CHARITY SCHEME A SCAM? IRS WATCHES: A FOUNDATION PUSHES ENVELOPE, ENRICHING ADVISERS IN THE PROCESS

The world of charity could be headed down a most uncharitable path.

A growing number of individuals are embracing a controversial tax strategy under which they form their own public charities, make tax-deductible donations and even pay themselves and family members for their philanthropic efforts. Some are also directing charitable dollars to financial advisers as payment for helping raise contributions.

The strategy, aimed primarily at the wealthy, is being promoted mainly by the Falls Church, Va.-based National Heritage Foundation, which acts as a clearinghouse for what are called “donor-directed” or “donor-involved” funds.

Some charity officials say they are outraged by the approach, fearing it will bring down the wrath of federal and state governments upon the entire philanthropic community and give the public another reason to mistrust them.

“When you cut right through to it, it’s just wrong,” says Jeffrey R. Lauterbach, chairman of Wilmington, Del.-based personal trust manager American Guaranty & Trust Co. “It’s a way for people to have their cake and eat it, too.”

The fears are not unwarranted. Marcus Owens, director of tax-exempt organizations at the Internal Revenue Service, says the agency is wary of donor-involved charities. Abusers could inflate the amount of contributions eligible for tax deductions or even improperly use the charities as shells to pay for a child’s college tuition or generate personal income.

“There are abusive cases out there, and we are looking for them,” Mr. Owens says, declining to name names. “I have concerns over investment policy and expenditure controls.”

A handful of organizations market donor-involved funds, but at the center of the controversy is the non-profit National Heritage Foundation, which is selling the strategy aggressively and gathering tens of millions of dollars in donor funds.

Its president, J.T. “Tick” Houk III, says much of the fuss is being made by jealous rivals who are competing for the $145 billion that Americans pour into charities annually.

“A lot of charities think we’re taking money away from their current donations,” Mr. Houk says. “Maybe we just have a better mousetrap.”

Here’s how that mousetrap works: For a one-time application fee of $285, a person establishes a donor-involved fund and claims a tax deduction for the amount of money deposited. The donor is then encouraged to build the fund quickly by getting as many friends and family members as possible to commit to contribute at least $1,000 over the course of the next 12 months. In return, they get to become members of the fund’s “board of regents.”

The organization, which claims to have more than 3,000 public foundations under its umbrella, charges the funds a marketing fee of 2.5% on each incoming donation. Foundations with more than $10,000 in assets are also charged an annual management fee of 2%.

Unlike private foundations, public foundations are not required to disburse a certain percentage of their assets annually. That means a donor who establishes a fund through National Heritage may allow assets to accumulate indefinitely. The foundation says it holds all funds in money market or mutual fund accounts until they are disbursed.

One of the most troubling aspects of the organization’s approach, critics say, is that it allows donors to pay themselves — and family members — for services they perform for the charity they have set up. According to the National Heritage Foundation’s website at www.nhf.org, a person as young as 14 is eligible for “reasonable compensation.”

The group also suggests that retirees get paid by the public foundation for “volunteering” at existing charities. The company’s web site spells out the payment strategy:

“Coach of a high school team, usher in church, teacher or teacher’s aide in a school — all these activities and many more can be compensated with taxable income by a foundation at NHF — either in the form of a full salary (in this case you would be regarded by the participating charity as a volunteer), or in the form of a salary supplement in the case that the charity is paying you what they can afford, but NHF determines it is below `reasonable compensation.’ ”

Mr. Lauterbach, whose American Guaranty & Trust manages a charitable gift fund that prohibits donor-involved funds, is no fan of National Heritage’s tactics. “It’s a real stretch to believe that people would not act in their own self-interest to take advantage of this.” he says.

Carol G. Simonetti, director of services at the Council on Foundations in Washington, D.C., agrees. “It just doesn’t smell right to me.”

National Heritage officials adamantly defend the approach, saying the foundation closely monitors donor-involvement to make sure no one is benefiting beyond a reasonable level. But even they are willing to concede there is at least some wiggle room for misuse.

approaching $100 million

“What corporation knows whether all its employees are not all out playing golf and not doing what they say they do?” says co-founder and executive director J.T. “Dock” Houk, father of the group’s president.

