How Foundations Work


With all the discussion about foundations, I think it’s a good idea to understand them a bit more. First off: if you see a foundation, it’s nearly certainly a tax dodge. Let’s get that out of the way.

The next piece to get out of the way is whether or not a foundation is a good thing for society. If you’re a consequentialist or another believer in moral systems, I’d say it’s going to be hard to argue that a foundation is a good thing; at best it’s a better thing than being an outright tax-cheat, but even that is questionable: for one thing, a foundation facilitates outright tax cheating and a cheat who uses a foundation has a better chance of getting away with it. For another, a foundation is inherently unequal: you can’t set one up unless you have about $100,000 to dispose of – so if your moral system includes notions of fairness, foundations exist for the 1% and their only purpose is to help the 1% be 1%ier. That stuff about charity and good works: that’s just window-dressing.

Here’s how it works. This actually happened to me; it’s a real example. Back in the early 90’s I worked for a security company and built a few products for them that made the company a heck of a lot of money. When I started there I was offered stock options, with an exercise price of about $2000. So I bought the shares and forgot about them. That was a critical decision-point that we’ll come back to later: I risked my $2000.

Fast forward 5 years, the company has been successful, I’ve moved on to another start-up, and the company I’m still holding shares in goes public.* The stock splits and leaps up and suddenly my $2000 worth of stock is worth $450,000. So I talk to a financial advisor who specializes in stock options and he advises me to create a charitable remainder trust – a foundation. He explains that in tax terms, if I sell the stock, I’ve just made $448,000 and I’ll owe a whopping amount of taxes.

Now we have to talk about capital gains taxes. There is a special class of profits called “capital gains” and there are short term and long term capital gains. The idea of differential capital gains taxes is (theoretically) to encourage investment instead of day-trading: get the capitalists to leave their money in the economy where it’s “working.” Capital gains are taxed at a different rate from income – 15%**  So if my income tax rate is 33%, long term capital gains are very attractive at 15%. By choosing to risk my $2000 5 years earlier I made a choice that resulted in $67,200  in taxes compared to $147,840.*** This is one of the many ways capitalists reward themselves for being rich enough to, uh, be rich: if you “invested” in lotto tickets and hit it big, it’ll all be taxed as income, but because, uh capitalism, you get capital gains (even though, if you “invested” in lotto tickets you’d also be putting money into the economy in the form of funding a new sportsball stadium or whatever the lotto money is earmarked for)

The magic of compounding growth on tax-free lootBut, if it’s painful to write a check for even $67,200. Foundations to the rescue! So, you create a foundation (required minimum is about $100,000) as a “charitable remainder trust.” The way that works is that when the foundation eventually shuts down the remainder in the trust (aka: what I haven’t spent!) gets disbursed to a named purpose. Let’s say the ASPCA. But in the meantime – for perhaps generations, like the Kennedy foundation, the foundation does whatever its directors decide. The foundation is a charity, so it doesn’t pay taxes – and we start the foundation off by giving it the stock, which is worth $450,000 but has a cost basis of $2000. The foundation sells the shares and now it has $450,000 and it owes no taxes at all, it’s a charity. If I was just exercising and flipping my stock options, I just avoided the $147,840 tax hit, which makes it more attractive – but either way, I sidestepped any tax consequences at all.

The director of the foundation is: me. The sole staff of the foundation is: me. And I’m allowed to pay myself a managment fee to manage the foundation, naturally. Or I can treat the foundation as a private stock-trading account! Let’s say I invested the foundation in Berkshire Hathaway A shares – in 10 years the foundation’s endowment is now $3 million. As director of the foundation I might forgo the management fee for 10 years. Then, when I retire, I can start paying myself a management fee of up to 10%, now $300,000/yr – which is income, but by sheltering the initial investment from taxes, it’s a whole lot more money. If I’m retiring, I (and my money) will move my official residence to Grand Cayman and my $300,000 management fee will probably escape the IRS. I can have the foundation provide me with a car, or an apartment in Milan, or internet service, or plane tickets, or a private email server, or whatever. Some of those “expenses” may be disclosable, some may not. Or if I have a girlfriend who needs a job, I can put her on the foundation’s payroll like Richard Dawkins appears to have done with one of his – it’s very convenient. If a mobster does this, it’s a “slush fund.” If Donald Trump does it it’s just how things are done. The Clintons are just “old money” smooth with their web of shell corporations. But they’re all playing the same game.

