Saving more by giving better
Giving to charity is one of the best tax planning opportunities because you enjoy not only a sizable tax deduction, but also the satisfaction of doing good. Plus you can control the timing to maximize your tax benefits. Well-planned gifts can trim the estate tax while allowing you to take care of your heirs in the manner you choose.
Choosing what to give
The first thing to determine is what you want to give to charity: cash or property. There are adjusted gross income (AGI) limits on how much of your gift you get to deduct depending on what you give and who you give it to. Giving directly from an individual retirement account (IRA) may lower your AGI. (See Tax planning opportunity 10 to find out if you are eligible.) Contributions disallowed due to the AGI limit can be carried forward for up to five years. (See chart 7 for the deduction limit by donation and the type of charity.)
Outright gifts of cash (which include gifts made via check, credit card and payroll deduction) are the easiest. The key is to make sure you substantiate them. Cash donations under $250 must be supported by a canceled check, credit card receipt or written communication from the charity. Cash donations of $250 or more must be substantiated by the charity. Despite the simplicity and high AGI limits for outright cash gifts, it may prove more beneficial to make gifts of property.
Gifts of property are a little more complicated, but they may provide more tax benefits when planned properly. Your deduction depends in part on the type of property donated: long-term capital gains property, ordinary-income property or tangible personal property.
Ordinary-income property includes items such as stock held less than a year, inventory and property subject to depreciation recapture. You can receive a deduction equal to only the lesser of fair market value or your tax basis.
Long-term capital gains property includes stocks and other securities you’ve held more than one year. It’s one of the best charitable gifts because you can take a charitable deduction equal to its current fair market value. Consider donating appreciated property to charity because you avoid paying tax on the long-term capital gain you’d incur if you sold the property. (See Tax planning opportunity 11.)
But beware. It may be better to elect to deduct the basis rather than the fair market value because the AGI limitation will be higher. Whether this is beneficial will depend on your AGI and the likelihood of using — within the next five years — the carryover you’d have if you deducted the fair market value and the 30-percent limit applied.
Tangible personal property can include things such as a piece of art or an antique. Your deduction depends on the type of property and the charity, and there are several rules to consider:
- Personal property valued at more than $5,000 (other than publicly traded securities) must be supported by a qualified appraisal.
- If the property isn’t related to the charity’s tax-exempt function (such as a painting donated for a charity auction), your deduction is limited to your basis in the property.
- If the property is related to the charity’s tax-exempt function (such as a painting donated to a museum), you can deduct the property’s fair market value.
Benefit yourself and a charity with a CRT
A charitable remainder trust (CRT) may be appropriate if you wish to donate property to charity and would like to receive (or would like someone else to receive) an income stream for a period of years or for your expected lifetime. The property is contributed to a trust and you, or your beneficiary, receive income for the period you specify. The property is distributed to the charity at the end of the trust term.
So long as certain requirements are met, the property is deductible from your estate for estate tax purposes and you receive a current income tax deduction for the present value of the remainder interest transferred to charity. You don’t immediately pay capital gains tax if you contribute appreciated property. Distributions from the CRT generally carry taxable income to the noncharitable beneficiary. If someone other than you is the income beneficiary, there may be gift tax consequences.
A CRT can work particularly well in cases where you own non-income-producing property that would generate a large capital gain if sold. Because a CRT is a tax-exempt entity, it can sell the property without having to pay tax on the gain. The trust can then invest the proceeds in income-producing property. This technique can also be used as a tax-advantaged way to diversify your investment portfolio.
To keep CRTs from being used primarily as tax avoidance tools, however, the value of the charity’s remainder interest must be equal to at least 10 percent of the initial net fair market value of the property at the time it’s contributed to the trust. There are other rules concerning distributions and the types of transactions into which the trust may enter.
Reverse the strategy with a CLT
A grantor charitable lead trust (CLT) is basically the opposite of the CRT. For a given term, the trust pays income to one or more charities and the trust’s remaining assets pass to you or your designated beneficiary at the term’s end. When you fund the trust, you receive an income tax deduction for the present value of the annual income expected to be paid to the charity. (You also pay tax on the trust income.) The trust assets remain in your estate.
With a non-grantor CLT, you name someone other than yourself as remainder beneficiary. You won’t have to pay tax on trust income, but you also won’t receive an income tax deduction. The trust assets will be removed from your estate, but there also may be gift tax consequences. Alternatively, the trust can be funded at your death, and your estate will receive an estate tax deduction (but not an income tax deduction).
A CLT can work well if you don’t need the current income but want to keep an asset in the family. As with other strategies, consider contributing income-producing stocks or other highly appreciated assets held long-term.
Keep control with a private foundation
Consider forming a private foundation if you want to make large donations but also want a degree of control over how that money will be used. A foundation is particularly useful if you haven’t determined what specific charities you want to support.
But be aware that increased control comes at a price: You must follow a number of rules designed to ensure that the private foundation serves charitable interests and not private interests. There are requirements on the minimum percentage of annual payouts to charity and restrictions on most transactions between the foundation and its donors or managers. Violations can result in substantial penalties. Ensuring compliance with the rules can also make a foundation expensive to run. In addition, the AGI limitations for deductibility of contributions to nonoperating foundations are lower.
Provide influence with a donor-advised fund
If you’d like to influence how your donations are spent but you want to avoid the tight rules and high expenses of a private foundation, consider a donor-advised fund. They are offered by many larger public charities, particularly those that support a variety of charitable activities and organizations.
The fund is simply an agreement between you and the charity: The charity agrees to consider your wishes regarding use of your donations. This agreement is nonbinding, and the charity must exercise final control over the funds, consistent with the charitable purposes of the organization.
To deduct your contribution, you must obtain a written acknowledgment from the sponsoring organization that it has exclusive legal control over the assets contributed.
Key rules to remember
Whatever giving strategy ultimately makes the most sense for you, keep in mind several important rules on giving:
- If you contribute your services to charity, you may deduct only your out-of-pocket expenses, not the fair market value of your services.
- You receive no deduction by donating the use of property because it isn’t considered a completed gift to the charity.
- If you drive for charitable purposes, you may deduct 14 cents for each charitable mile driven.
- Giving a car to charity only results in a deduction equal to what the charity receives when it sells the vehicle unless it is used by the charity in its tax-exempt function.
- If you donate clothing or household goods, they must be in at least “good used condition” to be deductible.
