What is self dealing?

Self dealing is a term that refers to situations where people who are connected with the private foundation derive personal benefits from interacting with the foundation. There are laws against that and serious problems can result both for the donors and other parties as well as for the foundation.

Rules against benefitting personally from a charity have existed in some form for as long as there have been foundations. However, in 1969, Congress established strict official rules against what became self dealing. This happened in response to perceived abuses of foundation insiders.

Among the first things you need to know about this subject is that there are two possible parties to a self dealing situation: the foundation and what is referred to as a disqualified party, or specifically, a disqualified person (“DP”).

What is a disqualified person?

Basically, the term “disqualified person” refers to any person who is not permitted to benefit directly from dealing with the foundation. This includes founders, donors, officers, board members and other insiders of the foundation, along with any person or business who can be classified as a “substantial contributor” to the foundation.

What happens if there is self-dealing?

You may wonder what will happen if the rules are violated. There are penalties, which can be severe, and can range all the way from a 7 ½% tax, to a possible 200% tax, to the loss of the foundation’s tax-exempt status.

So how do you avoid self-dealing?

You basically refrain from engaging in any activities that are not allowed. Unfortunately, this is easier said than done. However, it helps to understand that basically all financial transactions between private foundations and disqualified persons are prohibited. Still, the rules are so numerous that it would be almost impossible to keep track of them all. However, there’s an easier way to manage — by focusing on the exceptions.

What are the main exceptions?

There are two different categories of exceptions, statutory and regulatory exception.

Statutory exceptions are exceptions that are formally included in the statute. Those tend to be “special rules” that were created primarily to allow for transactions that benefit the foundation. Regulatory exceptions are those that are basically accepted by the IRS without being formally included in the statute.

Examples of statutory exceptions include the contributions of indebted property under certain conditions. They also include loans made to the foundation as long as no interest is charged and the money is used to further the foundations tax exempt purpose.

The foundation may also provide a disqualified person with any services, property use, or goods that it also provides the general public.

Are there exceptions that could benefit the donor or the founder?

There are indeed. They include exceptions for payments related to travel, and also reimbursement and “reasonable” compensation for services that are necessary to carry out the foundation’s charitable work.

The latter, of course, provide an opening that allows for targeted travel and activities to be reimbursed — and if the foundation has been created with the right mission, it can allow the founders to pursue a wide range of their interests — and get reimbursed by the foundation.

However, as you can see, with rules that are this complex, it’s generally a very good idea to consult an expert on private foundations before setting up your own foundation. That way, you can ensure that you have the greatest possible access to exceptions, while not running afoul of the many complex rules against self dealing.

Here’s a case study:

Recently, I was working with “Dave” (not his real name). He was an executive at a large Silicon Valley tech company. Part of his compensation package included incentive stock options and also non-qualified options.

Dave had been working “24/7″ for more than five years. He had been sacrificing his personal needs in the process. He had also gone through a particularly nasty. His “plan” was to keep working for another five to ten years.

As I was talking with Dave, I discovered several interesting things about him. He liked kids, though he had none of his own. He also enjoyed sports, particularly golf, although he hadn’t played in years. It had been a very long time since Dave had allowed himself to have fun.

He was very concerned about his current tax issues. Earlier in the year, he had exercised and then held about $1.5 million of company shares of stock. He had been told to expect a tax bill exceeding $500,000.

To find a solution, we completed a Macro Strategic Plan. This is a life plan that includes defining one’s vision and goals, and then proceeds to implementing those objectives by utilizing proper structures and tactics. Here’s how Dave executed part of his Plan:

1) He sold about 70% of his shares of stock, converting enough of the previous potential AMT to ordinary income. This left him with about $1,050,000 of ordinary income, more than enough to offset the potential AMT on the remaining unsold shares.

2) Dave set up a private foundation with himself as the founder.

3) Subsequent to setting up his foundation, Dave contributed $500,000 in cash to the charitable entity.

