Posted September 1st, 2003

Planning Matters

The Tax Reform Act of 1986 ushered in an era of changes in charitable gift planning not seen since the late 1960s. While few provisions of that tax act dealt directly with charitable gift planning, other changes such as large increases in capital gains tax and the elimination of many commonly used tax avoidance methods such as real estate tax shelters had an indirect, though substantial, impact on charitable gift planning activity.

Because it was still possible following the 1986 tax act to use charitable remainder trusts to diversify investments without payment of capital gains tax and to enjoy tax-free buildup of trust assets, many outside the nonprofit community who had previously had little or no interest in planned giving seized on what they perceived to be a powerful vehicle within which to hold investments.

This enthusiasm unfortunately resulted in situations where charitable gifts were openly promoted by for-profit planners and nonprofits alike as “tax shelters.” In some cases, for-profit planners were requesting finder’s fees, commissions, or other special compensation for delivering a planned gift to a charitable entity from a “donor” who otherwise had no interest in the work of that nonprofit. In those cases, the “donor” was primarily interested in tax benefits and the charitable remainder became “for sale” to any charity that would fund the cost of the planning that led to the creation of the trust.

These activities were quickly denounced by the nonprofit community, and newly created organizations such as the National Committee on Planned Giving adopted model standards of practice that denounced the payment of commissions or “finder’s fees” in the gift planning arena.

Even so, there was increasing concern that some of the marketing efforts of nonprofits were crossing the line from those appropriate for charitable gifts (generally exempt from federal and state securities registration) to those more standard for securities (subject to both federal and state scrutiny). Such efforts included communications that were heavily focused on various aspects of planned gifts such as the growth potential in trusts, the amount of income payments from gift annuities as compared to other “investments,” and the tax-free nature of income from various plans.

In some cases, nonprofits and for-profits alike were taking liberties with descriptions of planning tools that could be interpreted as inaccurate representations of the workings of plans. Some wondered if a point could be reached when gift annuities and certain other gifts might be considered “securities” under federal and/or state law. If that were the case, the plans and the persons who marketed them could be subject to extensive regulation.

In August 1990, these concerns were addressed in a Trusts and Estates magazine article entitled “Is There ‘Security’ in Planned Giving?” This article concluded that security law as interpreted in published Securities and Exchange Commission (SEC) staff opinions could, in fact, be interpreted to restrict certain activities. The article concluded that the SEC would not, however, consider planned gifts to be securities so long as a number of conditions were met. These included the following:

1. The gift should be irrevocable and qualify as a charitable gift under federal tax law.

2. Charities should provide full and fair disclosure to each donor or prospective donor.

3. Only volunteers or persons employed in the overall fundraising activities of the charity should solicit gifts and no part of their compensation should be in the form of commissions or other compensation based on the amount of a gift.

4. The anti-fraud provisions of the law would continue to apply.

The Philanthropy Protection Act

In the mid-1990s, a lawsuit was filed in Texas that claimed the planned giving activities of a charity had violated federal and state securities laws. The suit also included claims that the practice of recommending gift annuity rates by the American Council on Gift Annuities since 1927 violated the Sherman Antitrust Act. In response to this case, Congress enacted clarifying legislation in the form of the Philanthropy Protection Act of 1995, which gave statutory force to pre-existing S.E.C. guidelines and specifically amended the Investment Act of 1940, the Securities Exchange Act of 1934, and the Investment Advisors Act of 1940. A companion bill also amended antitrust laws to exempt the activities of the American Council on Gift Annuities in recommending rates.

Thus, under current law, it is unquestioned that certain planned gifts are treated as securities under federal law. These gifts include gift annuities, pooled income funds, and charitable remainder trusts where funds are commingled. These gifts are, however, exempt from registration, and those who work with donors need not be registered investment advisors so long as conditions are met that are much the same as those the S.E.C. had set out in the past. Under this act, donors are to be given full and fair disclosure of how gifts work, the gifts must be marketed by volunteers or those otherwise engaged by the charity, and no one can be paid commissions. In addition, anti-fraud provisions would continue to apply.

As the activities of most charities were already in compliance with these conditions, the passage of the Philanthropy Protection Act had little practical impact other than for charities to carefully review their compensation policies and their marketing materials to ensure they were accurate and did not misstate the workings of plans.

It is now generally accepted that the required disclosure may be in the form of a detailed letter or professionally prepared printed materials that accompany gift proposals. Material misrepresentations or omissions may give rise to liability under the antifraud provisions of the securities law or may subject your program to full-blown securities registration.

For example, in one case an institution gave a donor information on the amount of the tax deduction he could expect from a particular gift. The charity failed to add that there may be limitations in the amount that could be deducted. The donor was not able to use the full deduction and threatened action under anti-fraud provisions of federal securities law if the charity did not return the gift annuity funds. The charity refunded the money even though they had intended no harm. It was not anything they “said” that gave rise to the problem; it was what they “didn’t say.”

Better safe

At least annually, and more often if circumstances dictate, all internally or externally prepared planned gift-marketing materials should be reviewed for completeness and accuracy and updated as necessary. Such actions are prudent and necessary given today’s regulatory and legal environment. Make sure that any materials that have been purchased in past years for this purpose are up-to-date versions.

Securities laws as they affect planned giving should not be feared or give rise to undue concerns. It is important to remember that these laws were enacted not just to protect the public but also to protect charities from those who would commercialize and distort the underlying purpose of the charitable gift planning tools that are so vital to the continued financial health of the nonprofit community

The publisher of Give & Take is not engaged in rendering legal or tax advisory service. For advice and assistance in specific cases, the services of your own counsel should be obtained. Articles in Give & Take may generally be reprinted for distribution to board members and staff of nonprofit institutions and other non-donor groups. Proper credit must be given. Call for details.

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