Philanthropic Strategies For Entrepreneurs And Business Owners

In a nation that leads the world in private philanthropy,¹ entrepreneurs as a group rank consistently among the most generous segments of the population. Charitable giving by entrepreneurs reached a peak in 2007, when the 2008 Bank of America Study of High Net Worth Philanthropy found that business owners had donated an average of nearly $270,000 to charity — more than double the average of what other wealthy households were giving at the time.² And though the financial crisis and recession decreased what they could allocate to charity, entrepreneurs still donated more in 2011 than did any other group with the exception of those who had inherited their wealth.³ And the focus of entrepreneurs' generosity is spread widely among causes ranging from the environment and education to arts and culture.

Motivations to give are always personal and defy easy generalization. Still, Ramsay Slugg, Managing Director, Wealth Strategist, National Wealth Planning Strategies Group, U.S. Trust, sees a natural connection between entrepreneurs and philanthropy. "Entrepreneurs are, at their core, in the business of solving problems," Slugg says. "They find a problem, they come up with a solution and they build a business around that. That's the same thing charities do. There's a problem and a group of people come together to try to find a solution."

At the same time, it's hardly surprising that entrepreneurs are highly individualistic when it comes to philanthropy. Entrepreneurship depends on creative thinking, and "there's no one-size-fits-all strategy," Slugg says. "Different people are going to do things in different ways." That same attitude leads business owners to embrace diverse giving approaches and vehicles.

Active Involvement

Financial solutions are only part of the philanthropic story. Giving applies to time as well as to money, and entrepreneurs and other wealthy donors tend to be as generous with the former as with the latter. In fact, in 2015 half (50 percent) of wealthy individuals volunteered their time and talents to charitable organizations they care about⁴ - twice the rate of the general population (25 percent)⁵, according to the 2016 U.S. Trust® Study of High Net Worth Philanthropy.

"Business owners tend to throw themselves into their philanthropic ventures as enthusiastically as they do into building their businesses," says David Ratcliffe, Managing Director, National Philanthropic Expert – Thought Leadership and Research, Philanthropic Solutions, U.S. Trust. “They bring to the table all of their talents and entrepreneurial experience." And because entrepreneurs understand the concept of risk and reward better than most people do, and because they're old hands at making the best use of limited resources, they are often driven by a desire to make sure the charities they support handle money wisely and make forward thinking decisions — in other words, that they behave like successful businesses. Thus, even when entrepreneurs may not seek a highly visible role with a charity, they'll often accept a seat on the board because of the opportunity it gives them to help shape and monitor the group's operations.

Community Spirit

The primary philanthropic motivation for many entrepreneurs is a deep sense of connection between themselves, their companies and employees, and the communities in which they live and work. "They tend to be very supportive of volunteerism," Ratcliffe says. "They get on board with a walk for cancer or diabetes and open that opportunity to their entire workforce. They may even match donations made by employees."

Such gestures “send a message to employees that the owner has a philanthropic spirit and wants to pass that along,” Ratcliffe adds. “And encouraging employees to be engaged in that way can lead to a better functioning team at work.” Indeed, enlightened entrepreneurs often seek philanthropic goals that, in the best sense, benefit all concerned. Ratcliffe cites the example of a group of business owners in a city known more for recreation than for culture, who banded together to support a first-class public library and an arts center.

“In order to attract a specific type of talent to their firms, to convince them to move their families, they needed a vibrant cultural community,” he says. “Part of their motivation was philanthropic and part business. They recognized that those improvements would be good for the city and good for them.”

Direct Giving

When it comes to structuring the financial approach to giving, entrepreneurs, especially during the early stages of their careers, may prefer the directness of simply writing a check or offering a one-time gift of stock when the spirit moves them. That approach has the advantage of minimal paperwork and none of the managerial costs or responsibilities that come with more involved methods, such as launching a philanthropic foundation. It also enables donors to be highly focused by writing checks to meet very specific needs, Slugg says. In particular, direct giving often appeals to sole proprietors or small partnerships, because “what comes out of their own pockets and their company’s pockets is one and the same thing,” Slugg says. “You give the money and then you have no further responsibility.”

Yet, that very lack of an ongoing commitment means the donor tends to have relatively little control over what happens to the money once the gift is made. The more successful and established entrepreneurs become, the more likely they are to want a more formal mechanism for giving that helps them support a sustained philanthropic strategy.

Private Foundations

Entrepreneurs looking for the greatest degree of control may choose to start a private foundation, which is a separate charity set up and managed by an individual or a family. A foundation can institutionalize your philanthropy, Slugg says, with founders and family members on the governing board able to determine both the foundation’s underlying strategy for giving and how and when the money is actually spent. And, because its operation can be handed down from one generation to the next, a foundation can help build an enduring philanthropic legacy.

To get that control, however, philanthropists who establish their own foundations must accept certain limitations. Foundations are among the least tax-advantaged means of giving, offering lower deductions on gifts than are allowed for other philanthropic vehicles, and foundations must pay 1% to 2% tax on their annual investment income and file their own tax returns. Moreover, the finances of private foundations are open to public inspection, and a foundation can be comparatively expensive to set up and maintain.⁶

Donor-Advised Funds

As a sort of middle ground between direct giving and the formality of a private foundation, donor-advised funds (DAFs) offer entrepreneurs and other philanthropists both tax advantages and a degree of control over where the money goes.

