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For Investing With Madoff, Private Foundations Could Face Tax Fines
By LYNNLEY BROWNING
Published: February 11, 2009
Foundations that lost billions of dollars investing with Bernard L. Madoff have another reason to fret: they could be socked with sizable fines for failing to exercise sound judgment.
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Times Topics: Bernard L. Madoff | Ponzi Schemes
Under an obscure tax rule, private foundations can be penalized for failing to vet their investments properly, to heed red flags or to diversify prudently. While foundations are exempt from federal income taxes, they are subject to this excise tax, intended to keep them from taking outsize risks that could threaten their very survival.
“The I.R.S. could well assert these taxes,” said Marcus S. Owens, a tax lawyer and partner at Caplin & Drysdale in Washington, who headed the agency’s exempt-organizations division for 10 years.
The penalty can equal 10 percent of the amount invested during the tax year in question. If the foundation fails to try to recover the funds, there is an additional 25 percent penalty.
The foundation’s officers, directors and trustees also face a 10 percent penalty, and a 5 percent additional penalty if they ignored red flags or did not thoroughly vet Mr. Madoff’s investments and proposals. While the fines for individual managers are capped at $10,000 and $20,000, respectively, they are levied per investment.
At least 147 private foundations invested with Mr. Madoff, according to an analysis by Daniel E. Smith, the president of Benefit Technology Inc., a software company in Miami. Some of them, according the analysis, bet the farm — which some tax lawyers say could signal the lack of due diligence and fiduciary responsibility that the tax provision is meant to ensure.
Mr. Owens estimated the potential penalties at around $1 billion for all those invested with Madoff.
Though the I.R.S. has taken a gentle approach to pursuing tax penalties on charities, he suggested that might change with the Madoff case. “It’s pretty rare for a private foundation to make bad investments of this sort,” Mr. Owens said of the agency’s track record. “Most transgressions deal with excessive compensation or grants used for a noncharitable purpose.”
A spokesman for the I.R.S. declined to comment.
Among private foundations, the Picower Foundation, of Palm Beach, Fla., appears to have had the largest exposure to Mr. Madoff, investing virtually all its assets, more than $958 million. Others include the Carl and Ruth Shapiro Family Foundation, also of Palm Beach, which put its entire $199 million with Mr. Madoff; the Betty and Norman F. Levy Foundation of New York, which put in nearly all its assets, more than $244 million, and the Chais Family Foundation, of Encino, Calif., which appears to have lost all its $178 million.
Many, if not all, of the foundations would probably assert that they were fleeced in what prosecutors say is the world’s largest Ponzi scheme. As proof, they might point out that many of their donors also lost considerable personal money investing in this manner.
Still investors of all types, ranging from nonprofits to individuals to corporations, appear to have relied heavily on Mr. Madoff’s reputation and word-of-mouth referrals, which could suggest a lack of fiduciary responsibility.
Private foundations are typically created by a single family or donor, and exist to make grants. The other big piece of the nonprofit world is public charities — college endowments, hospitals and the like — with a broad array of donors.
Because private foundations have a limited base of donor funding, they have been subject for decades to the penalty excise tax, which is intended to encourage prudent investing decisions.
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