Editor's Note: The following article is a preview of a presentation Kathryn W. Miree will give at the 45th Annual Heckerling Institute on Estate Planning Conference, which will be held January 10-14 in Orlando, Fla.
Drafting long-term gift documents, whether the gift is a traditional endowment, a foundation, a donor-advised fund or similar entity, is difficult. These gifts are designed to be perpetual, but it is impossible to predict the economic or social climate 100 or even 50 years from now. Advisors must understand the client's goals, create a platform that anticipates likely issues and include a mechanism for change.
Understanding Client Objectives
To clarify the client's goals, advisors need to ask questions that shape his thinking and elicit thoughtful responses, building a vision of long-term outcomes and realistic terms and directives. Recent lawsuits involving endowments at big institutions such as Princeton, Tulane and Fisk universities provide cautionary tales for donors. Gifts that have a narrow purpose-especially those laden with restrictions-are doomed to fail because social, economic and political conditions change.
Ask your client the following:
What are the goals of the fund? Get clients to talk in terms of long-term, results-oriented goals. For example, rather than naming the "Success by 6" program, designate broader purposes, such as "funding for early childhood development programs."
Would it be more effective to place these funds directly with the charity or to use an umbrella organization, such as a community foundation, to add accountability and flexibility? This question is designed to educate and to discuss the pros and cons of available options.
How much do you intend to commit to the fund during your life and/or through your estate?
Are there secondary purposes/outcomes that should be included in the event the first is no longer relevant or becomes too expensive to administer?
Should the fund be perpetual or is a term more appropriate?
How important is accountability, and how might accountability be assured (i.e., through reporting or a third-party advocate)?
Do you want your family to have an ongoing role?
Donors who created endowments or foundations 50 years ago might be surprised at the current legislative and investment environment. Consider some of the forces that impact endowed funds today:
1. Congressional oversight and legislation. Since 2004, the Senate Finance Committee has passed reforms that have changed nonprofit structures, added penalties and altered contribution rules. For example, the Katrina Emergency Tax Relief Act of 2005 and the IRA Charitable Rollover provision that first appeared in the Pension Protection Act of 2006 gave donors new or extended options in giving to most public charities, but excluded donor-advised funds and supporting organizations. The Senate Finance Committee has also focused extensively on certain charitable sectors-including nonprofit hospitals and colleges and universities with large endowments-and has suggested there may be future legislation focused on them.
2. Taxation of endowments. Endowments-especially large endowments-are now targets of taxation by federal and local governments. For example, after Cambridge, Mass., proposed an endowment tax for nonprofits in the city, MIT negotiated an annual payment in lieu of taxes in 2004 that consisted of $1.2 million with a 2.5% increase each year. In Princeton Borough, N.J., home to Princeton University, local officials are contemplating a property tax on land owned by the university. In 2008, the university-which owns 43% of the borough's assessed land value-paid more than $8.2 million in property taxes on commercial ventures and voluntary payments to the community. A task force in Boston, meanwhile, is proposing that nonprofits make annual payments equal to 24% of the amount they would pay in property tax.
3. The volatile investment markets. The first decade of 2000 was a wild ride for investors. The Dow Jones Industrial Average finished the first decade of 2000 with a negative 9.3% return compared to a positive 317.6% return for the 1990s. As endowment income and asset values dropped, many charities began to invade principal. This caused endowment balances to decline further, decreasing the impact of the funds.
4. Lawsuits filed by donors and heirs. In a series of lawsuits over the last ten years, descendants of donors and other parties claiming a beneficial interest in charitable funds have filed lawsuits against charities alleging a misuse of perpetual charitable funds. Prominent cases include the Robertson family vs. Princeton, the Barnes Foundation's plea to change the terms of a foundation document, the Newcomb heirs' suit against Tulane University, the Daughters of the Confederacy vs. Vanderbilt University, and the legal battle over the future of the O'Keeffe collection at Fisk University. These lawsuits have generated extensive legal costs-some of which have been borne by the perpetual funds, and may increase as courts show an increasing willingness to give heirs standing to sue.
Overcoming Future Issues
While drafters cannot anticipate every issue, taking the following steps can improve the possibility of creating a document that withstands the test of time.
1. Clearly determine the donor's goals for the endowment, including its primary and secondary purposes, its size, the time frame and the family's role.
2. Select a structure that creates the greatest flexibility while making it likely the goals will be achieved. Depending on the ultimate size of the fund, options include: i) a traditional endowment held by a charity; ii) a private foundation or supporting organization that provides a platform that allows flexibility in grant making and a long-term role for family; iii) a donor-advised fund at a community foundation that provides flexibility for smaller donations and a role for families for several generations; or iv) a field of interest fund at a community foundation enabling the foundation to provide accountability and oversight.
3. Ensure flexibility by including a "Plan B" and maybe a "Plan C" if "Plan A" is no longer a priority, no longer effective or viable, or if the fund drops below a minimum dollar value. Alternative plans may include a different or expanded use of the funds at the original charity, or a distribution of the fund to another charity if the charity fails to use the funds as directed or no longer needs the funds for the purpose designated by the donor.
4. Consider a term limit for the fund. For example, a donor can stipulate the funds are to be used as an endowment for 25, 50 or 100 years and then be distributed to the charity's general endowment or distributed for the purpose named by the donor. The boards of some private foundations have now adopted this approach, most notably the Melinda and Bill Gates Foundation, which has committed to spending its funds within 50 years after the death of the current trustees (Bill and Melinda Gates and Warren Buffett).
5. Carefully review the policies and endowment structure of the charity receiving the funds. Get a clear understanding of how the charity invests the funds. Do they use outside managers? Do they have strong investment policies? Do they have solid returns? How did they respond to the investment downturns in 2008? Ask questions about accountability. How does the charity ensure that gifts are used for the purpose intended? Do they give donors reports? What do they do when they encounter a problem? If the charity is unable or unwilling to answer these questions, it may signal a problem that could prompt the donor to house the funds with a third-party charitable organization.
Drafting a gift document with a perpetual term is difficult. Advisors cannot see into the future and anticipate every variation or factor that may damage or impact an endowment. It is possible, however, by devoting time in the planning process to exploring goals, potential threats and outcomes to create a flexible structure to achieve the client's long-term goals.
Kathryn W. Miree, J.D., is the president and primary consultant for Kathryn W. Miree & Associates Inc., a provider of planned giving, endowment and foundation management services.