When my article on Pooled Income Funds (PIFs) was originally published in 2015, I got a lot of feedback. Since then there have been two presidential administrations, and the current one proposes far-reaching changes to the tax law. Even if only some of President Biden’s proposed changes to capital gains taxes come into effect (e.g. higher tax rates, carry-over base), the PIF will be an even more attractive strategy than it already is.
PIFs are essentially charitable foundations that “bring together” irrevocable gifts from one or more individuals, a family, or a charity. Very popular at launch, PIFs have fallen out of favor in recent years as their interest and dividend rates have been at all-time lows. The combination of low returns and reduced tax deductions lessened their broad appeal.
The tide seems to have turned again, however, as savvy practitioners set up new PIFs to take advantage of the current low federal rates in force – a published federal rate that reflects a benchmark used for many situations, including personal lending.
In accordance with Internal Revenue Service regulations, charity tax withholding for a PIF is calculated using a complex formula based on the highest return on assets within the PIF over the past three years. Older PIFs (with high interest rates) result in a small deduction as the expected return for the donor is higher under these conditions. As a result, the amount that remains for the charity is less. Given the flexibility and control you have in a Nonprofit Rest Trust (CRT), there’s really no good reason to compromise and use an older PIF.
According to the IRS, If a PIF existed for less than three taxable years immediately prior to the year in which the transfer took place, the highest rate of return is determined:
1. First, by calculating the average annual federal mid-term applicable rate (as described in Section 7520 of the Internal Revenue Code and rounded to the nearest 2/10) for each of the three tax years preceding the year of transfer.
2. Second, by lowering the highest annual rate by 1% in order to maintain the applicable rate. (TThe Fed only publishes the interest rate in November or December for the following year. For 2021 it is currently 2.2%.)
Since rates have been extremely low lately, income tax deductions are being driven up proportionally. While charitable giving isn’t usually motivated by income tax deduction, it doesn’t hurt to have a larger deduction.
Real world example
I was recently brought in by a family of entrepreneurs to help them negotiate the sale of their $ 5 million business that was an S Corporation (S Corp). The family have been very generous and will donate $ 2 million to charity when the sale was completed. The family counselors tried to use a CRT to accomplish their charitable goals while saving some taxes. However, you missed a few important things. First, cathode ray tubes are not qualified S-Corp shareholders and, second, S-Corp status would be revoked if the company’s shares were brought into the CRT.
While this was not inherently bad, the main problem – as with many private sales – was that the buyer did not want to buy the S-Corp stock; the buyer wanted buy the assets.
There didn’t seem to be a good way for either party to win. However, a post-sale post to a new PIF indicated that a $ 2 million cash deposit would result in a deduction of approximately $ 1.7 million based on the current age of the family member / donors. The deduction would offset much of the income tax liability incurred on the sale and save the advisory team from complications and headaches. The buyer could buy assets (not stocks) and the seller would get the full offer price he wanted.
Additionally, recent opinions about what “pooling” is to qualify for PIF status have led several commentators to agree that “more than one” life is enough. That is, a new PIF can be set up for a very targeted group of donors who may have a specific investment policy for the beneficiary (or the beneficiary’s investment manager) to follow.
While maintaining many different pools may seem problematic for a charity, current technology makes it a lot easier than it used to be. Additionally, charities need to become more creative and flexible to attract donors in today’s highly competitive giving environment. And there are several donation-friendly and advisor-friendly organizations that see a tremendous opportunity.
PIFs vs. DAFs and CRTs
Numerous surveys show that donors want more flexibility and control – a trend supported by the explosive growth of Donor Advisory Funds (DAFs). However, DAFs do not return income to the donor. And while CRTs allow the donor to receive an income, they often fail the 10% residual test due to the age of the donor. Involving one’s own children in the CRT is almost always out of the question. PIFs are somewhere in the middle. Like CRTs, PIFs return income to the donor, and they do not have a 10% residual qualification, which enables an income opportunity over several generations. Finally, PIFs offer a substantial tax deduction.
While income in a PIF is often limited to rents, royalties, dividends, and interest – the typical income definitions for nonprofit trust companies – there is a newer mindset to argue this something The profit made after the donation of the invested assets should also be counted as income. Certainly, short term profit shouldn’t be a problem. Some trustees may be willing to allocate a portion of long-term profits (usually less than 50%) to income. This should greatly stabilize or normalize cash flows and make the PIF more like a CRT. In addition, PIFs are not tax-exempt trusts like CRTs, so qualified investment advice is very important.
Setting up a new PIF is relatively inexpensive from a donor’s point of view. If fees are incurred, they are likely to be more than offset by the PIF’s withholding tax and capital gains tax avoided through the PIF. I’m not saying you need an “e-PIF-any”, but consultants should always take the time to familiarize themselves with strategies that will help them better advise their clients.
Randy A. Fox, CFP, AEP is the Founder of Two Hawks Consulting LLC. He is a nationally renowned wealth strategist, philanthropic estate planner, educator, and public speaker.