July 13, 2000 | Read Time: 6 minutes
By J.J. MacNAB
A year ago, a lawyer called me with a startling request. He wanted to know if I could put him in touch with any of my financial clients who fit this description: under age 30, seriously ill, and a life expectancy of two to three years.
The lawyer said he would pay the sick person $5,000 for the person’s medical records. The records, he said, would be very useful in setting up a form of charitable trust for one of his wealthy clients. The donor would base his tax deduction on the life expectancy of a healthy young person, rather than that of a sick person. But when the sick person died prematurely, the trust would stop paying money to the charity and the donor’s heirs would get most of the money in the trust free of estate taxes.
As I learned more about the arrangement, I dubbed it a “vulture trust,” a name that quickly caught on in the press and among estate planners.
It turned out that the lawyer who called me was one of a small number of financial advisers around the country who had been selling the concept to their ultra-wealthy clients. The word was out that financial advisers should put the plans into operation quickly and quietly — before the news media and federal regulators caught on.
The press did expose this scam last fall. Critics were concerned that the wealthy were exploiting the sick and dying to get a tax break. They noted that the dying person received only a few thousand dollars while the donor benefited by potentially getting hundreds of millions of dollars in tax savings.
Interestingly, though, no one seemed to care that the real victim was the charitable industry. The lawyers who tried to exploit this loophole were knowingly promoting a scheme that was contrary to the spirit of the charitable tax deduction.
Shortly after press accounts about the vulture trusts appeared, the Internal Revenue Service took steps to shut them down.
Every time the public opens a paper and reads about yet another charity scam, confidence and trust in the charitable industry are damaged. Not only that, but with each new unsavory scheme, Congress edges closer to imposing draconian rules on every form of charitable giving — potentially costing charities billions of dollars.
It’s no secret why charity scams have been on the rise. Charitable giving is the last frontier for tax-planning abuses. Over the years, the I.R.S. and Congress have gradually tightened the rules in other parts of the tax code to the point where there isn’t much left for financial advisers to exploit.
For charities, the stakes are high when unscrupulous tax planners go unchallenged. For evidence, look to what happened a few years ago with “charitable split-dollar insurance,” a scheme in which charities allowed donors to purchase life-insurance policies with tax-deductible dollars by using the charities as intermediaries.
Promoters of charitable split-dollar insurance were extremely successful before the regulators put a halt to the technique. Starting with only a few promoters offering the scheme to a handful of wealthy clients, split-dollar insurance grew in five years to more than 4,000 plans established with hundreds of charities that were actively involved in the marketing. Now, many of those same charities are embroiled in expensive lawsuits as they try to clean up the mess.
The charity world was slow to speak out against the split-dollar technique, and its response to the vulture-trust scam was similarly lacking in aggressiveness. Even after the tactic was exposed in the press, planned-giving experts remained silent. Instead, they criticized the news media for making charity look bad.
Indeed, some planned-giving experts still seem to question the need for a government crackdown on the scheme.
Last month, the Planned Giving Design Center, which runs online articles on estate-planning issues, posted an article by Baltimore lawyers Emanuel J. Kallina and Jonathan D. Ackerman.
The two wrote that they couldn’t find evidence that anyone had actually set up a vulture trust, and they questioned the need for federal regulations to put a halt to the technique. “Is it in the best interest of a fair administration of the tax system to promulgate Treasury regulations based upon a rogue promoter’s written description of an abusive tax transaction without evidence of abuse?” they wrote.
I posted a vigorous rejoinder to the Planned Giving Design Center article on an Internet discussion list for estate planners, and the next day the center retracted the piece and replaced it with a new version that had none of the questionable opinions. The center explained the switch by saying that it had “inadvertently released a draft rather than the final approved version of the article.”
While that may be true, the original version displayed an attitude that is all too common in the charitable world. Instead of acknowledging up front that a problem — in this case, vulture trusts — posed a credibility threat to non-profit organizations, the authors questioned the need for regulations simply because they couldn’t find much evidence of the scheme.
The same lack of wisdom prevailed with charitable split-dollar insurance. If only a few promoters were taking advantage of an abusive tax-shelter scheme, why bother criticizing it?
True, the National Committee on Planned Giving, an organization that represents fund raisers and estate planners, came out against charitable split-dollar insurance — but only after the scheme was in widespread use, the newspapers were writing about it, and federal authorities were moving aggressively to shut it down.
Furthermore, the committee’s credibility was damaged by the fact that one of the authors of its position paper criticizing the viability of the technique was actually promoting a variation of it through his own charitable organization.
The committee has also avoided taking a position on another push-the-envelope tax-shelter scheme called “charitable family limited partnerships.” In such deals, promoters offer wealthy donors a way to use charities as tools to pass assets to heirs largely without paying hefty capital-gains and estate taxes.
The I.R.S. is investigating the technique, and many, many charities are steering clear of it. But the planned-giving committee remains on the fence. It issued a “white paper” on the partnership technique — but only to tell estate planners that the committee “does not take a position” on it. The committee said it was offering the white paper “as an educational tool to help gift planners understand the pros and cons of this gift-planning device.”
The committee never did officially take a stand on the vulture trust.
That’s not surprising. The charitable world has been conspicuously silent on the ever-growing problem of advisers using highly aggressive charitable planning tools to gain disproportionate tax benefits for their clients. And even when charity leaders do raise their voices, it is usually only after too much damage has already occurred. Perhaps this silence is the result of lack of interest, or perhaps it indicates that a growing number of charities are relying on financial advisers as a source of referrals for new donors.
One of these days, the vulture that swoops down on philanthropy is not going to be an abusive form of charitable trust. It’s going to be Congress, taking a big bite out of legitimate forms of charitable giving.
J.J. MacNab is a Bethesda, Md., consultant who specializes in planned giving, tax planning, and fee-based insurance analysis. Her e-mail address is jj@deathandtaxes.com