Since Dave was interested in kids and sports, he set up his own charitable program that helped handicapped children learn how to golf. His foundation could subsidize the costs of special equipment, the time to perform due diligence on the types of courses best suited for handicapped children and subsequent educational programs to integrate physical therapy programs

Implementing the above plan allowed him to offset $500,000 of income. Because that $500,000 was contributed to his foundation, and because Dave was the director of his foundation, it was Dave who controlled how the assets in his foundation were managed.

In addition, Dave was able to combine his interest in children and sports by helping handicapped kids learn how to play golf. By starting his foundation, he managed to resolve his financial issues and at the same time achieve a personal dream as well. He was able to integrate his strategic planning goals with his vision and values.

That’s the beauty of private foundations. They can help you integrate your values and vision into strategic planning. They can also help pay for pursuing your interests and save lots of taxes, all while making a real difference in the world.

If that interests you, click on that yellow field at the top right of this page and get a
free chapter of my guide private foundations for wealth management. If you have questions, I’ll be happy to talk with you. Just call me at 702-247-6809.

Don’t just jump into setting up a private foundation without very careful research and soal searching. It’s a big commitment. You and your family have to be very clear about what’s involved. And then, there’s that most important issue of all: You have to choose the right goals.

What are your true goals in life?

A foundation is forever, at least almost. So you’ll need to be ready to stick with your foundation for the long haul. That’s why it’s so important that you choose the right goals. And those goals must be truly yours — plus they need to have staying power.

What happens if you skip that step? The number one problem I’ve seen with people setting up foundations is that many of them neglect that crucial step and focus strictly on the immediate tax benefits, which can be substantial. Unfortunately, that can easily get in the way of developing a real philanthropic program.

Instead of selecting activities that are truly exciting to them, those people take on programs that they believe are more politically correct. As their enthusiasm wanes, their commitment generally wanes as well.

If you want to avoid having that happen to you and your private family foundation, you should think seriously about what exactly you would really like to accomplish. What are the activities they would like to be able to do as part of your work for the foundation?

Do you enjoy gourmet cooking? Are you interested in exploring other cultures? If so, you should work on finding ways to incorporate those into your foundation by building it around those activities. You could for example set up a foundation that provides international gourmet cooking classes for economically disadvantaged teenagers.

As you pursue activities that are of real interest to you as the founder and your families, your private family foundation becomes a mechanism where you can legally tax leverage and institutionalize your hobbies and passions.

If you get that part right and you have carefully integrated your foundation in your overall life plan, working with it can become so rewarding that the considerable commitment involved won’t be too much of an issue.

To find out more about it, just click on that yellow/golden square at the top right of the page and get your free sample chapter from the ultimate guide to using private foundations for wealth management, written by yours truly. And I’ll be very happy to talk with you if you should have any questions. Just call me at 702-247-6809.

Please mark each of the following statements as either true or false:

1. The main reason for creating a foundation should be the resulting tax savings.
2. Setting up a foundation is similar to setting up a corporation.
3. A private family foundation would make a terrific Christmas present for my family.
4. If I don’t like my foundation anymore, I just close up shop.
5. Done correctly, a foundation can be very rewarding and bring the family closer together.
6. It’s important to focus on political correctness when picking a purpose for the foundation, whether I like the activities involved or not.
7. A private foundation is private, so there are few if any reporting requirements and administrative hassles.

Answers

1. False. Tax savings may be one of the benefits, but you should focus first and foremost on what you’re passionate about and make that the mission of your foundation. To make your foundation work rewarding, you need to find a way to integrate it with your own passions and your life. Many of the tax savings actually come from your being able to pursue your passions on pretax dollars.

2. True. Setting up a foundation is very much like setting up a corporation. In fact, a foundation is generally set up as a corporation. There’s also a significant amount of legal and administrative work that must be done on an ongoing basis.

3. False. A foundation is a huge commitment. Unless your family has been closely involved in the decision making process, and is deeply committed to the foundation, it won’t work. “Surprising” your family with a foundation is a very bad idea.

