The Zuckerberg Charitable Pledge and Giving from One’s Wealth

Mark Zuckerberg and his wife, Priscilla Chan, recently pledged to donate 99 percent of their Facebook shares to charitable purposes over their lifetimes. They are doing it through the Chan Zuckerberg Initiative, which uses a limited liability corporate structure.

Why not give to an IRS-approved charity, or a foundation created by Zuckerberg and Chan, instead? Two reasons leap to my mind, both shaped by nonprofit law. The first, which I fail to see in most commentary to date, is that generous lifetime giving by the wealthy can’t get much of a charitable deduction no matter how structured. Second, the Zuckerberg-Chan pledge falls into a class of efforts sometimes labeled “fourth sector” initiatives, which give much greater flexibility for how the money is used, including combining charitable and business purposes and lobbying for a favored cause—essentially what private individuals can but pure charities cannot do.

Economic Income, Realized Income, and the Charitable Deduction

In studies examining the behavior of those with significant wealth, other researchers and I show how little income they tend to realize, often 3 percent or less of the value of that wealth. That doesn’t mean the investors have earned such low rates of return. In fact, many like Mark Zuckerberg became millionaires or billionaires because they got very high returns. Most of their money, however, tends to be in stock or a closely-held business and, especially for those with only a few million dollars in total wealth, residences and vacation homes. As long as the wealthy don’t sell those assets, they won’t “realize” for tax or other accounting purposes the true economic returns or gains they achieve. And those gains can be substantially more than 3 percent: from 1926 to 2014, including during the Great Depression and Great Recession, stocks produced an average annual return of about 10 percent before inflation.

Related research examining the charitable activities of such wealthy individuals shows that most delay a huge portion of their giving until death. That is, they give from the wealth of their estates, not the income of their lifetimes. Why? Because tax law provides very little incentive to give huge donations to charity during a lifetime. Let’s suppose that Mark Zuckerberg and Priscilla Chan normally realize as income 2 percent of their estimated $45 billion wealth, or $900 million, this year. The charitable deduction is limited to 50 percent of yearly income, which in Zuckerberg and Chan’s case is $450 million; it’s only 30 percent ($270 million) if they want to give to foundation. Thus, if Zuckerberg and Chan give away more than 1 percent of their wealth each year, they run out of allowable charitable deductions. If in an average year they earn 10 percent on their wealth and give away only 1 percent, they are still accumulating much faster than they are giving it away, unless they consume billions annually.

Running out of charitable deductions doesn’t mean that the wealthy gain nothing from giving away money directly to charities earlier in life. Once assets are transferred to a charity, the donors don’t have to pay taxes on the income earned from those assets. But donors such as Zuckerberg and Chan would achieve only modest tax savings from early gifts to charity as long as their taxable income from the alternative remains a small percentage of their wealth. What also might be in play here, and I don’t fully know, is that the charitable side of the Chan Zuckerberg initiative will yield enough losses, transfers, and sales to needy individuals at below-market cost to offset any taxable income otherwise earned on the business side, so it can effectively avoid income tax just as well as an outright charity.

For Benefit Corporations and the Fourth Sector

So limits on the advantages of a charitable deduction provide a significant impetus for wealthy individuals to pledge money for charitable purposes without necessarily giving it to a charity. Donors may also think the flexibility they gain is substantial relative to any potentially modest tax costs. Giving to charity later is always an option, thus avoiding estate tax; meanwhile, other options haven’t been foreclosed.

Among the additional options at play is combining nonprofit and business activity. Among the many efforts of this type that get complicated in a pure charity setting are raising private equity; sharing real estate investment returns with low-income residents; running a business centered around training its workers and building up their equity rather than making profits for investors; investing in new drug research and pledging that the public, not investors, will garner any potential monopoly returns from some successful patent; or investing in green energy by granting some risk protection to private capital partners; and garnering research and development tax credits.

Some states have tried to create special rules applicable to certain “for-benefit corporations” that allow shareholders and charities to share returns. But, for the most part, the walls surrounding charitable money can’t be torn down. Federal and state tax and other nonprofit laws protect money that now essentially belongs to the public (with the charity as fiduciary), not to the donors.

If donors aren’t worried about getting a charitable deduction up front anyway, as is likely the case for Zuckerberg and Chan, the easiest route is to create a potentially profit-making limited-liability business. Meanwhile, donors can engage in all sorts of ventures without having their lawyers shouting “Stop” to each new creative idea because it might violate some charitable law. At the same time, Zuckerberg and Chan need a new entity since they can’t pursue their charitable pursuits directly through Facebook without soon running into problems meeting that corporation’s obligations to other shareholders.

If Zuckerberg and Chan decide that they want to lobby government, they also can avoid any limitation imposed on foundations or other charities.

These types of private initiatives, sometimes labeled as a Fourth Sector, push society in new, exciting, and yet-to-be-determined directions. As I’ve discovered when I raise money for charity, people will often consider giving away much more when asked to think about giving out of their wealth, not just their realized income. Fundraisers, take note: I don’t think we’ve even begun to tap this way of encouraging giving. Also, people often see new possibilities for enhancing charitable purposes when not confining themselves within the walls surrounding a typical charity, with entrepreneurs and venture capitalists often especially excited by the new adventure. Zuckerberg and Chan are merely two of the richer faces giving new attention to these broader movements.



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