When the Chesapeake Bay Foundation, the Johns Hopkins University and other Maryland nonprofits want to maximize the money they can spend in pursuit of their missions, they do what many wealthy individuals and businesses do.
They open investment accounts overseas.
Many of Maryland's wealthiest nonprofits — including the University of Maryland Foundation, the Baltimore Museum of Art, The Associated: Jewish Community Federation of Baltimore and two organizations that support the Naval Academy — maintain accounts in such tax havens as Bermuda, the British Virgin Islands, the Cayman Islands and Ireland.
Also on the list are several Baltimore-area private schools, including Gilman, McDonogh and the Calvert School, according to Internal Revenue Service filings.
The accounts allow such organizations to shelter a type of investment income that would normally be subject to taxes — even for nonprofits that generally do not pay such levies. By investing in hedge funds based in those countries, they can keep most earnings beyond the reach of the IRS.
While the arrangement — which can involve investments of hundreds of millions of dollars — has come under periodic scrutiny in Congress, it is perfectly legal. And officials of several of the organizations say they are trying only to get the most out of their donors' contributions.
"It's to diversify our portfolio and get an attractive return on investment," said Hank Sanford, the chief financial officer for the United States Naval Academy Foundation and the United States Naval Academy Alumni Association. "That's the principal consideration. Avoidance of tax is not the reason we participate in it."
But as charities and other nonprofits make their critical year-ending fundraising appeals, analysts warn that investing in hedge funds overseas exposes donations to risk, could discomfit potential supporters and leaves the organizations open to attack by opponents.
Critics of the Humane Society of the United States, for example, have highlighted the animal welfare group's offshore investments.
The Humane Society "is a nonprofit," reads a post at HumaneWatch.org, a group associated with the conservative Center for Consumer Freedom. "It's not in the business of investing money in hedge funds to make a profit."
And a group that is battling the Chesapeake Bay Foundation over dredging the Susquehanna River focuses on the foundation's Caribbean holdings in an online video.
"We were just completely stunned actually, totally shocked when we found out that they have millions of dollars in offshore Cayman Island accounts. Millions," the narrator says.
Not only are the investments legal, they are also quite common among nonprofits in Maryland and nationwide, according to data provided by GuideStar. Still, the tactic is not widely known by the public, and few if any of the organizations that practice it are publicizing it.
"People would care if they knew," said Rebecca Wilkins, senior counsel for tax policy at Citizens for Tax Justice in Washington.
Investing overseas is one way that public charities, universities, foundations and other nonprofits navigate complex tax law.
Qualifying organizations are exempt from paying sales tax, property taxes and tax on returns on most investments — with one exception. They are responsible for paying tax on revenue generated from operations not related to their charitable missions.
Congress devised what is known as the unrelated business income tax more than a half-century ago to prevent charities from using their exemption to stray from their missions and compete unfairly with for-profit businesses.
Lawmakers were responding to the controversy that arose when New York University received an unusual donation: the entire stock of a macaroni company. Once the company was owned by the nonprofit school, its profits were no longer taxable — giving it a significant advantage over competitors.
The unrelated business income tax, introduced in the Revenue Act of 1950, made NYU liable for taxes on earnings from the pasta-making enterprise, and the competitive balance was restored.
As the law evolved, Congress applied it to more sophisticated business practices, including lease-back arrangements. Now, the focus is on investments in hedge funds.
Although Congress has exempted nonprofits' investment income — stock dividends, for example — from taxes, that exemption does not apply to income generated from investments financed with borrowed money.
That applies most obviously to gains from hedge funds or private equity, the managers of which typically borrow money to increase their investments — and, they hope, the size of their profits.
Tax-exempt organizations with large endowments — particularly pension funds and universities — have turned to hedge funds to increase their holdings. Investing in hedge funds overseas enables them to minimize or avoid the unrelated business income tax.
"A majority of hedge fund investors are tax-exempt institutional investors" such as pension funds, endowments and foundations, reports the Managed Funds Association, a trade group for hedge fund managers. "Countries such as the Cayman Islands, Bermuda, Ireland and the British Virgin Islands are popular choices for setting up offshore hedge funds."
A common practice is for hedge fund managers to funnel investments through what are known as blocker corporations registered in tax-friendly locales. These corporations "block" profits from the unrelated business income tax by converting them into dividends.
The University of Maryland Foundation, for example, reports in its tax forms a partnership with AG Mortgage Value Partners. The $418 million hedge fund is based in the British Virgin Islands and is managed by Angelo, Gordon & Co., a New York City firm that manages $26.5 billion in assets.
The foundation reported transferring $15 million in cash to the offshore fund for a 5.5 percent stake, according to its tax forms.
Samuel D. Brunson, who teaches tax law at Loyola University in Chicago, reviewed the foundation's documents and said that such a transaction likely involves a blocker corporation. A foundation official declined to confirm that.
During 2013, the foundation reported $236 million in hedge funds accounts in several countries.
"The investments we have in the Cayman Islands, British Virgin Islands and Bermuda represent hedge fund investments where the investment manager has chosen to organize the fund under the laws of those countries," Pamela Purcell, the chief financial officer for the University of Maryland Foundation, wrote in an email. "[T]his is common practice, legal and sanctioned by the IRS."
The IRS has approved the process. But every few years lawmakers consider changing it.
The Senate Finance Committee discussed closing what some describe as a loophole in 2012 in order to collect what some say amounted to billions of dollars in lost revenue. Others proposed ending the tax on profits that nonprofits receive from hedge funds and other debt-financed investments. The issue arose after opponents of then-Republican presidential candidate Mitt Romney raised his use of offshore accounts for an IRA.
