Boost Charitable Giving through Partnerships
How can you help donors make more sizable charitable contributions each year to help their favorite charities while boosting their own tax deductions? If your client has a family limited partnership (FLP) or limited liability company (LLC), you may be able to help him or her leverage this asset for larger gifts. With an FLP or LLC, a donor can give a preferred partnership interest to charity while the family retains the other interests.
This kind of gift is especially favorable for charitably minded individuals who are looking for a large charitable tax deduction to offset income in a particular year. The donor receives an up-front deduction, and the partnership benefits from annual charitable deductions that can offset partnership income. The charity benefits because the preferred interest entitles the recipient (the charity) to guaranteed payments over the life of the partnership.
How It Works
Instead of giving a cash gift of $10,000 a year out-of-pocket and claiming a $10,000 tax deduction, a donor funds a partnership with securities. If an appraisal determines that the current fair market value of a gift providing $10,000 a year to the charity for the anticipated period of time is $100,000, then the donor can claim an immediate one-time tax deduction of $100,000. This is an accelerated deduction representing the total value of the gift to charity.
The donor cannot take a personal charitable deduction for the guaranteed annual payment — that deduction goes only to the partnership. But the donor also does not have to recognize as income — and pay tax on — the income shifted to the charity. In other words, says Richard Oshins, a trusts and estates attorney in Las Vegas, “The money paid to charity is tax neutral.”
With its built-in guarantee, the preferred interest is like preferred stock, says Oshins. The interests retained by the family are more like common stock in that the family receives any earnings in excess of the guarantee.
The ongoing gift — the annual stream of income to the charity — comes from income earned by the partnership. This ongoing gift generates annual deductions for the partnership. But it’s also important to note that under Internal Revenue Code section 707(c) the guaranteed amount must be paid to the charity even if the partnership fails to earn enough income in a given year.
Watch Out for Sham Arrangements
The partnerships that Oshins describes are legitimate under Internal Revenue Code section 707(c) for two reasons: First, something of substantial value is actually being given to charity. Second, as he put it in an April 2001 article in the CCH Estate Planning Review, “The entity is structured so that it cannot be terminated without the consent of the charity.”
But advisors should be careful in assessing promotions of similar-sounding arrangements. Many other versions linking family limited partnerships with charitable donations (so-called Char-FLPs) are shams — or in Oshin’s words, “a shell game” — and are likely to be challenged by the IRS.
“If done right, charitable FLPs can be a viable strategy,” says Paul Frimmer, a partner in the law firm of Irell & Manella, LLP, in Los Angeles, “but they are often abused.” As a result, the IRS is highly suspicious of the transactions.
To be done right, there must be an arm’s-length transaction designed primarily to benefit the charity rather than to produce tax benefits for the donor. The gift of a partnership interest, says Stephan R. Leimberg, an attorney and nationally recognized financial-planning expert in Bryn Mawr, Pennsylvania, should be “outright, not part of a prearranged plan designed to (a) wash capital gains, (b) overvalue the deduction, or (c) buy the stock back from the charity at an undervalued price.”
In Leimberg’s Estate Planning Newsletter, he suggests that carefully drafted arrangements may work — but only if all of the following facts are in place:
• Valuations are “totally and demonstrably at arm’s length and for fair market value” and discounts, if any, are not excessive.
• Charities are not forced to sell back their interests.
• Management fees paid to the donor and family members are reasonable and appropriate.
• The arrangement does not provide excessive benefit to the donor at the expense of the charity.
Perhaps most important, as Leimberg puts it, “The net intent and result is much more of a gift to charity than a disguised gratuitous shift of wealth to the donor’s children and grandchildren.”
Straightforward arrangements that benefit charities while meeting these guidelines are reasonably likely to pass muster with the IRS. However, with the IRS increasing its scrutiny of all
FLPs, advisors need to be wary of charitable donations that give even the appearance of being abusive tax shelters. With careful planning, savvy advisors can help their clients establish legitimate charitable FLPs that benefit both favorite cause and donor for years.
Grace W. Weinstein is a freelance writer based in Englewood, New Jersey.
Copyright CFA, 2004
Used with permission