If I’m Mitt Romney, my foundation is a for-profit business (Bain Capital) but it’s in a tax haven and pays/reports no taxes, and (in case you haven’t figured it out) Romney is the sole shareholder and sole employee. You can mess with those parameters easily by resigning as a director, while keeping ownership of all the shares, during your embarrassing run at the White House. When you want the directorship back, the shareholders (that’s you) unanimously vote for the new director (that’s you) – the Clinton foundation is one of the Clintons’ tax dodges, Bill owns a few Delaware corporations that he funnels some of those speaking fees and consulting gigs into. Some Wall St company pays Bill’s lobbying firm $1 million, the Delaware lobbying firm doesn’t pay taxes on it, but Bill can pay himself from his lobbying firm, or have it donate money or put friends on the payroll, or whatever. If you’re a grifter like Trump you have your foundation pay businesses you own for services during your electoral bid: your foundation pays your apartment complex for office space – money goes from your left pocket to your right pocket. That’s probably one reason the Koch Brothers hate Trump: they realize that their money isn’t going to go to his presidential campaign, it’s going to go into his pocket – but it’ll linger briefly in the presidential campaign long enough to get sucked up as campaign debt. The Clintons are smoother than Trump, that’s about it. Ironically, their child got rich the traditional way (married it) so providing for the next generation of oligarch/aristocrats is probably pointless, unless she decides to buy her way into politics with a head-start thanks to, uh, democracy.

Another way foundations keep giving is that they protect you (somewhat) from some liabilities. That’s why tin pot dictators are fond of Swiss bank accounts: you can’t touch the money once it’s hidden away. If gawkerbro Nick Denton diversified any of his net worth into a tax shelter, he can go personally bankrupt and his foundation can independently turn around and elect him to its directors once the dust settles. Bankruptcy doesn’t mean the same thing to the rich – for them it’s an inconvenience and their golf buddies may give them a good-natured ribbing about it. But once you’re rich, it’s hard to get poor unless you’re really sloppy about it and ignore the advice of your asset managers who’ll help make sure your money is protected from the IRS and you.

Enough slices of 10% of a pie, and soon you have more than the original pie

Enough slices of 10% of a pie, and soon you have more than the original pie

Back in the day, foundations were discreet, and 10% management fee was considered “aggressive” – by 2001 foundations like the Johnny Micheal Spann trust**** were embedded into legislation like the PATRIOT act, with congressional authorization of up to 15% management fees.

Imagine you have a cake and I tell you “you can’t eat all of it at once but if you are comfortable with agreeing to eat it in slices of  1/10 of the cake, I’ll give you a slice a year for 30 years.” And you say “holy crap YES!! That’s three cakes!!” But then I stop you: “Wait, there’s more: you can give your kids 1/10 of a cake a year for their whole lives.” It’s infinite cake, because: capitalism! Your frogspawn can experience life with a silver spoon firmly in their mouth from day one. Born onto the board of directors! They can pat themselves on the back for being self-made millionaires, just like Trump and Romney, hire ghost-writers about it, and eventually be accepted into the oligarchy.

Foundations have gotten a little attention in the last few elections but the financial maneuvers behind them have been largely left un-discussed. Because everyone in the 1% is doing it, and pulling back the curtains on the practice is pyrric victory because it airs everyone’s dirty laundry. The first rule of tax shelters is: you don’t talk about tax shelters. Trump and Clinton are complaining about each other’s foundations only where they’ve been notably egregious. The really disgusting part is that they exist at all. The poor ought to be rewarding the 1% with “free tumbril rides for all!”

Capitalism has done a very good job of promoting its ideology: that capital gets to collect its percentage in return for assuming risk; but it’s pretty obvious that capitalism does whatever possible to eliminate risk, and to amplify profits from rent-collection on money through selective tax advantages like capital gains. It’s not as if Bain Capital was starting businesses and boosting the economy – it was “asset stripping” companies: shut down the workforce, take its capital from its bank account, then break the company up and sell off the parts. The foundations that do “charity” work are doing whatever the foundations’ well-paid directors want (which is, coincidentally, whatever I want!) but they’re doing it with money that should have been under control of, well, the taxpayers. Remember, if you paid any taxes at all last year you probably paid more than Donald Trump ever has.

The venture capitalist who makes $50 million on a start-up’s success is making that $50 million at a capped tax-rate. Because they deserve $43 million instead of a measly $34 million. That’s a lot of champagne, Lamborghinis, and cocaine that the taxpayers won’t get to watch Congress waste on the F-35. As my accountant once said “a penny tax-deferred is 15-30% of a penny earned.” If you want $1 you have to either earn $1.50***** or more, or you earn $1 and don’t pay any taxes.