Brunson's research published in 2012 shows that $40 billion to $70 billion in tax revenue is lost each year from taxpayers who use offshore havens. But he acknowledged that there is no good estimate of the amount that applies to charities.
Sen. Ben Cardin, a Maryland Democrat who serves on the Finance Committee, said in 2012 that the blocker "is clearly abusing its status."
"When you cross the line and are in competition with the private sector, you should pay the tax," Cardin told The New York Times. His office did not answer questions on his current position.
Despite bipartisan scrutiny, the Senate never took action.
Finance executives at large charities say they are trying to generate as much money as possible to serve their missions.
"The tax issue isn't the driving force for doing it," said Sanford, whose Naval Academy-affiliated groups each reported $7.4 million in investments in the Caribbean to the IRS during fiscal year 2013.
Sanford, a retired Navy officer, said attempts by Congress to tax such investments are "all about generating revenue for the government." He said lawmakers need to know that such measures would take money away from his groups' missions.
"If Congress changes the law, then we would comply," he said. "The overarching reason is to get as good a return as we can while mitigating risk to support the mission we're here to accomplish, which to us is supporting the Naval Academy."
Wilkins, of Citizens for Tax Justice, said nonprofits are actually jeopardizing their financial stability by investing in hedge funds or private equity, which can involve greater risk than stocks and bonds.
"You don't expect charities to be in private equity and venture capital, not only because of the leverage but because of the risk of those investments," she said. "As a donor, you have to think about how well are they being a steward of the money that I'm giving them?"
She said nonprofits should focus on how they can best spend their money in pursuit of their missions, not serve as perpetual pools of investment assets.
"Is a charity really supposed to be focused on getting the best return?" she asked.
Steven M. Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, says the tax code pushes nonprofits to use offshore accounts.
"There is a stigma attached to investing offshore, but it's routinely done," Rosenthal said. "This is a common planning technique."
Critics of some nonprofits have sought to exploit the stigma — as in the case of the Center for Consumer Freedom and the U.S. Humane Society.
"Donors think their money is being put to work right away, not socked away offshore," said Will Coggin, senior research analyst for the center, which receives funding from the food industry. "Most donors would say, 'Why can't you spend some of that money right now helping pets?'"
A spokeswoman for the Humane Society called such comments "irresponsible."
"Of course the Humane Society of the United States invests its funds, with the goal of getting the best return possible on those investments and putting the returns toward taking on the biggest fights to protect animals," spokeswoman Heather Sullivan wrote in an email. "Whether it's a stock market or mutual fund index or other investment, some of those funds are global."
The John Hopkins University reported $776 million in investments in the Central America-Caribbean region in fiscal 2013, which accounted for two-thirds of the $1.17 billion the school reported in international activities.
Tracey A. Reeves, a university spokeswoman, identified the Central America-Caribbean investments as "hedge funds and/or private partnerships" that are "structured as Cayman Islands exempted" limited partnerships.
The Baltimore Museum of Art reported $1.6 million in investments in the Caribbean, with accounts in the Cayman Islands and the British Virgin Islands.
"The BMA has limited investments in entities located in the Cayman Islands and the British Virgin Islands and has fully disclosed all investment information required by law," museum communications director Anne Mannix-Brown said in a statement. "These investments, as well as all of the other BMA investments, are managed in compliance with all federal and state regulations, including, but not limited to the Maryland Uniform Prudent Management of Institutional Funds Act.
"Beyond that, we limit discussion of our investment strategy to the staff, Board of Trustees, and our investment service providers."
Brunson, the Chicago law professor, says Congress should either stop taxing debt-financed investments or prohibit the use of offshore accounts to avoid the tax.
"I don't like the idea of forcing them to go through these loops to do it. It sets these groups up for criticism," Brunson said. "I can understand the unease with it. We agree tax havens are bad, but when we think about them we usually think of the rich doctor hiding money from the IRS in the Cayman Islands. This strikes me as one of the least bad uses of tax havens."
The Chesapeake Bay Foundation reported $4.7 million in overseas investments in fiscal 2013, with accounts in the Caymans and the British Virgin Islands. That number declined to $2.5 million for the fiscal year that ended June 30.
"We only have one company now still in our portfolio" that is registered offshore, said Will Baker, the foundation's chief executive. The change is a response to the performance of investments, he added.
Cliff Rossi, who teaches finance at the Robert H. Smith School of Business at the University of Maryland, became a supporter of the Chesapeake Bay Foundation three years ago when he and his wife included the group in their estate planning.
Rossi said he would rather see his donations invested to maximize profits that the foundation can then use to pursue its mission than see it taken by the government.
"This is a practice that's been around for quite some time," Rossi said. "Many nonprofits use it. It's a tax minimization strategy. ... I have no problem with them making those types of investments."
Select Md. nonprofits investing overseas
OrganizationCaribbean-Central America Investment
Johns Hopkins University $776 million
University of Maryland Foundation $236 million
The Associated: Jewish Community Federation of Baltimore $82 million
University of Maryland Medical System $79 million
Gilman School $31 million
McDonogh School $16 million
Carroll Hospital Center Inc. $15 million
Baltimore Community Foundation $9 million
Calvert School $8 million
United States Naval Academy Alumni Association $7 million
United States Naval Academy Foundation $7 million
Johns Hopkins University Retiree Medical Benefits Trust $6 million
Chesapeake Bay Foundation $5 million
Baltimore Museum of Art $2 million
- Colleges and Universities
- Medical Research
- Politics and Government
- United States Naval Academy
- U.S. Congress
- Internal Revenue Service
- Chesapeake Bay Foundation
- Johns Hopkins University
- Baltimore Museum of Art
- New York University
- Humane Society of the United States
- The Associated: Jewish Community Federation of Baltimore
- Ben Cardin
- Loyola University Chicago
- Robert H. Smith