Donors apparently are flocking to NHF. A Dun & Bradstreet report last May said the group’s roster of 3,000 foundation accounts was up from 1,587 at the end of 1997. Contributions skyrocketed to $51.6 million in 1997, according to NHF’s latest IRS filings, from $8.5 million a year earlier. Contributions in 1998 are expected to approach $100 million.

“We’re growing by leaps and bounds,” says Tick Houk.

Much of National Heritage’s growth is fueled by financial advisers. The group works with advisers through its marketing arm, the National Association of Charitable Estate Counselors, with which it shares the Falls Church address.

NHF’s website claims nearly 3,000 members in the estate counselors’ group, though Tick Houk last week said the total is more like 1,500. While association membership is marketed toward financial intermediaries, it is open to anyone who is willing to pay the $100 membership fee and has a “heart for charity,” according to the website.

Through a program known as the Harvester Plan, donors are encouraged to set aside 20% of their fund’s assets into a “special nominating account” which may be used to pay financial planners, accountants and other go-betweens.

“It’s seed capital,” explains Ronald D. Philgreen, who founded NHF along with Dock Houk. “We reinvest that money and use it to build a second harvest and a third harvest and a fourth harvest …”

Mr. Philgreen, executive director of the Leawood, Kan.-based Charitable Tax Planning Center Inc., says the Harvester plan recently received “some type of letter of approval” from the National Committee on Planned Giving, a Washington, D.C.-based trade association.

But Tanya Howe Johnson, the committee’s executive director, says no way. “That is absolutely untrue,” she says. “We have not commented on anything to do with the National Heritage Foundation at this time.”

Only members of the estate counselors group are allowed to set up NHF-approved foundations on behalf of donors and they may bill the newly formed charity — instead of the donor — an hourly rate for their services. The adviser may collect 40% of a 2.5% “marketing” charge that NHF imposes on donations flowing into the foundation.

National Heritage also allows advisers to collect a fee for managing their client’s foundation assets, provided the adviser is registered with the Securities and Exchange Commission. And they may also receive up to 50% of NHF’s administrative management fees.

That’s not all. To keep bringing advisers into its fold, along with more charities set up by individuals, the foundation allows some advisers to recruit others — paying them up to 1.5% of the assets brought in by those recruits.

“I do not believe in volunteer fund-raisers,” says Dock Houk, a Fulbright scholar and Brown University graduate who speaks with the zeal of a street preacher. (Indeed, the former economics teacher at Liberty University, the Lynchburg, Va., institution run by televangelist Jerry Falwell, insists that NHF-approved foundations do not make charitable gifts that “encourage violence, promote atheism or compromise the freedoms guaranteed in our Constitution.”)

earlier controversy

Mr. Houk argues that you get what you pay for. “I’ve seen volunteer fund raisers really screw up a gift plan,” he says. “If I want the financial community to work, I’m going to have to pay them.”

This isn’t the 66-year-old Mr. Houk’s first brush with controversy. National Heritage is also a major promoter of charitable split-dollar insurance plans, a strategy for paying life-insurance premiums with tax-deductible dollars which is currently being investigated by the IRS. To head off potential adviser jitters, the foundation notes on its website, and Tick Houk confirms, that it maintains at least $200,000 in a legal defense fund to fend off trouble from the IRS or anyone else.

Back in 1983, the IRS withdrew the tax-exempt foundation status of an earlier version of NHF, terming it nothing more than a collection of private foundations operating as a public charity. (Public charities are more loosely regulated and have less stringent reporting requirements.) It alleged the organization overpaid financial advisers who brought in contributions, and allowed donors to reap too many benefits through their affiliation with a charity.

The organization challenged the IRS in the U.S. Court of Claims and in 1987 won back its tax-exempt status. In the interim, the foundation’s board had ousted Mr. Houk and changed its name to the National Foundation Inc. (That organization also offers donor-involved funds under its own name and that of the Christian Community Foundation. Richard Houston, president of the two groups — which share the same Woodland Park, Colo., address –declined to comment on National Heritage or its leaders.)

In 1994, Dock Houk created the current National Heritage Foundation and has since used it as a platform to promote his vision of a new approach to philanthropy.

“What we’re trying to do is fairly revolutionary,” he says. “There are some elements to it that one must understand and agree with, or one would be an opponent.”