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What happened to my foundation? I don’t know. I gave away all interest in it back in 1997 as part of a divorce settlement. I am considering setting up an “Institute For Trolling” so, after my death, my money can fund legal assistance for people suing cops or police unions. As someone who is very unhappy with how the US Government spends tax money, I am reluctant to see more money getting tossed into the all-hungry maw of the pentagon. I think we can say, legitimately, that we all have two enemies and it’s fair to avoid giving them as much of our loot as possible: the government, and Verizon. Feeding them just makes them stupider and more aggressive. So, I sort of support tax-cheating in principle but not to the degree and for the purpose that people like Trump and the Clintons do it. For the record: the second fortune I made, I outright paid all the taxes on it at income rates, which means I probably bought a handful of the smart bombs they dropped on Syria. If you are sensing some ambivalence in me, your instincts are spot on.

(* “Going public” means that the company’s shares are sold on the public markets – New York Stock Exchange or NASDAQ – and the shares become a liquid commodity.)

(** lately that varies with wealth, so it may be 20%)

(*** Many people exercising stock options buy the shares right before they sell them – a risk-free transaction. But, doing that makes the profits income instead of capital gains.)

(**** Johnny Spann was a CIA interrogator thug who was killed in a prisoner uprising in Afghanistan. Congress buried the tax shelter in the PATRIOT act and I was apparently one of the very few people who actually read the whole thing. It has since been removed but doubtless there are others)

(***** Depending on state taxes and tax bracket)

Comments

  1. polishsalami says

    I’m surprised that the close relationship between the Clintons & Trump hasn’t been a bigger issue. There are even reports that Bill Clinton encouraged Trump to run, which is quite remarkable. The idea that Trump is running dead against Clinton can’t be entirely dismissed.

  2. brucegee1962 says

    The remarkable things about the Trump foundation are that a) it doesn’t seem to be get much if any money from Trump himself; rather, he hits up his rich friends to make donations, and b) it doesn’t seem to actually do much with actual charity.

    You are correct that foundations as a whole are often a dodge. However, it’s also true that, if you were rich and were actually motivated to give back to the community and help the poor, you would ALSO set up a foundation, because it’s the only game in town.

    It’s instructive that journalists have been combing over the Clinton foundation for months now, and the only dodgy thing they found was the source of a few donations who might have been looking for favors. When it comes to the actual work done, it looks as if the Clintons actually are trying to benefit people. I usually find Politifact pretty reliable, so here’s their take:

    http://politifact.com/truth-o-meter/article/2016/sep/06/clinton-foundation-tanzania-work-farmers/

  3. Mano Singham says

    Thanks for this explanation of how foundations work. I am of the opinion that ALL tax exemptions and deductions
    for religious, charitable foundations, home mortgages, etc. should be eliminated.

  4. says

    polishsalami@#1:
    I’m surprised that the close relationship between the Clintons & Trump hasn’t been a bigger issue. There are even reports that Bill Clinton encouraged Trump to run, which is quite remarkable. The idea that Trump is running dead against Clinton can’t be entirely dismissed.

    They’re all disgusting crooks. But they’re not equally disgusting crooks.

  5. says

    brucegee1962@#2:
    The remarkable things about the Trump foundation are that a) it doesn’t seem to be get much if any money from Trump himself; rather, he hits up his rich friends to make donations, and b) it doesn’t seem to actually do much with actual charity.

    Yes, that’s a point I under-emphasized. A charitable trust doesn’t have to actually do a damn thing that’s charitable. It can exist solely as a place to collect donations and bribes, or to fund a hobby, or as a tax-free day-trading account.

    Now, it appears that the Clintons try to do some good with some of their trust. Other than providing a sinecure for Chelsea, and whatever other stuff they want for themselves. That makes sense: there’s more money in there than two normal people can spend in their lifetimes, so why not? Besides, they have shell corporations that they also funnel money off into. I guess they’re just tax cheats with hearts of gold.

    It’s instructive that journalists have been combing over the Clinton foundation for months now, and the only dodgy thing they found was the source of a few donations who might have been looking for favors.

    Yeah, that’s because 501c3 charities have to file a budget (which is never scrutinized) – the stinkier stuff is not being done by the foundation any more than Trump’s stink ends with his foundation. The shell corporations are the Clintons’ main way of accepting bribes and pay for influence; the foundation is their way of making sure Chelsea can buy a political office (or a small country) some day if she ever wants to.

    The Clintons have so much money already, it’s got to just be greed that keeps them grabbing more. Ditto Trump. They are all disgustingly corrupt people.