4. False. A foundation, like a corporation, is a long-term commitment. It becomes an entity of its own. You can’t just start and shut them down at will.

5. True. If your foundation is truly built around your passions and those of your family, and is well integrated into your life plan, it will likely be very rewarding. And working together on a shared passion is bound to result in a closer relationship between you and your family.

6. False. Absolutely not. You must create your foundation around your own passions, not around what you perceive to be the politically correct issue of the moment. If you don’t, you will lose interest very quickly, and your foundation will become a chore, and maybe a nightmare.

7. False. The name notwithstanding, a private foundation is subject to numerous requirements. For example, there are reporting requirements, legal and administrative requirements, as well as requirements about disbursing funds to charities or for charitable activities.

The Results

So what’s your score? If you have answered at least 6-7 questions correctly, you may be ready to take the big step. Be sure to get all the facts, though, so your foundation will become the rewarding experience you deserve.

However, if you answered fewer questions correctly, you should start by getting more information on private foundations. You need to find out how they really work and what is involved.

A private family foundation can do far more for you than just save taxes — and you get to make a real difference in the world. But you have to make sure that you integrate it with your passions — and your life.

If you want to make sure you get all the details right, get your free sample chapter from my ultimate guide to using private foundations for wealth. Look for it in the yellow/golden area at the top right of my blog.

And if you want to know more, feel free to call me at 1-702-247-6809. I’ll be glad to talk with you about whether a private foundation could be right for you.

http://taxprof.typepad.com/taxprof_blog/2009/07/henry-louis-gates.html

First of all, Harvard is a mess (financially and in my opinion ethically regarding being politically correct).

I was aware of the arrest of Gates.  There is plenty of finger pointing in the case; the cop could have remained cool when accused of racial profiling, but Gates lost his cool too and clearly does not know how to act in front of a police officer.

Regarding Henry Louis Gates’ tax problem related to the foundation, 40% of expenses being earmarked for administration is not unusual for a private foundation (it would be unusual for a public charity).

However, giving grants to insiders IS unusual and in my opinion a conflict of interest if not outright self-dealing.  I would not approve any insider gift as it is too easy to interpret it as compensation anyway.

Foundations can be the perfect solution to one of the vexing problems that wealthy families have — how to handle philanthropy the right way.

First, philanthropy can take many forms and once defined can still change from generation to generation. Most wealthy families tend to be giving. It’s part of the whole ethic involved in generating wealth — the idea of giving back. However, there’s usually a problem when this is done without proper planning: Giving back to one’s community becomes a misguided and vague self-imposed duty and not something that is done with joy.

Rather than give to those areas of need that are of a real interest to them, wealthy individuals tend to get hit up with an endless list of requests from charities. The unfortunate result is gifting with no sense of purpose. Even if they find areas of interest in philantropy, they’re rarely able to truly integrate them into their lives in a meaningful way.

This is unfortunate, because in philanthropy lies a tremendous opportunity for integrating the personal with the professional. From a tax perspective, wealthy people benefit greatly from making charitable gifts. So if their giving is coordinated with their personal interests and activities, the result can have a cascading positive effect on the lives the givers as well as the recipients. Bringing one’s charitable mission together in a coordinated way as to completely absorb one’s personal life is the ultimate leverage in planning and can bring order from chaos.

In order to reap the benefits from this process, a plan is essential. And starting a foundation forces the founder to come up with a plan, which starts with a mission statement. Just like the business plan, its for-profit cousin, the mission statement results in clarity as to how time, energy and money will be directed towards causes the founder or family wish to support.

When first meeting with clients in an effort to create that mission statement, I’ve always found it very helpful to start by asking the following question, “If you had all the wealth you needed and found you only had 2 years to live what would you do with the remainder of your life?”

The answers to that question will get them off to a great start with their mission statements. It helps them pinpoint their interests and forces them to come up with a plan on how to integrate them with their lives as well as their foundation.

One particular structure is especially well suited to this integration of life and business:  the private foundation.  There are three major reason why this is so:  A foundation helps preserve personal wealth, which makes it a key ingredient in wealth management planning.  A foundation can also be a vehicle to allow for the deepest expressions of one’s personal interests.

