Charitable giving is an important part of life for many clients. Whether donating money or property, dedicating time and effort, or a combination thereof, giving is a way to promote values and leave a legacy for future generations. Charitable giving can also be a valuable part of the overall financial plan, and understanding some basic ways to give can add significant economic efficiency to benefit the donor and their family for the long-term.

On the strictly financial side, the 2017 Tax Cuts and Jobs Act (“TCJA”) reduced opportunities to claim itemized income tax deductions, leaving most individual/joint taxpayers able to report deductions for medical and dental expenses, mortgage interest, state and local taxes paid (capped at $10,000), and charitable gifts. With deduction limitations in place, having a better understanding of different funding sources and ways to give can save money on tax bills, and do so whether one takes a standard deduction or itemizes. 

Most clients new to Wealthspire have traditionally made charitable gifts by simply writing a check or donating cash. Cash donations to public 501(3)(c) charities provide a current year income tax deduction up to 60% of adjusted gross income (AGI) with a 5-year carry forward to utilize the full deduction if the client is above the AGI limits. However, using cash is seldom the most efficient way to give. Below we will explore some of the more common and efficient ways to make charitable gifts and how to integrate these strategies into a long-term financial plan.

Common Charitable Gifting Strategies

Donate Appreciated Assets

For high-net-worth taxpayers, managing capital gains adds significant tax-efficiency to the portfolio. We often utilize tax-loss harvesting when markets are volatile and strategic gain harvesting in low-income years. For the charitably inclined, using low basis, long-term capital gain positions to donate also adds tax-efficiency. Appreciated assets can be viewed as charitable currency since asset donations allow for a current year income tax deduction at fair market value and will not trigger a capital gain on the disposition of the asset. So, that stock that a client paid $10k for and is now worth $100k? It can be donated to charity and they will receive a charitable income tax deduction of $100k and avoid paying capital gains tax on the $90k gain since the tax-exempt charity will sell the position.

Most charities can receive direct donations of securities or other appreciated assets and donations of appreciated assets to public charities are limited to 30% of AGI with a 5-year carryforward. And, if the asset is one that a client would like to continue to own, there is no preclusion from purchasing it back with cash (cash that would have otherwise been used to make the charitable gift) which will reset the cost basis to current market value. When using appreciated securities, it is important to make sure that the asset donated is a long-term capital gain holding (i.e., it has been owned for one year or more), as short-term capital gain positions have their deduction limited to cost basis and not current market value.

Use a Donor Advised Fund

What if someone would like a tax deduction this year, but they do not want to give all the funds to the charities they plan to support right now? The donor advised fund (DAF) provides a simple solution. A DAF is a charitable investment account that is itself a public 501(c)(3) charity. DAFs have modest initial funding requirements (Fidelity’s DAF has no initial minimums, Schwab’s a $5,000 initial minimum) and can be funded with cash, appreciated assets, collectibles, or other investments (real estate/illiquid investments). Funds are donated into one’s own designated account within the DAF that can have their name attached to it or remain anonymous.

The donation is complete and tax deduction received once the funds are inside the DAF, and since the DAF is a public charity, assets can then be sold inside the DAF account with no tax consequence. While the donation is irrevocable, the donor will have the ability to 1) direct investment of the funds, tax-free, inside their DAF account, and 2) nominate other public charities to receive grants from their DAF account. Grants are then sent out by check from the DAF to the end-charity. The is no legal deadline to send funds out of a DAF; however, many DAF sponsors require at least a $50 grant to a public charity every three years.

Given the TCJA’s limitation on itemized deductions discussed above, “bunching” gifts often makes sense. This technique involves making multiple years’ worth of charitable gifts into the DAF to take a deduction in the current year and then spreading out grants to end-charities over time. Then in the following year(s), the taxpayer takes a standard deduction before bunching to itemize again in a future year.

Make Qualified Charitable Distributions from Traditional IRA Accounts

A qualified charitable distribution (QCD) is a donation from a Traditional IRA to a qualified charity. While required minimum distributions (RMDs) of Traditional IRA funds are not mandated until age 73, IRS rules allow for those 70½ or older to donate up to $100k ($200k for a couple) directly to public charities without taking the distribution as taxable income. Itemizing deductions is not necessary to take advantage of a QCD and one does not have to be of RMD age – 70½ is the magic age. If taking RMDs, the QCD can reduce the amount that must be taken in as taxable income (e.g., a 2023 RMD is $200k and a $100k QCD is made, so tax is only paid on $100K). In addition, under the recently enacted Secure Act 2.0, the annual QCD of $100k is scheduled to be indexed for inflation going forward. One important note is that QCDs must go directly to end-charities and cannot be made to a DAF or private foundation.