    Historically, we’ve had social good come from corrupt foundations. Carnegie/Mellon, The Gates Foundation (another tax shelter) The Kennedy Foundation (the Kennedy family were some of Wall Street’s biggest manipulators back in the day) – some of these were exceptionally stinky people who decided, Alfred Nobly, to try to do something good to cover up the stench of their lives.

  6. says

    if you were rich and were actually motivated to give back to the community and help the poor, you would ALSO set up a foundation, because it’s the only game in town.

    That is manifestly not true. You could set up a corporation, let it pay taxes on its profits, and have its remaining profits go to whatever good works you wanted. Or, if you wanted to REALLY help the community you’d set up a corporation for the purpose of employing people, and giving them a percentage of their profits – like a cooperative. A corporation intended to be lightly profitable, while providing medical care and good wages for its employees – would be a perpetual gift that kept on giving. And if it was a sustainable business it’d be able to grow organically and pay its taxes – unlike many other profitable American corporations like Apple, Boeing, Yahoo! etc.

    There are lots of games in town. One of capitalism’s big lies is that you have to play the game the way the capitalists would.

  7. says

    Mano Singham@#4:
    I am of the opinion that ALL tax exemptions and deductions
    for religious, charitable foundations, home mortgages, etc. should be eliminated.

    Yeah, I am too. I’ll continue to pay my taxes but I am seriously considering refusing to do so if the US continues using my money for wars of aggression.

    It seems to me that one of the levers we could pull to achieve a fair society would be to block heritable wealth. There are huge issues with that, of course, but, there are issues with anything.

    Capital gains, mortgage deductions, inheritance taxes and tax shelters: you’re completely right – they are all just ways of helping the rich get richer.

  8. Brian E says

    Foundations sound pretty much like trusts in Oz. But I’m not an expert, so might have details wrong.
    Another lurk here, but not just for the super wealthy, is negative gearing. You buy a second/third/nth house and claim the interest and whatever money the house costs as a tax deduction. The taxpayer is subsiding you building a property portfolio. House prices go up and so do rents because of this demand.
    No government will touch this lurk it as people like getting richer off the taxpayer and the media will scream that ‘battlers’ are being attacked by greedy government. A ‘battler’ is someone doing it hard, which those negative gearing aren’t, but Murdoch can dress any pig up if it benefits him and his mates.
    Of course, you have to be able to own more than one house, which means lower income people who can’t buy a house only pay the taxes (assuming they don’t fall below the tax threshold) and rents that make the richer rich.They can’t get in the property game. They often end up paying exorbitant rent in someone else’s property and paying tax that provides the subsidy. Then when you flip the house, you can avoid capital gains tax in measure that are probably analogous the the US. It’s probably small potatoes to what the super rich does, but a lot of tax money that could be building hospitals, roads, and sadly buying F-35s is redirected into the pockets of those who don’t need it.

  9. springa73 says

    Ideally, it would make sense to require that a foundation would have to demonstrate that it is seriously involved in actual charity work in order to qualify for tax exempt status. Of course, that would require a lot of extra paperwork.

  10. says

    Brian E@#9:
    I did a little reading of some of the Clinton Foundation’s tax filings. It looks like one thing the foundation owns is about $100million worth of real estate. That’s fairly typical for these types of operations: real estate is a good endowment with growth potential and can be transferred around conveniently. I know a rich person who has a foundation that owns a villa outside of Milan, worth about $10million – he’s the only person who ever stays there but in principle one of the other foundation staff might be allowed to use the place. Except there aren’t any.

    A lot of universities maintain their non-profit status by not being profitable through acquiring more real estate. After all, if you keep buying mansions you can’t be profitable. Very nice. A lot of Wall St investment banks do that, too; I knew one asset management fund that had a board room full of art – a couple million dollars worth of Frederick Remington bronzes and some stuff like that. By purchasing those sort of assets to decorate the office, they drive their profits down, and the assets appreciate in value. Or, they can be depreciated off the books and given to an executive as a reward.

    That’s another common trick: buy a Ferrari as a corporate-owned or foundation-owned asset, and let (whoever) drive it for a couple years. Once it’s been depreciated off the books, it’s no longer “worth anything” as an asset, and you let (whoever) was driving it all those years buy it for a nominal sum, like $1000. If you’re ever at a trade show and you see a booth display with a sports car: that thing is there to depreciate and was bought by the company out of the marketing budget. It’ll quietly be sold to the CEO in 5 years. A $400,000 car you paid $1000 for? It’s not taxable.

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