The IRS tax code sets forth rules and regulations under which US taxpayers remit monies to the federal government. Our taxes, along with borrowing, supply the US government with its operating funds. The tax code also encourages certain behaviors, and discourages others. For example, it encourages charitable giving through generous tax deductions. Clearly it discourages speculation by taxing short term gains at one’s marginal tax rate rather than at the more favorable long term gains rate.
In this blog piece I want to describe some of the charitable giving strategies available to the affluent. I as an advisor would be remiss if I didn’t bring this conversation up to a client. Is there a church or synagogue you wish to favor? A university? A specific charity? The opera guild? There are many favorable ways to give, which can also produce a guaranteed income for the giver.
Charitable giving is itself a discipline within the larger discipline of estate planning. Through 2021 the estate exemption is $11,700,000 for an individual, and twice that for a married couple. As the estate exemption rises, the impetus for charitable planning becomes less and less tax driven, and more and more income and good works driven.
In choosing the most appropriate charitable gifting strategy, the donor needs to think through these issues:
There are several charitable techniques out there, including donor-advised funds, charitable remainder trusts, charitable lead trusts, family foundations, and gift annuities, to name several. What follows is a brief discussion of each.
By definition, donor-advised funds (DAFs) are public charities under Section 501(c)(3) of the Internal Revenue Code, and contributions to such funds are tax deductible. The donor makes a tax-deductible gift to the DAF, and then recommend grants from the DAF to charitable organizations. The tax deduction occurs at the time of the gift. Say, for example, you’ve just sold a business and have a large liquidity event. You can make your DAF contribution and take the deduction, but wait years before recommending a gift from the DAF. Meanwhile your gift grows within the DAF, not taxed, thereby increasing the value of your eventual gift.
A donor-advised fund can accept various kinds of assets, including art and collectibles. Typically, the donor will gift low basis / highly appreciated securities, so the fund can sell the security without paying any capital gains tax. Donors are able to recommend how their contributions should be allocated among the available investment choices. Indeed, many DAFs allow for the current investment advisor to continue to manage the funds within the DAF.
Donor advised funds are typically sponsored by a charity. The convenience and administrative simplicity of a donor-advised fund allows donors to spread their grant making out over months or even years, in accordance with their own personal charitable impulses.
In a charitable remainder trust (CRT) you set up a trust – generally $500,000 is the very minimum where this makes sense – and receive an income over a period of no more than 20 years or over your lifetime. The remainder of any money left in the trust after your income is paid out goes to your stated charity. You receive an up-front income tax deduction for the present value of that estimated remainder interest.
The payments can be fixed, as in a Charitable Remainder Annuity Trust (CRAT), or variable, as in a Charitable Remainder Unitrust. With the latter, additions can be made in subsequent years, and a fixed percent of the trust, as revalued annually, is paid out as income.
If the circumstances are right, the CRAT and CRUT can effectively be paired with a life insurance policy to replace the asset in the donor's estate. If insurable, the CRAT donor can use some of the income payments to purchase a life insurance policy. The beneficiaries of his estate, usually the children, can then receive income-tax and estate-tax free, an equivalent amount of money that was settled into the CRAT initially.
A charitable lead trust (CLT) works sort of the opposite way as the CLAT or CLUT: it is the charity that receives the income, and your beneficiaries receive the remainder interest. This provides the giver with the enjoyment of seeing the charity receive and use the income from the CLT during his lifetime. There is an upfront income tax deduction of the present value of the stream of payments to the charity.
These are a huge tax dodge. A single family establishes a foundation, and makes tax-deductible donations to it. The foundation must have an educational and/or charitable purpose. The foundation must pay out 5% of its corpus annually for the charitable purpose. That’s all! (This was the Clinton Foundation, by the way. Chelsea Clinton was the President, at a salary of some $300,000 plus, and other Clinton associates were also on paid staff.)
Want your heirs to get invited to the best parties? Set up a family foundation. Charities and educational institutions will always be knocking, looking for donations. There’s no direct income to the giver here, but the foundation can certainly make gifts to family members for educational purposes. $1.0 at a very minimum to establish a family foundation.
You buy a gift annuity from a sponsoring charitable organization. In exchange for a gift, the donor receives an annuity – an income, in other words. This income will generally be for less than the donor could have received had he purchased an annuity for any insurance company, so there must be donative intent for this to make sense.
Clients often have large liquidity events, which may be taxable - they've sold a business or piece of real property, or converted a Traditional IRA to a Roth. One of the ways to mitigate the tax bite is with a large charitable gift to offset the taxes. I know that sounds like spending a dollar to save a dollar, but at least your money is going to a charity and not to the IRS. But when you consider that the charitable gift may produce a stream of income for you - well now you've done some good planning.
I hope this piece has opened your eyes up a bit on the topic of charitable giving. Yes, there should be donative intent – you mean to make a gift in direct support of someone else’s good works. But to sweeten the deal, you can also secure a good income for yourself in the bargain, and even obtain a large up-front tax deduction.
For more perspective, see Glenn's piece, You Are Generous. Give Creatively. Questions? Feel free to get in touch with us at [email protected] Also follow us LinkedIn, Facebook, Instagram, and YouTube for more personal financial information relevant to you!