Editor: Theodore J. Sarenski, CPA/PFS
"Best practices" is a term CPAs are quite familiar with; however, the term takes on a new meaning when the discipline of tax compliance is combined with that of personal financial planning. This combination creates a new type of best practice, which may be more aptly referred to as an "outstanding practice."
CPAs who have combined tax compliance and personal financial planning services have most likely experienced the considerable satisfaction of offering them to their clients. CPAs who have not yet combined these two disciplines will, hopefully, gain a new perspective from this column and begin to enter the win-win experience of outstanding practices.
It is important to clarify that personal financial planning is not fundamentally about managing assets or selling a product. CPA personal financial planners may do these things if they are so inclined, but they create an outstanding practice when they combine the discipline of tax compliance with the discipline of personal financial planning. Investment management and product sales are not included in the discipline of personal financial planning; they are their own disciplines.
Charitable giving and philanthropy provide an excellent example of the two disciplines coming together to create an outstanding practice of exploring how philanthropic vehicles can create the maximum charitable contribution deduction. The process begins by identifying clients with investment accounts. Then asking:
- Do these clients have donative intent?
- Do they have concentrated stock positions?
- Do they have highly appreciated stock?
- Do their investment advisers have a need to rebalance or sell securities to generate cash?
- Do they have concerns over how much money to leave to charity and how much to leave to their children and/or grandchildren?
If the answer is "yes" to any of the above questions, there is an opportunity to introduce these clients to two philanthropic vehicles: the private foundation and the donor-advised fund (DAF).
Why is this considered an outstanding practice, when these vehicles can be used without combining the two disciplines? First, consider a CPA offering tax compliance services without personal financial planning services. The CPA can share these strategies with clients; but due to the focus on tax compliance issues and deadlines, these conversations may take place after year end when it is too late to facilitate implementation of the appropriate vehicle. However, if CPAs also provide personal financial planning services, their clients are speaking and meeting with them throughout the year. This provides a clear picture of a client's overall financial situation and ample time to integrate tax compliance and implement the appropriate strategies.
Next, consider a CPA who offers personal financial planning services without tax compliance services. The CPA personal financial planner is aware of the client's entire financial picture and offers strategic planning ideas; however, the CPA does not sign the client's tax return, and therefore the tax compliance component is missing. The CPA personal financial planner does not know if the CPA who is signing the tax return will agree with a position taken and does not have as clear a picture of the ever-changing tax law and tax environment as does the CPA who offers tax compliance services. (Full disclosure: The author's practice offers personal financial planning services only and therefore does not engage a client who does not have a separate engagement with a CPA for tax compliance services.)
An actual client scenario helps to highlight this outstanding practice: A CPA who has combined both disciplines of tax compliance and personal financial planning has been made aware by a client's investment adviser that a large capital gains tax will be incurred during the year because the client is anxious to diversify his concentrated stock position. The CPA financial planner has ample time to plan and implement a strategy to reduce the client's tax. The CPA who offers tax compliance services only would not learn about the situation until she receives the client's investment statements for the prior year, well past the time to plan and implement a solution. In this example, the client has donative intent; otherwise, a charitable contribution is not an appropriate recommendation. An outstanding practice occurs when instead of selling the stock and incurring capital gains tax, the CPA and the client have time to plan, consider all options, and implement the most appropriate strategy for the client, which in this case is a contribution of all the stock to a private foundation or a DAF.
In either case, the donation is valued at the stock's fair market value (FMV). If the donation is made to a DAF, the client can take a deduction in the year of the donation of up to 30% of adjusted gross income (AGI), with a five-year carryover of any amount over the limitation. If the stock is donated to the client's private foundation, the client can take a deduction in the year of donation of up to 20% of the AGI. Under both scenarios, the client can take a deduction in the current year for the donation (subject to the limitations) and have the donation distributed to one or more charities over one or more years.
Private foundations and DAFs have become increasingly popular over the past few years. For many clients, the limitations of a DAF make a private foundation the more obvious choice. Understanding the differences between the two is critical in determining which is more appropriate for any given client's facts and circumstances. Whether a client wants control with a private foundation or confidentiality and fewer restrictions with a DAF, each has its proper use.Private foundations
A private foundation is a Sec. 501(c)(3) not-for-profit organization that is not a public charity. It can be established by an individual, family, or corporation and typically involves a large initial donation. For the most part, further donations come from the individual, family, or corporation and are managed by the foundation. A private foundation can be funded with cash, securities, land, buildings, art, and other tangible assets. A private foundation generally does not solicit funds from the public. To maintain its tax-exempt status, a private foundation supports charitable, educational, religious, or other activities that serve the public good. (See the sidebar, "Private Foundations: A Range of Charitable Purposes.")
