Cash Gifting Watchdog

Bypassing the hype and getting the facts about cash gifting can be hard. The first article in our Cash Gifting Basics series briefly explores the background and operation of cash gifting programs.

What does “cash gifting” mean?

If you’re at an age where estate planning has become a concern, you’ve undoubtedly been told about “cash gifting” by your accountant or attorney. Gifting has been an acceptable form of wealth sharing for centuries, and is in fact approved by the IRS under Tax Code Title 26, Sections 2501-2504 and 2511.

Cash gifting has been used legitimately as a means to reduce the size of your estate, and the estate tax burden on your heirs. You’re allowed to gift as many individuals as you like up to $12,000 each within a calendar year, and those people will not have to declare or pay tax on that money.

But, like any good thing, there’s a catch - if your cash gift is to qualify under IRS regulations, it must be given with no strings attached. You can’t get anything in return from the gift’s recipient. It is this restriction which has given rise to the many creative ways in which cash gifting programs have tried to separate themselves from elaborate Ponzi schemes.

What’s a Ponzi scheme, and how do they apply to cash gifting?

Named for Charles Ponzi, Ponzi schemes promise impossibly high investment returns in unrealistically short periods, and rely on those promises to keep new investors coming. It’s the money from the new investors which is used to pay most of the remarkable returns to the earlier ones, because Ponzi schemes almost never have any additional sources of income.

As more investors join a Ponzi scheme, more money is needed to pay them, and the scheme will eventually collapse when the amount of money it owes eclipses the amount of money coming in. The scheme’s most recent investors will lose the most because their investments have been used to pay earlier investors.

Many cash gifting programs trying to avoid a Ponzi label have steered clear of calling themselves investments. Investments fall under SEC regulations and those suspected of being fraudulent can be shut down. There are criminal penalties for those who engage in illegal investment activities.

Cash gifting programs will also avoid calling themselves business opportunities, because that name implies the existence of a contract between a buyer and a seller, for goods or services and would be regulated by state laws.

So how do cash gifting programs work?

Most cash gifting programs have “systems” requiring membership fees to cover their operational costs, which include promotion. Anyone joining one of these programs will receive money, but only from the people he or she persuades to join later.

You can’t enroll in a cash gifting program without agreeing to give a specific amount of cash to someone else. For your enrollment and monthly membership fees, you’ll receive a private member number which tracks the amounts of the gifts you give and receive. The most sophisticated cash gifting programs will supply documents detailing their members’ cash transfers.

The biggest cash gifting programs teach their members a marketing system for attracting new members, without whom the entire system would collapse. This is the Ponzi aspect of cash gifting schemes.

Why do cash gifting programs eventually fail?

If members fail at marketing the programs to an ever-widening base of new members, then the pool of money being “gifted” among the existing members will dry up.

Cash gifting clubs promote themselves at invitation only gatherings similar to Tupperware parties, except that no product is being sold.

All those invited are there because an existing member of the program thinks they have money available to participate and will risk giving it to a complete stranger for the chance to have several complete strangers the same amount of money to them, multiplying their money (again, it’s never called an “investment”).

The “presenters” at cash gifting program gatherings give chalkboard or Power Point presentations which invariably end up with an image of a pyramid, showing how each member will make his or her way from the base to the top, where they will get the big payoff.

The money contributed by an incoming member goes to the top of the pyramid immediately, while the penniless member sits at the base of the pyramid until enough other members join to completely pay off the member at the top and move everyone else up a notch. Once a member is paid off, he or she is free to move on, but for a club to keep working, the money given to that member will have to be replaced from somewhere.

If, for example, the promised payout of a cash gifting club is $20,000, and the gift required is $2,500, only eight new members must be recruited to pay off one old member.

But what happens when a club reaches 100 members? If each of them is to get the full $20,000, for a total of $2,000,000, then 800 people must join. If each of them is to be paid, 6,400 must join. With each new level, the numbers grow more unrealistic.

For this example club, with its relatively low gifting and payout levels of $2,500 and $20,000, to continue for only two cycles after it gets its 100th member, 51,200 members must join.

Many clubs count on their paid off members to keep returning. Even if they all do, it is mathematically impossible for a cash gifting club to survive without an exponentially increasing membership base.

When the pool of new members dries up, so do the cash gifts, and any members who joined too late are out of luck - not to mention money.

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