Why Do We Give?
- Charitable Intent
- Income Tax Deduction
- Reduce Capital Gains Tax
- Reduce Estate Tax
- Unlock Assets for Current Income
Charitable giving is a great way to support your favorite causes while also creating tax advantages. It’s worth considering the various options to help maximize the impact of your donations and your financial benefits.
Many charitable donors enjoy seeing the results of their generosity while they are still alive. Lifetime giving can also create income tax deductions and reduce your estate taxes. Donations of appreciated assets like stocks and real estate can also avoid capital gains taxes, leaving the full value of the asset for the non-profit recipient, while allowing the donor to benefit from the full, “fair market value” charitable deduction. The accompanying chart shows a hypothetical example, where a charity would receive $100,000 through a direct donation of appreciated shares, but only $78,580 if the donor first sold the shares, then paid taxes on the sale, and donated the remaining proceeds.
Gifting from an IRA: IRA holders over the age of 70-1/2 can gift IRA funds directly to a qualified charity (not a DAF), and can exclude up to $100,000 from gross income per year. While the gift is not tax deductible, these withdrawals currently can be counted towards satisfying the annual required minimum distribution (RMD). Donations from a SEP or a SIMPLE IRA are not eligible.
Donor Advised Fund (DAF): Also known as a Charitable Gift Fund, a DAF is an account managed by a public charity which allows you to advise how your gifts will be distributed. A DAF is significantly less expensive to administer than a private foundation (PF), with many of the same benefits. DAFs help simplify the process of making strategic contributions to charity. The donor receives an immediate income tax deduction for the value of assets transferred to the DAF, and then can grant funds (either immediately or over time) to the charities of their choice. Note: A DAF can’t be used to fulfill a personal charitable pledge or pay for auction items. By law, DAF distributions can’t provide more than an “incidental” benefit to the donor.
Charitable Gifts After Death
Some donors prefer to retain the use of their assets while they are alive, choosing to support charities as part of their estate plan. You can make donations through wills or trusts, or by naming a charity as your beneficiary in a life insurance policy or retirement account. Charitable gifts at death typically do not provide income tax advantages (the exception is gifts of retirement accounts, which might otherwise require individual beneficiaries to pay income tax as the funds are withdrawn). These types of gifts do, however, reduce the donor’s taxable estate for state and federal estate tax purposes, which can result in significant savings.
More Complex Giving Options
Donors seeking more customized strategies have many options that are available either during lifetime or after death. Here are the three most commonly used:
Charitable Remainder Trust (CRT): A CRT is an irrevocable trust through which a charitable beneficiary eventually receives assets, while a non-charitable beneficiary receives income from those assets for a specified period of time. Think of this as “Giving away the tree, but keeping the apples.” For example, a property owner could gift a rental property to the charity, but retain the income generated for a term of years or the remainder of their life. A CRT provides an income tax deduction for the donor, can remove the asset from the estate, and can defer and even reduce capital gains taxes. The CRT itself is tax exempt, but the non-charitable beneficiaries do pay income tax on the cash flow that they receive.
Charitable Lead Trust (CLT): A CLT is another type of irrevocable trust in which the non-charitable beneficiary retains the assets, while the charitable beneficiary receives an income interest. This reverses the CRT relationship, and amounts to “Giving away the apples, but keeping the tree.” CLTs are often used in estate plans. Depending on their structure, the donor may or may not receive an income tax deduction, and may incur gift taxes. A CLT will sometimes be used to transfer assets to children at a reduced gift tax or estate tax cost, while restricting access until they mature.
Private Foundation (PF): A foundation provides the structure for distributing very large assets over many years, while maintaining maximum control for the donor. Many families have set up foundations to build their legacy and fund specific causes that may have special meaning to them.
However, a foundation can be the costliest and most complicated option for charitable giving, with the least favorable tax status. Foundations pay 1-2% taxes on net investment income and must distribute 5% of assets each year. Distributions for taxable expenditures, including political activities, are prohibited. Generally, donors with endowments smaller than $10 million are better served with a DAF or other choices.
We’d like to thank Susan Peterson, Director or Philanthropic Partnerships at the Seattle Foundation, who contributed to this article.
Using your wealth to support worthy causes can be very rewarding. If you’d like to include charitable giving in your financial plan, your Paracle advisor can help. We’ll be happy to discuss your options and refer you to philanthropy experts for more information.
Paracle Personal Financial Management is an independent financial planning firm founded in 2004 with an honest desire to help people optimize their finances by providing unbiased financial planning and investment advice that puts their clients first. Paracle specializes in delivering expert, comprehensive wealth management services to busy families. Their expertise integrates financial planning with investment management to ensure their clients experience confidence in every aspect of their plan so they can focus on what matters most. To learn more about Paracle, connect with them on LinkedIn.