For decades (well actually more than half a century), the wealthy easily and legally avoids income taxes with their private charity. The tax term for a private charity is “private foundation.” All of us heard of the Clinton Foundation. The Clintons’ did a impressive job avoiding taxes with their private charity.
Presumably, the tax law has a big penalty for what is called self-dealing transactions with your charity. However, the IRS has exceptions… great exceptions.
This blog will show you how the tax law was created to help you legally avoid taxes with your private charity. The IRS started a “streamline” process for a small private charity to obtain their tax exemption.
The rules regarding self-dealing are found in IRS regulations. Keep in mind that the IRS is an agency of the White House. Why? The Executive Branch (one of our three branches of government, along with the legislature and the courts) is responsible for the IRS. It appoints the IRS commissioner.
The wealthy in both parties have their private charities. It is not just Republicans. For example, the Clinton Foundation is often in the news. The Foundation does great works, and it keeps the Clinton name is the public eye.
Bill Gates is another role model. While the Gates Foundation promotes farming in Africa with Monsanto GMO foods seeds, Bill Gates invests in Monsanto. Your foundation can have symmetry with your business or investment.
Another way is speaker fees or personal service fees. When someone pays a foundation, you do not have taxable income unless it is clearly instead of an existing invoice.
For example, pretend that I have a private charity. Its mission is to provide education on tax law (such as maintaining a blog like this one). You want to learn how to avoid tax with an offshore trust. You could sponsor my charity to make a report by making a donation. Of course, my charity would write a report and post it to this blog.
Universities often received a grant from a profit making business to undertake a study that includes their product. When the study is released, it bolsters the product.
Okay, back to the tax law. When the start your private charity, the tax law gives you a tax deduction for your “charitable contribution”.
So, let’s say I have an extra $100,000. I also live in California where the combine U.S. and state tax bracket is 53% (we call this the sunshine tax). And my extra $100,000 is Apple stock that purchased a long long, time ago. In my example, my gain on the sale of my Apple stock is $50,000.
If I sell the stock the U.S. & California tax is $20,000. If I gift the stock to my charity, I get a charitable tax deduction of $100,000. I will save $53,000 in tax. But it gets better. When my charity sales the Apple stock, it pays $0 tax versus my $20,000.
So, far I am $73,000 ahead, and now I have cash of $100,000 in my charity for my next investment.
Now, I have my charity, and it is making a fortune on its new investments. Of, course it does not pay tax on this wealth. Thus, the wealth compounds many times faster. For example, fast forward 20 years. My $100,000 increased by $220,000 (at six percent) versus $80,000 (at 3%). So, now I have $320,000.
Being 20 years older, I am in the retirement stage of my life. It is time for me to start to get some money out. As you will read below in the IRS regulations, I can charge my charity for my time as an executive or as the CPA (at the same rates I bill my clients).
As a retired person, my income is less and so is my tax rate.
Well, enough of the “how to do it” writing. Here are the IRS’s tax planning examples (with my tax planning notes included). Yes, the IRS tells you examples just in case you can’t you come up with some of your schemes.
IRS regulation “section 53.4941(d)-3. EXCEPTIONS TO SELF-DEALING (author note: Yes, the IRS wants to be sure you find the loopholes, so they place the title in all Caps. Remember that the IRS is an agency of the White House. By the way, Congress writes these laws… yes, the Democrats and Republicans can work together).
(2) EXAMPLES. The provisions of this paragraph may be illustrated by the following examples:
EXAMPLE (1). M, partnership, is a firm of 10 lawyers engaged in the practice of law (Author note: in my case a CPA). A and B, partners in M, serve as (for me, it just myself) trustees to private foundation W and, therefore, are disqualified persons. Also, A and B own more than 35 percent of the profits interest in M, thereby making M a disqualified person. M performs various legal services for W from time to time as such services are requested.
The payment of compensation by W to M shall not constitute an act of self- dealing if the services performed are reasonable and necessary for the carrying out of W’s exempt purposes and the amount paid by W for such services is not excessive (Do you get it? They are a “disqualified person” but can still get paid at their high billing rates).
EXAMPLE (2). C, a manager of private foundation X, owns an investment counseling business. Acting in his capacity as an investment counselor, C manages X’s investment portfolio for which he receives an amount which is determined to be not excessive. The payment of such compensation to C shall not constitute an act of self-dealing (By the way, I also do investment management).
EXAMPLE (3). M, a commercial bank, serves as a trustee for private foundation Y. In addition to M’s duties as trustee, M maintains Y’s checking and savings accounts and rents a safety deposit box to Y. The use of the funds by M and the payment of compensation by Y to M for such general banking services shall be treated as the payment of compensation for the performance of personal services which are reasonable and necessary to carry out the exempt purposes of Y if such compensation is not excessive.
EXAMPLE (4). D, a substantial contributor to private foundation Z, owns a factory that manufactures microscopes. D contracts with Z to produce 100 microscopes for Z. Any payment to D under the contract shall constitute an act of self-dealing, since such payment does not constitute the payment of compensation for the performance of personal services (Obliviously, I am not going to manufacture microscopes).
These examples are just the tip of the iceberg. Only one’s imagination limits the ways of exploiting your private charity. Besides income tax savings, a private charity is exempt from inheritance taxes. They also make a fantastic asset protection entity.
If you need to up the quality of your tax planning, then contact me, Brian Dooley, CPA, MBT, at [email protected]
So, if you are wanting to become wealthy and have a passion for any social cause including love for animals, the environment, feeding the poor, educating the public and religion, then get with your tax team. The sooner you start, the sooner you will create wealth for yourself.