Charitable Giving – Optimize Your Giving

Charitable Giving – Optimize Your Giving

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In the first part of our series, we looked at the reasons why people give. Today, we’ll dive into the basics of optimizing how to give — particularly for reducing your tax bill.

“Helping people doesn’t have to be an unsound financial strategy.” – Melinda French Gates

Taking Deductions

To receive a tax benefit for giving, you’ll want to itemize your deductions on your tax return. If you don’t itemize, by all means, continue to give, but you can skip this post for now. The IRS limits charitable deductions to a percentage of your adjusted gross income (AGI) for the year. Any unused deduction can carry forward for up to five subsequent years.  More details are available in IRS Publication 526. Also be aware that the Pease limitation on some itemized deductions for 2015, including charitable gifts, begins with incomes of $258,250 or more ($309,900 for married couples filing jointly).1

Before You Give

The purpose of various giving vehicles — such as private foundations, donor-advised funds, trusts, and others — is to transfer assets to charitable causes, but choosing the right tool can be a complex process. Perhaps this complexity is why most high net worth individuals do not use a giving vehicle.2 Let’s distill the choices into clear options.

giving-vehicles

First, start by focusing on which of the following six factors best matches your philanthropic preferences and giving goals, and then move on to the specific giving vehicles. Choosing a giving strategy is not an “either/or” decision: many giving options make excellent complements to one another and, when paired, will optimize your charitable impact.

Cost
The more money you spend on fees, the less available for charity. Most giving options have associated administrative fees to cover startup, employee, investment, and service costs, and others may require legal or accounting expenses.

Distribution
Ensure the giving vehicle allows you to support charitable causes in sync with your mission and, if desired, gives you the ability to give to many charities on a consistent basis or grant one large sum in the future.

Control or level of input
Choose how much direct oversight and decision-making power you need for each aspect of your charitable giving, including areas such as grant-making, investing, or administrative work. Often, strict legal regulations will dictate a donor’s rights or ability to exercise control with different giving vehicles, and some giving options permit donor input or advice without allowing the donor to exercise direct control over the assets.

Legacy options
Leaving a philanthropic legacy is a personal decision that can take various forms, from bestowing assets to others, to naming a charity as a beneficiary in a will, or continuing a family tradition of giving. By their makeup, some giving vehicles cannot support specific charitable wishes and intergenerational philanthropy after a donor passes (e.g., direct giving).

Tax efficacy
Outline the types of assets you often gift, and ensure your giving strategy allows for optimal tax deductions. Deductibility limits vary based on the type of asset donated, giving vehicle, personal income, and if you receive a personal benefit from the gift.

For example, a donation to a charitable gift annuity, which allows the donor to receive income, does not allow for as large a tax deduction as a direct gift. The most tax-effective assets to donate are also sometimes the most difficult. If relevant, choose a vehicle that supports liquidation of complex special assets or appreciated securities.

Recognition versus anonymity
If anonymity is important to you, some vehicles will not be a good option. For example, private foundations must file public reports that include information on grants, trustees, and employees. A better option for anonymity would be a grant from a donor-advised fund, which can maintain your confidentiality.

How to Give

Direct Giving

A donation made directly from an individual to an IRS-approved charity in return for a full tax deduction based on the fair market value of the gift. Direct giving allows you to choose each time you gift whether a donation will be made anonymously or with recognition.  No startup costs or spending requirements.

An effective option if you: gift smaller amounts of cash, prefer to personally manage your investments and contributions, and want maximum control over your donations.

Donor Advised Fund (DAF)

A tax-effective way to donate, accrue, and recommend grants to 501(c)(3) public charities. A DAF can invest its funds in the markets, providing the opportunity for tax-free growth after the initial donation and ultimately more funds for giving. Minimums vary; typically an initial contribution is $5,000 or less.  Most donor-advised accounts are not subject to annual spending requirements; although many must make at least one grant every few years. DAFs provide an easy way to take a significant upfront tax deduction to offset a year with high income (e.g. the sale of a business) while spreading grants over many years. They can support a variety of legacy plans.

An effective option if you: want to consolidate your giving in a tax-effective way and have the option to contribute all types of assets. Do not need complete control over assets or administrative details.

Private Foundation

An independent charitable organization with governing legal documents and governing body with complete control over investment and grant-making decisions.  Start-up costs can exceed $15,000, but ongoing operating expenses vary. Subject to 1-2% excise tax on annual net investment income, require a 5% annual distribution, and must file an annual IRS Form.

