Just Found A Foundation. For The Tax.

For the past few weeks, I’ve been eating mince pies.

Because I love mince pies.

And as I keep telling people, when I eat a mince pie, “It’s the most wonderful time of the year” starts playing in my brain.

I blame the brandy.

Mince pies always come back onto the shelves (at least here South Africa) in early November. And as they land, you know that the festivities are just beginning. It’s the herald of end-of-year functions and Secret Santas and pre-Christmas dinners. Work starts to wind down; email signatures get a dash of tinsel; leave application forms get filled out. It’s bonus time. And holiday time. And release time for new music and new books. There’s usually a new Peter Jackson film to look forward to. And turkey sandwiches with cranberries and stuffing.

And it will officially begin with Thanksgiving Thursday this week*. Followed by Giving Tuesday next week.
*I know it’s not a South African holiday – but I never pass up an opportunity to roast a Turducken. And Thanksgiving is such a great-sounding holiday.

In the lead-up to Thanksgiving, Black Friday and Giving Tuesday, all the finance/economics podcasts are freshly themed with season-appropriate topics. Three main ones:

The economic crazy of gift-giving
The best way to do charity
Sale prices are all in your head.

I’ve covered most of that before:

But then I listened to “The Philanthropy Edition” of the Slate Money podcast, which went in a slightly different direction on the charitable front. And mainly, they were questioning the benefit of tax-deductible donations. Because if you’re going to give money to a cause, how much difference does a tax deduction really make?

And actually, why would donations ever be made “for tax reasons”?

The argument has always seemed wildly-flawed to me. Example:

My tax rate is 20%.
Let’s say that I donate $100,000, which is tax-deductible.
So I get a $20,000 tax deduction.
But I’m still $100,000 short.
I just paid $100,000 for a $20,000 tax deduction.
Seems like a terrible bargain.

Is the theory that without the tax deduction I would only have donated $80,000? Leaving the charity $20,000 out of pocket?

In which case, the whole story of tax-deductible donations is simply a government subsidy for charity, without the administrative burden of having to collect the tax and then pay it across.

Which still seems like a really curious thing…

Why The Wealthy Start Foundations

Good news: after some trawling, I’ve another explanation for why foundations are so hot right now.

Here’s how a foundation works:

It’s registered as tax-exempt.
It receives tax-deductible donations, which become part of the foundation’s endowment.
It has to pay out a minimum 5% of its assets each year.
That 5% payout is made up of charitable distributions and expenses.
Those expenses can include the salaries of the family members that run the foundation.

So if you’re being taxed in the top income bracket at 40%, you could do one of two things:

Pay the 40% tax; or
Donate half of your income to the foundation for free, and drop your effective tax rate down to 20% immediately. The foundation can pay your family members for their “services”, as well as cover some of the family “expenses” (~~parties~~ fundraisers, ~~holidays~~ trips abroad on behalf of the foundation’s initiatives, etc). The endowment can be invested and earn returns, creating a passive income stream to support your errant offspring. And at the most, you’ll have to give out 5% of the asset value each year (if you can’t come up with any family members to pay), topping your effective tax rate out at 22.5%*.
*40% of the 50% you keep + 5% of the 50% endowed = 22.5% of the full income.

Perhaps it seems bizarre – to place your assets into the hands of an entity that is not you. But the wealthy do it all the time: placing their money into trusts and offshore vehicles and so on, where they technically don’t own it and it’s technically not in their hands.

And that’s how you make charity work for you.

Of course, it does mean that foundations will tend to give out a maximum of 5% of their endowment each year – which does call into question whether they’re actually effective (sometimes, you need the big cash injection to make a difference, not a dribble of what the foundation has to distribute in order to keep their tax-exempt status).

But I suppose some money is better than no money at all? And at least the libertarian folk can rest easy in the knowledge that there is some autonomy for the rich in how their otherwise-tax dollars are being spent…

Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.