So you want to be charitable, but aren’t fully sure which financial gifting tool is right for you? Here are some common options for those with charitable intentions.
A 501(c)(3) organization is an IRS approved non-profit entity. The organization itself is exempt from the federal income tax, and donations to these organizations are tax deductible. Tax deductions essentially lessen an individual’s taxable income, meaning donating to charity may be one way to lower your tax bill.
Donor-advised funds (DAF’s) have become a rather popular philanthropic financial vehicle for individuals who are looking to give back. Essentially the donor sets up the fund to be managed by a third party (sponsor) while they still retain partial control in deciding which charitable organization benefits from the assets in the fund. The individuals can deduct up to 60% of their adjusted gross income (AGI) for cash contributions, up to 30% of their AGI for non-cash assets such as stocks or mutual funds, or 50% of their AGI for a combination of the two (if donation is over that percentage of AGI, the amount can be carried over five years).
When donating through a donor-advised fund you can avoid the capital gains tax of up to 20%, which comes into play when selling an asset for a gain. Rather than selling an asset, paying capital gains, and gifting the funds to a charity, you can transfer the asset into your DAF, avoiding capital gains and possibly taking a tax deduction. Furthermore, assets transferred to a donor-advised fund are excluded from your taxable estate (if subject to estate tax) and avoid probate.
Starting a private foundation may be more advisable than a DAF for someone with substantial assets and/or someone who wants more control. Foundations are typically started with a large sum of money (endowment) that is then invested. The investment income is paid out yearly in the form of “grants” to other non-profit organizations (at least 5% of the total assets in the foundation must be granted yearly and a 1-2% excise tax is levied additionally). Private foundations are certainly more time consuming and complex than a DAF, but offer more direction over who receives the grants. Furthermore, having a private foundation can give the donors a notable legacy and encourage a charitable mindset for future generations. A private foundation isn’t unlike a typical company, requiring management, an investment team, and advisors. The personal tax breaks aren’t as beneficial, however. Currently, the tax write off for contributions to a foundation is capped at 30% of AGI for cash contributions and 20% of AGI for non-cash assets.
Those who are charitably inclined, but may not be able to give away a large sum of money should consider a charitable trust. A trust allows the grantor (“donor”) to transfer the title of the property to a trustee, which the trustee holds (invests) for the benefit of the beneficiaries. Setting up an irrevocable charitable trust can allow the donor or their next-of-kin to benefit from the assets in some way, while the charity of their choice is listed as a beneficiary as well. There are a few charitable trust options that may be right for you:
- Charitable Remainder Unitrust (CRUT) – a CRUT is a charitable remainder trust that allows the donor (or another non-charitable beneficiary of the donor’s choice) to benefit from the income generated by the trust with the remainder (i.e. principal) going to a charity when the trust terminates. The trust will periodically pay out a set percentage (between 5-50% as determined by the donor) of the annually adjusted value of the entire trust to the income beneficiary. A primary consideration with charitable remainder trusts is the 10% test – the future interest the charity will receive must be valued at 10% of the total initial trust value. For that reason these types of trusts usually have a set term length depending on the age of the donor.
- Charitable Remainder Annuity Trust (CRAT) – a CRAT is essentially the same as a CRUT with the similar overall guidelines, except the set payout between 5-50% is based on the beginning trust value. It’s important to note that contributions can be made to a CRUT but not a CRAT.
- Charitable Lead Trust (CLT) – a CLT is simply the opposite of a CRUT or CRAT. The charity receives income until the trust terminates, and upon termination a non-charitable beneficiary, such as a surviving spouse or children, receives the remainder of what is left. The income can pay out either the annually adjusted value or the beginning value.
Charitable trusts offer more for the individual or family still seeking to benefit financially from their assets, while simultaneously accomplishing philanthropic wishes. Furthermore, you may also receive an immediate charitable deduction for the amount contributed to the trust. Assets placed in the trust are also excluded from your estate. Like other forms of gifting listed above, capital-gains tax can be avoided when contributing appreciated property such as stocks or mutual funds to a charitable trust.
For a more in-depth covering of charitable trusts check out this IRS guide.
There are, of course, other ways for individuals to be charitable without going through the trouble of setting up a DAF, foundation, or trust. Donating cash or an investment(s) holding directly to a charity can be a much easier and more feasible solution for most people looking to give back. Cash contributions would be those made by check, debit card, or even by credit card. Investment assets you could donate include individual stocks, mutual funds, ETFs, or possibly even cryptocurrencies (if the charity accepts it) which have appreciated in value. The benefit of donating appreciated investment holdings is you avoid capital gains tax and receive a tax deduction at the same time. Generally speaking, your tax write-off for cash donations is limited to 60% of your Adjusted Gross Income (”AGI”), while the write-off for stock donations is limited to 30% of AGI. Any excess above those limits can be carried-forward as a write-off in future years.
Another simple way to donate charity is via an IRA distribution. Retirees who have IRAs are likely familiar with the Required Minimum Distribution (“RMD”) rule, which requires them to take distributions from their IRA annually starting at age 72 – even if they don’t need the money. If you don’t need your RMD to cover living expenses one year, consider a “qualified charitable distribution” which is a direct transfer of funds from your IRA to a charity. Qualified charitable distributions are not included as income on your tax return, but you likewise will not receive a tax write-off like a regular charitable donation.
We recommend chatting with one of our financial advisors to see which charitable giving vehicle is right for you.
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