You hear a lot about how “the rich” are using charities to effectively reduce their tax to minimal amounts, among other methods.
On the face of it without digging, it obviously makes people angry and detest the rich. But scratching beneath the surface, I’m not quite sure how exactly they would achieve this? In order to claim the tax back from money donated, you still have to… donate money? Which would still equal more than the money claimed back from tax.
So unless they are actually doing something illegal and funneling money through a charity, claiming tax, and then using that money from the charity to fund purchases not related to the charities mission, how exactly is it benefiting the donor (financially)?
In: Economics
They create their own charitable foundations which they are able to operate within the rather loose guidelines of what makes it a charitable foundation.
Lets make up a rather egregious but probably borderline legal example:
Say I developed a charity that disburses scholarship money to deserving high school students. Every year, the charity picks out 10 deserving students from my hometown school and awards them with $10,000 to put towards their further education.
This charity only costs me $100,000 to operate. I cannot afford that, so lets also pretend I’m stinking rich. I like this example. I want this charity to stay afloat forever. At first I’ll need to donate $100,000 every year. That’s not saving me money though, I’m just giving it away.
One way to make a charity self sufficient is to set up investments in what’s called a “trust”. This trust sets guidelines that decide how the investments are managed and how the funds are disbursed for charitable purchases. i.e. the trust would decide how much money can be given away every year, and it can also decide the eligibility criteria for deserving students. I can manage the trust myself or appoint another person (or family member) to do so. As long as the foundation operates within the guidelines of the trust, it should qualify as a charitable donation.
Now time for the abuse. I want to live a lavish lifestyle, and I want to pay for it as efficiently as possible.
Lets say I earned $10M last year, and I want to buy a house. Instead of paying taxes on that $10M and being left with around $6M for myself, I decide to donate the entire $10M to my charity. I then direct the charity to purchase a $9.9M home which I will be allowed to rent at a discounted but otherwise “fair” rate of $5k/month. The other $100k can go to the students.
The home is property of the charity, it’s an asset, and it’s expected to appreciate in value. Therefor it’s contributing to the future health of the foundation. It doesn’t matter that it will be our family home for generations to come.
Next year I earn a lot of money again, and I want to furnish and decorate this home to my liking, so I buy obscure paintings and artwork through private deals. The real purchase prices are often not public, but I know a high end art dealer that can get them appraised for a high value.
I commission 5 paintings from different artists for $10,000 each. I get my appraiser to value them, and he determines that due to the uniqueness of this one it’s worth $100,000. Another is only $5000. This one here is $20,000. These paintings aren’t hitting the auctions anytime soon, so there’s not much fact checking going on. The appraiser knows the game.
The $100k and $20k paintings, I donate to the charity at the appraisal value. The other three I keep for myself until they “appreciate in value”. All 5 of them get hung in the house I rent from the charity. I get a charitable donation deduction for the $120k of donated assets to the charity. My tax rate is around 40%, so that deduction is worth $48,000. I effectively commissioned 5 professional paintings for only $2000.
All of the physical assets I would buy for myself, I am using clever ways to deem them as assets and growing investments held by the charity, and using the home as a storage facility for these assets.
What’s next? Well vacation homes of course. The charity holds real estate in the trust, so lets expand that. The charity buys a property in the Hamptons, in New York, L.A., etc.
We expand the charity to start giving scholarships in other cities. This should justify transit between these cities, so now it’s reasonable for the charity to own a private plane and hangar for transporting charity board members.
I want a vacation property in the Caribbean, so guess where the charity expands next? We give out a few grand of scholarships every year, and this justifies our flights to and from the vacation property that the charity owns.
All of these things cost money, don’t get me wrong. But since most of my money is being funneled through the charity, I’m able to enjoy these luxuries on what is essentially pre-tax income.
The charity is still doing good things, and when I die I’ll die with zero dollars in my bank account, but who cares? I’m dead and I can leave the charity to my kids.
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