An effective option if you: want total control and more flexibility over charitable activity, wish to involve family members in management of charitable assets, and are comfortable following strict compliance and granting regulations.

Charitable Gift Annuity

A contract established with a charity that allows individuals to transfer assets to the nonprofit organization in return for a partial tax deduction and fixed income for the donor’s lifetime. After the donor dies, the charity keeps the remainder of the gift. Can be established for as little as $10,000. The present value of the annuity and deduction are set using the Section 7250 interest rate (currently at a low historical level).

An effective option if you: need income and want to support only one charity through donations of easy-to-liquidate assets, such as cash or publicly traded securities.

Charitable Remainder Trust (CRT)

An arrangement that allows individuals to transfer assets or property to a trust for a partial tax deduction, receive income from the trust for a set period of time, and name a charitable beneficiary of the residual principal of the trust. CRTs are traditionally set up at a financial institution, a process which requires legal expertise. Startup costs and minimums vary. Contributions to a CRT typically exceed $100,000.

An effective option if you: prefer to receive income while fulfilling charitable goals and plan to gift to charity after you die.

What to Give

There are a variety of assets you can give.  Cash is most popular among high net worth donors, but it is not always the most tax-efficient option if you have appreciated assets.

assets-given

Special considerations by asset types:

  • Cash
    • Keep all receipts (canceled checks, bank debits, letters from the organization, etc).
  • Appreciated publicly traded securities
    • For maximum benefit, shares must be held for more than one year.
    • Transfer the shares, do not sell them at a gain.
    • “What if I only have investments with losses?” Instead of donating the actual investment, sell it first to realize the loss and use it to offset your personal income tax and then donate the proceeds to the charity.
  • Other appreciated assets (privately held stock, real estate, art, hedge fund, etc)
    • Need appraisal, not all charities and charitable accounts can accept it.
    • You must donate privately held company shares before finalizing a sale to receive tax benefits.
    • There is a higher capital gains tax rate on collectibles, but the corresponding investment tax savings is offset somewhat as the deduction is the lesser of cost basis or fair market value.
  • Household goods and clothes
    • Must be in good condition.
    • 30% deduction based on fair market value, not purchase price.
    • Appraisal if over $500 along with Form 8283.
  • Time
    • You can’t deduct the time you volunteer, but the IRS does offer reimbursements for driving for nonprofits. Keep a mileage log with the date, the purpose, and the total miles driven, as well as a confirmation from the charity.  You’ll get a deduction of 14 cents per mile.

Example

If you are still skeptical about how you can optimize charitable giving to reduce your taxes, here’s an example.

Bob and Betty file jointly and itemize their deductions in the 28% federal income tax bracket (we’ll ignore local taxes to keep things simple)3. They are deciding between a gift of $20,000 in cash or a gift of $20,000 of long-term appreciated stock with cost basis of $10,000.  The cash gift would result in a deduction of $20,000 x 0.28 = $5,600. The gift of the stock would receive the same deduction, but also save $10,000 x 0.15 = $1,500 in capital gains tax. That’s a major win for option #2.

Timing
As we get close to year-end, remember you can deduct contributions in the year you make them. If you charge your gift to a credit card before the end of the year, it will count for 2015. This is true even if you don’t pay the credit card bill until 2016. Likewise, a check will count for 2015 as long as you mail it in 2015.

Taking a longer view for maximizing tax benefits, concentrate your giving in years when you are in higher income tax brackets. For example, during peak earning years or when selling a business.

Finally, you are generally far better off giving in life rather than through your estate, all else equal. You receive income tax and estate tax benefits from gifting while alive, but only estate tax benefits with bequests. We will cover considerations for bequests in an upcoming post.

Now that you have a handle on the different ways to give and how to maximize your tax deductions, you’ll need to decide which charities are the best options. Coming up in our next post: nonprofit due diligence.

Always remember to consult your tax advisor before making starting any significant gifting strategies. This blog post does not constitute legal or tax advice.

  1. This is more accurately a stealth surtax on income, not a limit on deductions. More information.
  2. The 2014 U.S Trust Study of High Net Worth Philanthropy
  3. This example conveniently bypasses the extra complexity of the 3.8% Medicare tax on investment gains, the alternative minimum tax, and the Pease limitation
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Jordan Kunz

Jordan Kunz is passionate about problem solving and using technology to make the financial world more transparent and accessible. Jordan is a CFA charterholder and CERTIFIED FINANCIAL PLANNER™ professional. He is currently an advisor at Colorado Financial Management in Boulder, CO.

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