And here’s a third way in which a private foundation helps with that integration.  It can help solve an area of major frustration that a majority of my high net worth clients struggle with.  And that is the challenge that parents face with passing on their values to their children.

I was always been aware of the fact that wealth created in one generation is generally lost or destroyed by the third generation.  More specifically, I have seen the first generation businessman have children who go on to become professionals, and grandchildren, who go on to become artists.  Essentially, the wealth is gone by the third generation.  Rags to riches to rags again.

This means, ironically, that one of the primary challenges faced by families is to pass on money management and entrepreneurial skills.  These skills, generally never taught or learned in school, are invaluable in handing down wisdom, especially as it relates to wealth, to future generations.

A private foundation may be the bridge that narrows the gap between the generations and can help that passage of wisdom to be preserved.  Foundations are also an excellent way to integrate those activities you hold most dear.  And by getting the family involved in the work with the foundation, channels of communication open up, especially with the younger generation, that otherwise might not be as easy to establish.

And that increased level of communication can and should start right from the beginning, as you start working on your mission statement.  As you develop  and implement your mission statement, you have many opportunities to engage others (friends, family and even strangers) and bring them into your inner circle.  This will help with passing on your values to these individuals in a unique and permanent way.

Others can’t help but notice your level of commitment and enterprise in this process.  You will stir curiosity and envy in others.  This learning process can have a particular impact on the young, who will always learn best by example.

There are several key factors that make it work:

A private foundation is essentially a corporation which, once it is completely set up, will be able to get a tax-exempt status.  In addition, the foundation’s corporate form also limits liability to the founders and ensures its longevity.  Moreover, the founders can control the assets inside the private foundation by becoming the directors. All this results in many benefits for the family, including the following:

1. Dollar-for-dollar, there may be income tax deductions for gifts made to the foundation (up to certain limitations).

2. There are no capital gains on the sale of appreciated assets gifted to the foundation.

3. The family benefits by receiving salaries and other corporate reimbursements.

4. As with any corporation, the foundation is perpetual and continues to exist well beyond the lives of the original founders.

5. Any assets gifted to the entity are no longer part of your estate.

The foundation also provides significant additional benefits, particularly as it relates to your lifestyle.  For example, while you could take compensation from the foundation in the form of a salary, you could also take your compensation in the form of fringe benefits (medical, dental, welfare benefits and so on).  You could even elect to take compensation in the form of reimbursements for foundation-related activities.

Among the possibilities are so-called due diligence trips.  Because you are responsible for proper evaluation of any charity and/or cause you decide to support, personal visits might be advised.  With proper documentation (as in any business), you could be legitimately reimbursed for any these expenses you incur during these trips.

The key to maximizing your foundation’s usefulness is to incorporate your interests into your philanthropy.  Rather than thinking of supporting “charity”, think of involving yourselves with your community.  And then… think of your community as the whole world.

For example, Dave indicated he had an interest in children and sports.  So Dave set up his own charitable program that helped handicapped children learn how to golf.  In this way, he was able to purchase special equipment through his foundation.  His foundation also could subsidize the cost of performing due diligence on the types of courses best suited for handicapped children and subsequent educational programs to integrate physical therapy  programs.   He could get very creative where he wanted to focus his activities.  As an example, he could choose  populations that live in any cities he would like to spend time in, either in the US or abroad.

While starting a foundation clearly has many benefits, it does require great care and can get quite tricky.  There are numerous issues that can mean trouble if they’re not handled correctly, from a variety of prohibited transactions to tax ramifications of various activities.  So while it can be an excellent tool, it would be wise to include someone in your planning stages who is familiar with all the aspects of setting up and running foundations and how they related to private wealth management.

Many months ago I was working with “Dave” (not his real name), an executive at one of the large high tech firms in Silicon Valley. Part of his employment package included both incentive stock options as well as non-qualified options.

