Few people can match the $1 billion donation of Ruth Gottesman to the Albert Einstein School of Medicine endowing the school to be forever tuition-free. However, incorporating charitable giving into your estate planning offers considerable rewards even at substantially lower amounts. Gottesman’s gift was certainly not motivated by any tax savings agenda, but nonetheless, it will likely provide her significant tax savings. Similarly, donating to charity can provide you with both income tax and estate tax deductions if done correctly.
Charitable Planning Considerations
Most people donating to charity are motivated first and foremost by philanthropic motives, hoping to support an institution or cause, and a secondary motive in some cases may be the associated tax savings. Accordingly, charitable planning should take into account the donor’s wishes and the beneficiary’s needs in addition to tax considerations. In this way, the gift can make the greatest possible impact on the charity while maximizing the tax benefits to the donor, the donor’s estate, and heirs.
Tax Implications of Charitable Giving
Charitable donations can save taxes in different ways. For example:
- Gifts made directly to qualified charities are exempt from gift tax.
- Gifts during the donor’s lifetime receive an income tax deduction in the year the gift is made. This deduction can be “carried forward” or spread out over five years to maximize the benefit of the deduction.
- Donating highly appreciated securities that would be subject to capital gains tax when sold can save the donor capital gains tax while providing great value to the charitable recipient who may sell the assets without incurring tax.
Options for Making Charitable Gifts
There are several ways to structure a gift depending on your circumstances. The most common of these options include:
- Donor-Advised Fund (DAF). A DAF is a philanthropic vehicle administered by a public charity or sponsoring organization that allows you to make irrevocable charitable contributions, receive an immediate income tax deduction, and direct how and when the charity will receive the money.
- Private Foundation. A foundation provides more control and flexibility over a donation than a DAF. However, there are significant costs associated with establishing and maintaining a foundation (akin to running a non-profit).
- Charitable Lead Trusts (CLTs). A CLT pays an income stream to a charity for a term of years. At the end of the term, the remainder passes to designated beneficiaries. Such trusts can be set up as grantor or non-grantor trusts.
- Grantor Trusts – In this case, the person who donates to the trust (Grantor), remains the owner of the funds. The Grantor may take an immediate tax deduction for the value of all future payments to the charity (measured at fair market value at time of donation) subject to certain limits depending upon whether the trust benefits a public charity or a private foundation. Key to realize is that the trust’s investment earnings are taxable to the Grantor for the life of the trust, so they should make sure that this doesn’t unduly diminish the tax deduction.
- Non-Grantor Trusts – Here the trust owns the funds, not the Grantor, and the trust pays the taxes on the investment income. Therefore, the Grantor cannot take an immediate tax deduction, however the trust may take a tax deduction for the distribution to the charitable beneficiary, with no limits on the deduction, making this structure more suited to minimizing future capital gains and income taxes.
- Charitable Remainder Trusts (CRTs). A CRT provides a payout to you (or other beneficiaries) during your life or other specified term. The remainder interest goes to charity. Notably, the CRT is tax-exempt so investment income (such as capital gains, dividends, and interest) generated by the trust is exempt from tax, but distributions to the income beneficiaries may be taxable and are subject to special tax rules. Often, donors choosing a CRT will fund the trust with highly appreciated assets that the donor wants to sell as this will defer capital gains tax and provide an income stream to the donor.
IRA Gifting
Donating IRA assets to charity can provide tax savings in two ways.
- Making a Qualified Charitable Distribution (QCD). Sometimes referred to as IRA charitable rollovers or IRA charitable distributions, a QCD allows account holders aged 70½ or older to make a contribution directly from a traditional IRA (not simple IRAs) to a qualified charity or charities of up to $105,000 total per year, which can be counted toward their required minimum distributions (RMD) without it being considered a taxable distribution. The deduction effectively lowers the donor’s adjusted gross income (AGI) and thereby, saves income taxes. Notably, the distribution cannot also be taken as a charitable deduction because it was never taxed as income. To take advantage of the deduction, it is essential to follow IRS rules. The account holder cannot first take the distribution and then send it to the charity or else it will be treated as a regular distribution.
- Gifting an IRA Upon Death: A charity can be named as the designated beneficiary of an IRA. If more than one charity is named, the beneficiary form should specify what percentage of the account assets goes to each charity. The account owner can also allocate assets between charities and other heirs. No income taxes are paid on distributions to charities. In addition, as long as the value of the IRA assets is counted in the gross estate, the estate will get a charitable deduction from estate taxes.
Developing an Appropriate Charitable Giving Plan
Charitable giving offers many rewards but to ensure that you maximize the benefits to you, your heirs, and the charities involved, you should consult experienced financial and legal professionals. Contact us to discuss a comprehensive estate plan that allows you to give to the causes that are important to you and provides income and tax savings during your lifetime and for your estate.
