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Monday September 16, 2019

Case of the Week

Lucky Lucy Lindstrom's "No Self-Dealing" Charity


Lucky Lucy Lindstrom finished college and headed west. She started as a financial analyst with a large company in Seattle. After just four years, she became a Registered Investment Advisor (RIA) and began advising clients. Lucy also managed her own investments. With her keen insight into financial markets, Lucy soon began to move from traditional stocks and bonds into futures and commodities markets. Lucy was so successful in these markets that she now manages only her mega-dollar personal portfolio.

Somewhat late in life, Lucy discovered the wonderful world of philanthropy. She volunteered at her favorite charity and learned that giving someone in need a helping hand is even more gratifying than making another million in the futures market.

Lucy had invested $1,000,000 in stock in a Canadian oil "wildcatter" with the name Northern Long Shot, Inc. This company has been drilling new exploratory wells in the far north. Recently, the stock rose from the $1 per share that she paid to over $5 per share. Lucy was delighted with her gain and decided she wanted to give the $5,000,000 to a charitable foundation to help those in need.

Lucy discussed options with her attorney and her favorite charity. Lucy was very interested in a private foundation. She asked her attorney for reasons to select a private foundation. Her attorney noted that private foundations are more expensive to operate, appreciated gifts are deductible only up to 20% of adjusted gross income (AGI) and deductions for gifts of real estate to a private foundation are limited to cost basis. He also explained that there is usually a 2% excise tax on investment income and that private foundations are subject to various rules on self-dealing, minimum distributions and excess business holdings. However, a private foundation would give Lucy full control.


Lucy said, "Wow! There are a lot of negatives about private foundations. So why set up a private foundation? And if I fund a private foundation, can I manage the investments and receive my normal Registered Investment Advisor payments from the foundation?"


Her attorney responded and noted that private foundations are subject to the Sec. 4941 self-dealing rules. There is an incidental exception for payments to donors, family members and other disqualified persons. However, the compensation must be for necessary services and must be reasonable.

For the private foundation, the additional services for management of the portfolio are necessary. Lucy's proposed level of compensation is reasonable and comparable to that received by other individuals in similar circumstances. Thus, the Sec. 4941(d)(2)(E) exception would apply and compensation to Lucy will be permitted.

However, her attorney suggested that there was no need to run any risk with the Lindstrom Private Foundation. Lucy does not need added income, and the foundation fees will not be a large part of her annual income. Therefore, Lucy decided to provide the portfolio management services to the Lindstrom Foundation without compensation.

Published September 14, 2018

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