With a DAF, donors contribute assets to a nonprofit fund administered by a charity that acts as custodian. Then, donors can recommend how and when those funds will be distributed. While the recommendations aren’t legally binding, the custodian usually follows donors’ wishes, so long as the recipient is an approved nonprofit.

Among the advantages to donors is an immediate tax deduction for the gift. Yet, because DAFs don’t require an annual payout (as foundations do), one can take one’s time deciding how to distribute the money. Because the donor doesn’t have to actively manage the fund, a DAF is usually less expensive than a foundation. And because DAFs are not open to public inspection, they offer a greater degree of privacy than foundations provide.

Split-Interest Giving

Philanthropy doesn’t happen in a financial vacuum. A split-interest trust can enable entrepreneurs to support charitable causes while at the same time addressing personal tax, income or estate needs. Split-interest trusts serve two interests — those of the giver and of a charity — and can take two basic forms. Both charitable remainder trusts (CRTs) and charitable lead trusts (CLTs) deliver money to a philanthropic organization while also providing a financial benefit to oneself or one’s heirs. But the two kinds of trusts achieve those goals through approaches that are essentially opposite — and those differences can make one or the other a better fit for your particular financial situation.

In the case of a CRT, the trust assets are used to generate current income for the donor or designated beneficiaries, continuing either for a set number of years or for a lifetime. Then, when the income interest expires, the remainder goes to the charity, which again can be a public charity or a private foundation. (The tax deduction depends on the projected value of that remainder.)

With a CLT, by contrast, one places money in a trust set up to provide annual support to a charity of one’s choosing. Depending on how the CLT is set up, the donor may get an income tax deduction, which is useful to offset income from a large taxable transaction. Or the donor may choose to forgo the income tax deduction and use the CLT more as a method to transfer wealth in a gift- and estate-tax-efficient manner. In either case, the annual payment to charity may go either to a public charity, or to the family’s foundation or donor-advised fund. At the end of the trust’s term, the founder of the trust or his or her heirs receive the remaining trust assets.

Within these broad definitions, however, both kinds of split-interest trusts can be customized to help meet a wide variety of specific needs.

A Customized Strategy

Even beyond what one hopes to accomplish with his or her giving, the approach is directly influenced by the underlying structure of one’s business: whether a C corporation, which pays income taxes as a separate taxpayer; an S corporation, in which income and expenses flow through shareholders; or a traditional partnership.

Even among those classifications, keep in mind that every business, like every family, is unique. “Say you’ve got a family-owned car dealership or manufacturing company. Maybe the real estate it sits on is owned by another entity within the family,” Slugg says. “And then there’s inventory, or perhaps a separate piece of property. Each of these considerations can influence how and in what way you structure your giving.”

Especially at a time when government policy may lead to greater tax sensitivity, the proper structure may help donors reach such goals as maximizing gifts, bringing efficiency to their tax picture, or providing regular income for them or their beneficiaries.

For example, a business owner who has reached a point where he or she is ready to sell a business could face capital gains taxes. As an alternative, the owner might consider placing the company or a portion of the company inside a charitable remainder trust. As a nonprofit trust, the CRT can then sell the company without paying capital gains at time of sale. The purchaser gets the company, the former owner or a beneficiary gets steady income (subject to income taxes), and a designated charity gets the amount left over when the trust expires.

But there are restrictions. The owner can’t arrange to sell the company until it’s part of the trust; and any business income the company earns while in the trust will be taxed as unrelated business income (UBI). Careful planning could lessen the impact of those restrictions.

Consider a hypothetical couple, the Greens, who have built a successful seasonal business open from March through November. They’re ready to sell and are aware of a buyer likely to offer top dollar. Yet, since they built the company from nothing, if they simply negotiate a sale, they will be liable for hefty capital gains taxes.

Instead, the Greens place the company in a CRT. They do so in the winter, when the company is dormant and not generating income. As soon as the company is part of the CRT, the couple reaches out to the potential buyer to work out a sale agreement.

Working diligently, they close the deal before the business opens for the spring. The trust pays no capital gains on the sale, and, since there was no income while the company was in the CRT, there’s no unrelated business income tax. The couple gets a deduction based on their expected gift to the charity, as well as a regular stream of income for themselves. Best of all, a charity they care about stands to receive a substantial sum.    

Of course, these approaches are complex, and it is important to move carefully and seek guidance to ensure full compliance. And there’s no need to restrict yourself to just one method of giving. “It’s not an either/or proposition,” Ratcliffe says. “The solution to your philanthropic needs might be a combination of approaches.”

For example, an entrepreneur who has a private foundation might start a charitable lead trust to support a charity while also using the resulting tax deduction to mitigate an event such as the sale of a business that generates large capital gains. “Certain assets work better in particular strategies than others do,” says Ratcliffe. “It’s all about what you are trying to accomplish, what the nuances of the specific assets are and how they fit into your overall strategy.”