As an investment advisor, HM Payson not only manages investments for our clients, but we also field many questions on the different ways our clients can engage in charitable giving. There are many ways to give, and the right fit depends on the client, their assets, and their goals. With careful planning, a client can accomplish their charitable objectives in the most tax-efficient manner. In this note, we provide an overview of the options available to our clients, and the circumstances in which they might be suitable. Because some methods involve more complicated planning, it is best to start thinking about charitable giving earlier in the year, rather than in December.
Charitable giving can be done during a person’s lifetime or at death. Lifetime giving offers several benefits: it provides the donor with an income tax deduction for the amount of the gift, subject to certain limitations; it reduces the size of the donor’s estate that may be subject to estate tax at death; and it allows the donor to see the impact of the gift. Before making a lifetime gift, however, the donor must be confident that they will not need the assets during their lifetime. Charitable giving at death may provide the donor’s estate with a deduction against estate taxes.
While lifetime gifts to individuals are subject to the annual gift tax exclusion (capping non-taxable gifts at $16,000 per donee for 2022 and $17,000 per donee for 2023), a donor can make unlimited gifts to charity for estate and gift tax purposes. To take a charitable deduction on one’s income tax return, a donor must itemize deductions. However, because 2018 Federal tax legislation nearly doubled the standard deduction, far fewer people now itemize their deductions. With this in mind, a donor may want to consider bunching several years’ worth of charitable gifts into a single year. For example, rather than giving smaller amounts every year that would be less than the standard deduction (resulting in no tax benefit), a donor may want to give a larger amount once every 2-3 years so that the charitable gifts, with other itemized deductions, exceed the standard deduction.
One of the easiest ways to give to charity is through a cash donation — simply mailing a check to the charity of your choice. Lifetime cash gifts to most charities provide the donor with an income tax deduction for the amount of the gift, up to 60% of the donor’s adjusted gross income (AGI), with a 5-year carry forward for gifts in excess of this limitation. Another advantage of cash gifts is that they can be done last minute at year-end. Checks mailed by U.S. Postal Service are deemed to be delivered to the charity when the donor places the envelope in the mail.
Donating appreciated stock can provide you with more tax benefits than a simple cash donation. If a donor makes a gift of stock with unrealized long-term capital gains, the donor can claim an income tax deduction for the stock’s full fair market value. The donor can also avoid the capital gains tax that they would owe if they sold the appreciated stock. The annual deduction limitation for gifts of stock to most charities with unrealized long-term capital gain is 30% of AGI, with a 5-year carry forward for gifts that exceed this limitation.
Tax-deferred assets such as retirement accounts provide significant income tax benefits during life. At death, however, they are subject to estate tax in the donor’s estate as well as income tax when beneficiaries start taking distributions. Making a charity the beneficiary of tax-deferred assets instead can give the donor’s estate a charitable estate tax deduction, and the amount passing to charity will not be subject to income tax. If you are going to give to charity at death, consider using your tax-deferred assets first, and leaving your heirs other assets that will get a “step-up” in basis at your death.
If you have reached age 70 ½, you can transfer up to $100,000 per year directly from your IRA to charitable entities of your choice, excluding donor-advised funds or private foundations. This planned giving option is known as a qualified charitable distribution (QCD). You do not receive an income tax deduction for QCD gifts, but the amount you give counts towards the annual amount you may be required to withdraw from your retirement account (required minimum distribution, or RMD), and is not included in your taxable income. There are many reasons you may wish to keep your taxable income below a certain threshold; but, to name a few, you may not want to be pushed into a higher tax bracket once you begin taking RMDs, or you may not want your RMD income to adversely impact your Social Security income or Medicare benefits. This is a tax-planning opportunity for charitably inclined people, regardless of whether they itemize or take the standard deduction.
Split interest trusts, such as charitable remainder trusts and charitable lead trusts, are irrevocable trusts established and funded by a donor, in which the income interest is separate from the remainder interest. Payments from these types of trusts can either be a fixed dollar amount (an annuity payment) or a fixed percentage of the trust principal (a unitrust payment). There are expenses involved in setting up and administering a split interest trust, including legal fees for preparing the governing trust document, accounting fees for the annual trust income tax returns, and trustee fees for administering the trust. The two common types of charitable trusts are charitable lead trusts and charitable remainder trusts.
A charitable lead trust (CLT) pays an income stream to a charity for a set term of years, after which the remainder is paid out to an individual or individuals. For certain types of CLTs, when the trust is funded, the donor receives an income tax deduction based on the actuarial value of the income stream the charity will receive, and the value of the gift to the individual(s) who are the remainder beneficiaries is the present value of the individual(s)’ future interest in the trust. This type of trust makes sense for people who do not need the income stream from their donated assets and would rather support a charity for a number of years before passing the remainder on to heirs.
A charitable remainder trust (CRT) pays an income stream to an individual or individuals, often the donor, for a set term of years (or for their lifetime), and at the end of that term the remainder passes outright to charity. Upon funding the trust, the donor receives a charitable income tax deduction for the present value of the remainder interest, and the assets are not taxed in the donor’s estate for estate tax purposes. Another advantage of CRTs is that you can fund them with highly appreciated stock, which can then be sold in the trust without capital gains tax consequences to the trust at the time of the sale. Instead, the capital gain is accumulated and passed out to the beneficiaries with their annual distributions from the trust. This type of trust is often suitable for people who want a fixed income stream, such as those approaching or in retirement, but want to give to charity later.
A donor-advised fund (DAF) is essentially an account that is part of a public charity. An individual can donate securities to a DAF and receive a charitable income tax deduction, even if the funds aren’t immediately distributed to a charitable organization. The donor then acts as an advisor to the account, making suggestions about when to make grants, which charities should receive them, and how much to give. DAFs are simple to establish, with no initial setup costs, and provide a means for a donor and his or her family’s ongoing philanthropic involvement. The initial minimum funding amount and operating costs vary depending on the fund. For donors wanting anonymity, a DAF is a good vehicle since grants can be made anonymously. The main drawback is that the donor serves only as an advisor and does not have total control over the fund’s management and administration.
A more complicated form of charitable giving, private foundations are charitable entities that donors can establish as either corporations or charitable trusts. A private foundation must apply to the IRS to obtain tax-exempt status and is required to file annual tax returns. Donors receive an immediate charitable deduction of up to 30% of AGI for cash gifts and up to 20% of AGI for gifts of securities. In addition to the tax deduction, private foundations allow a donor to remove assets from his or her estate, potentially reducing estate tax liability. A private foundation can also enable a donor to pass philanthropic values on to future generations, since the donor and his or her family can have ongoing involvement in the foundation’s administration, the selection of grantees, and the management of the investments. However, because the rules and tax regulations governing private foundations are complex, expert tax and legal advice is needed to properly establish and run a foundation. Among other requirements, private foundations must distribute approximately 5% of their assets each year to qualified charities and are subject to penalties if they fail to do so. They also must pay a small tax on their income (usually 1-2%). Because of the complexity and expense involved in setting up and running a private foundation, they are generally only suitable for those who intend to contribute upwards of a million dollars and are willing to secure the necessary tax and legal advice to run the foundation properly.
As we have seen, there are a wide variety of means available to donors to achieve their philanthropic and asset management goals, ranging from very simple to complex. Finding the appropriate vehicle will depend on your goals, your assets, and your stage of life. We would be happy to explore the options with you if you are considering any form of charitable giving.