There are two types of foundations: operating and nonoperating. An operating private foundation must spend at least 85% of its adjusted net income or its minimum investment return, whichever is less, on its activities. Examples of operating foundations include museums, zoos, research facilities, and libraries. Most families use a nonoperating private foundation. "Nonoperating" means the foundation makes grants out of its own assets to other charities instead of using the funds for its own activities.
In the past, the entry point for a client using a private foundation was a $2 million donation; however, this has slowly evolved, and the entry point is currently approximately $200,000 to $250,000. Administration costs of establishing a private foundation have decreased dramatically, and if the client gives 5% of the prior year's average net investment assets to charity and files an annual tax return, there are no other requirements. Board members do not have to be compensated, and the foundation need not have employees if the family is willing to work in it.
Control of the funds can be maintained in a single family, allowing successive generations to participate in giving. This is especially important for high-net-worth families who may be looking to fund a foundation with a large initial gift out of which to give for many years. The private foundation can create a family's legacy. It can also reduce any friction regarding the amount of money a generation wishes to give to charity and the amount it feels the next generations are expecting and perhaps even asking for. A family that comes together for philanthropic purposes, makes decisions, and carries out accompanying actions together has a powerful tool that reduces fear and increases camaraderie, family unity, and peace of mind.Donor-advised funds
A DAF is a separately managed charitable investment account that is operated by a Sec. 501(c)(3) organization, also known as a sponsor or sponsoring organization. A client can contribute cash and appreciated securities and receive an immediate tax deduction. These assets grow tax-free, and, in turn, the client can make donation recommendations to the sponsor, although the sponsoring organization has the right to make the final decision. Some DAFs allow for successor advisers, and some allow contributions of real estate and other property.
An internet search of DAFs will reveal that many community foundations have sprung up — there are over 800 community foundations. Community foundations are a great way for a donor to become more involved in his or her community and directly assist in fighting homelessness, hunger, poverty, and drug addiction and supporting other worthy causes for the benefit of the residents of a defined geographic area.
A great resource on DAFs is the National Philanthropic Trust's 2019 DAF Report, which is available at nptrust.org/reports/daf-report. The AICPA's 2019 comment letter on DAFs is available at www.aicpa.org.Comparisons
A private foundation is a true legal entity, while a DAF is best thought of as an account held with a sponsoring charity in the name of the donor. This distinction is vitally important when it comes to the issue of control. Because a foundation is structured as an independent corporation (or trust), it is under the complete control of the founders/board of directors. Assets put into a foundation remain fully managed by the foundation leaders and their investment advisers. By contrast, a DAF is controlled by the sponsoring charity. Some sponsoring charities permit the donor to continue using his or her investment manager, but this is not the case with every DAF.
The largest DAF in the United States is the Fidelity Charitable DAF. The largest private foundation in the world is the Bill and Melinda Gates Foundation. DAFs have an estimated $121.42 billion in funds. There are approximately 80,000 private (noncorporate) foundations with an estimated $872.65 billion in assets.
The chart, "Private Foundations vs. Donor-Advised Funds," (below) shows the differences between the two vehicles and compares the tax considerations and benefits of each.
An outstanding combination
Combining the discipline of tax compliance with that of personal financial planning creates outstanding practices. An example of an outstanding practice is the use of a private foundation or a DAF to maximize clients' charitable deductions, provide solutions for difficult situations in their financial lives, avoid capital gains tax, and create a family legacy. These benefits can be achieved in each discipline separately as a best practice, but when these two disciplines are combined, they create an outstanding practice. The CPA's client moves from fear, worry, anxiety, and confusion to peace, happiness, and clarity in new knowledge applied for the benefit of his or her family. Private foundations are permanently dedicated for a charitable purpose; however, the variety of potential beneficiaries is large. A few examples include:
Susan M. Tillery, CPA/PFS, is president and CEO of Paraklete Financial Inc. in Atlanta. Paraklete Financial provides integrated fee-for-service financial planning and focuses on independence and objectivity. She is chair of the AICPA Personal Financial Planning Executive Committee and a past chair of the AICPA Personal Financial Specialist Credential Committee. Theodore J. Sarenski, CPA/PFS, is president and CEO of Blue Ocean Strategic Capital LLC in Syracuse, N.Y. Mr. Sarenski is chairman of the AICPA Advanced Personal Financial Planning Conference. He is also a past chairman of the AICPA Personal Financial Planning Executive Committee and a former member of the Tax Literacy Commission. For more information about this column, contact email@example.com.
Private foundations are permanently dedicated for a charitable purpose; however, the variety of potential beneficiaries is large. A few examples include: