commercial business is; however, it can structure a programme of activities designed to benefit the community but which are not charitable for one or more reasons. Beyond the CIC, some nonprofit organisations in the UK are formed as simple companies limited by guarantee. Due to the lack of useful tax transparency that a US LLC affords, CICs and non-charitable other companies have not taken off as a popular alternative to a foundation. However, if a philanthropist is well advised, identifying early on that their giving priorities are more expansive than the regulatory confines of what is 'charitable' can allow for a non-traditional approach.
[i] For a fairly comprehensive look at the tax policy concepts, see, OECD (2020), Taxation and Philanthropy, OECD Tax Policy Studies, No. 27, OECD Publishing, Paris, https://doi.org/10.1787/df434a77-en
[ii] The term 'foundation' is widely used in this functional manner to describe an entity that is charitable and which is funded by a single or small number or funders. In the US, a private foundation is a tax classification of one type of tax-exempt organisation, while in the UK, the term foundation has only a colloquial, but no legal, meaning. In some European jurisdictions, meanwhile, the term can refer to an entity with a wholly or partly private non-charitable purpose.
[iii] See for instance, Eisinger, Jesse, "How Mark Zuckerberg’s Altruism Helps Himself, New York Times," December 3, 2015, https://www.nytimes.com/2015/12/04/business/dealbook/how-mark-zuckerbergs-altruism-helps-himself.html
Alana Petraske is a partner in the charities and philanthropy team at international law firm Withers where she advises both charities and their donors on a wide range of legal, fiscal, and regulatory issues. Alana specialises in philanthropy and nonprofit organisations; tax-efficient charitable giving and fundraising; European cross border giving; and global nonprofit groups.