We discussed what was happening in Dave’s life. He had been working “24/7″ for over five years, sacrificing his personal needs in the process. More recently, he went through a particularly nasty divorce (as if there is any such thing as a friendly divorce), and he was very much in a WIIFM (What’s in this for me) mode in discussing his planning options. In fact, Dave’s planning up to this point were for practical purposes, nil. His “plan” was to keep working for another five to ten years.

In talking with Dave, I discovered a number of interesting things about him. He liked kids, although he had none of his own. He also enjoyed sports, particularly golf although he had not allowed himself the time to enjoy activities outside his career for years. It was clear that it had been many years since Dave had experienced having fun.

A large part of his concerns revolved around his current tax issues. Earlier in the year, he had exercised and then held about $1.5 million of company shares of stock. He had already been advised by his accountant to expect a large combined federal and state income tax bill exceeding $500,000.

To find a solution, we completed a Macro Strategic Plan. This is a life plan that includes defining one’s vision and goals, and then proceeds to implementing those objectives by utilizing proper structures and tactics. Here’s how Dave executed part of his Plan:

* He sold about 70% of his shares of stock, converting enough of the previous potential AMT to ordinary income. This left him with about $1,050,000 of ordinary income, more than enough to offset the potential AMT on the remaining unsold shares. * Dave set up a private foundation with himself as the founder. * Subsequent to setting up his foundation, Dave contributed $500,000 in cash to the charitable entity.

Dave had indicated he had an interest in children and sports. So Dave set up his own charitable program that helped handicapped children learn how to golf. His foundation could subsidize the costs of special equipment, the time to perform due diligence on the types of courses best suited for handicapped children and subsequent educational programs to integrate physical therapy programs

Implementing the above plan allowed him to offset $500,000 of income. Because that $500,000 was contributed to his foundation, and because Dave was the director of his foundation, it was Dave who controlled how the assets in his foundation were managed.

In addition, Dave was able to combine his interest in children and sports by helping handicapped kids learn how to play golf. By starting his foundation, he managed to resolve his financial issues and at the same time achieve a personal dream as well. He was able to integrate his strategic planning goals with his vision and values.

First of all, the biggest difference is that while private foundations are, by definition, private, supporting organizations are public charities. As such, they are not subject to the more restrictive rules and limitations that apply to foundations, specifically ones that don’t actually administer their own programs (called non-operating foundations).

Here is an example: When a cash contribution is made to a supportive organization, it is deductible up to 50% of the donor’s adjusted gross income. In contrast, a cash contribution made to a private foundation can only be deducted up to 30% of the donor’s adjusted gross income.

When you contribute appreciated assets, such as real estate or stock, to a supporting organization, these assets are deductible at full fair market value up to 30% of the donor’s adjusted gross income. In contrast, these same contributions made to a non-operating foundation are only deductible up to 20% of the donor’s adjusted gross income. Not only that, but the deduction is only available if the appreciated asset is “qualified” stock, which essentially means that it consists of publicly trades shares.

In addition, supporting organizations are technically “public” charities. As such, they are subject to the “intermediate sanction” rules that apply to public charities. On the other hand, private foundations are subject to the more onerous private foundation operating rules under Code Sections 4940 through 4945. These draconian rules include the following:

1. A 1% to 2% tax on net investment income; 2. An excise tax if at least 5% or more of the value of the foundation’s investment assets are not distributed annually; 3. An excise tax (which is really nothing more than an income tax in disguise) on “jeopardy investments.” 4. An excise tax on “self-dealing,” which is a very broadly defined set of no-no’s that include prohibitions of transaction between the foundation itself and certain insiders. The prohibited transactions are far reaching and include certain sales, loans, compensation and providing services or goods between the foundation and certain family members, contributors or foundation managers. 5. Excise taxes on taxable expenditures, e.g., payments to persons or entities other than qualified public charities.

Supporting organizations are not subject to all these limitations. So if you’re thinking of setting up a foundation, you may want to learn more about the various options you have, and specifically be sure to include supporting organizations in your considerations.