Other Charitable Gifting Methods

Charitable giving can also be coupled with the donor’s desire to retain an income stream from donated assets while also supporting charity. The techniques below are more complex but can be useful for high-net-worth individuals with both philanthropic and income goals in mind.

Charitable Gift Annuity

Many larger charities offer charitable annuities which allow donors to support the organization, receive a partial charitable income tax deduction up front, and receive a fixed income stream from the charity for a single or joint life with the remainder interest reverting to the charity. A gift annuity is a contract between a donor and a single charitable organization. It can be funded with cash, property, or appreciated securities. The terms of the agreement lock in the annuity rate and amount/timing of payments back to the donor. The annuity payment is based on several factors including the donor’s age when making the initial gift. Annuitants receive an income tax deduction at the time of the original gift with the deduction based on the estimated amount that will eventually go to the charity after all the annuity payments have been made. Assuming long-term capital gain assets are gifted, the capital gains tax will be spread out for a period of time based on the donor’s statistical life expectancy as the donor receives the income payments. If the donor outlives their statistical life expectancy, income payments moving forward are taxed as ordinary income.

Charitable Remainder Trust

Like the Charitable Gift Annuity, the Charitable Remainder Trust (CRT) also provides an upfront charitable income tax deduction and tax-advantaged income stream for a period of years or life. CRTs can be created during life, or as part of the estate plan after death. They can also be created directly with a charitable organization (mostly larger organizations offer CRTs) or by the donor directly, in which case multiple charities or a DAF can be named as remainder trust beneficiaries.

CRTs are often used as a low-basis stock diversification strategy since, similar to the strategies discussed above, donations to a CRT are valued at current market value and assets are sold and diversified once inside the CRT with no current capital gain consequence. The funds are then invested in a diversified manner inside the CRT and an annual/quarterly income stream is paid to the donor or another named beneficiary. CRTs can have fixed payments (known as a Charitable Remainder Annuity Trust (CRAT)) or varying payments that are a fixed percentage rate of the CRT value each year (known as a Charitable Remainder Unitrust (CRUT)). There is also a CRT variation typically used when immediate income is not the goal or when illiquid assets that do not generate an income stream are used for the initial funding. This is called a Net-Income Make-Up Charitable Remainder Unitrust (NIM-CRUT). Donations to a CRT provide a current year charitable income tax deduction. Payments made to an income beneficiary are taxed in a tiered system which typically allows for deferral of the long-term capital gains tax that would have been due upon the sale of the asset(s) used to fund the CRT.

After the end of the CRT term or death of the last income beneficiary, the remaining CRT assets are distributed to designated charitable beneficiaries. Depending on how the CRT is drafted, the trustee may be given the power to change the charitable remainder beneficiaries during the term of the trust.

There are more complexities and costs with CRTs. If creating a CRT on your own, the trust must be drafted by legal counsel. A CRT will also generate a K1 for the income beneficiary’s tax reporting. To learn more about CRTs, please check out our previous post here.

Charitable Lead Trusts

The inverse of the CRT is the Charitable Lead Trust (CLT). CLTs can have a fixed (known as a CLAT) or varying payment (known as a CLUT) and a term of years or lifetime term. They can be created during life or as part of the estate plan at death. Unlike the CRT, the CLT makes its annual payment to one or more charities and has its remainder interest either revert to the grantor or more commonly, pass to designated beneficiaries as a longer-term discounted gift. The CLT is also a more complex strategy that requires both legal and accounting considerations. Depending on how the CLT is set up, it can also provide a large upfront income tax deduction. Learn more about CLATs here.

Beneficiary Designations / Naming Charities in your Estate Plan

Leaving assets to charity through an estate plan should also be a consideration. An estate plan often lists specific charitable bequests and may designate one or more charitable organizations as the taker-in-default (e.g., who receives the estate if all other beneficiaries are deceased). While such provisions are common, naming a charity (which can also be a DAF) as contingent beneficiary for a Traditional IRA or other retirement plan may make sense for some. Under the Secure Act 2.0, Traditional IRA funds passing to a non-spousal beneficiary are given a 10-year deferral period before the total account must be distributed out and the inherited IRA may have RMD requirements for the beneficiary over the 10-year period. All distributions are taxable as ordinary income to the beneficiary. For those with a potentially taxable estate (for 2023, greater than $12.92MM for an individual / $25.84MM for a married couple), naming a charitable contingent beneficiary for Traditional IRA dollars will reduce the amount of the taxable estate by donating an account that may be tax-inefficient for a non-charitable beneficiary.

Conclusion

Charitable giving is an important part of the overall financial plan, not just something to think about near year-end. Well considered sources and methods of donations can lead to a greater impact for the charity and better tax outcomes for the donor. We are here to help you sort through the options and make decisions that are best for you and your family.

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