Charitable deductions are generally equal to the fair market value of the asset when the charity takes ownership, unless the asset has short-term appreciation. For a short-term appreciated asset, the deduction is equal to the basis.
The IRS has limited the amount of the charitable deduction a taxpayer can claim. The limit is based on the type of charity the assets are contributed to, as well as the type of asset contributed. The charitable deductions for gifts made to public charities are limited in each tax year to 60 percent of adjusted gross income (AGI) for gifts of cash and 30 percent of AGI for long-term appreciated assets. For clients looking to contribute to a private foundation, deductions are generally limited to 30 percent of AGI for cash gifts and 20 percent of AGI for long-term appreciated assets.
The good news is if your client is not able to use his or her charitable deduction fully in a given tax year because of the AGI caps, he or she can carry forward any excess, unused deduction for up to five years.
Bunching gifts. Under the Tax Cuts and Jobs Act, the standard deduction has been increased significantly to $12,200 for a single person and $24,400 for a married couple. With the deduction that high, many advisors are concerned that charitable giving will no longer make a difference in clients’ bottom lines, as clients would need total itemized deductions in excess of the standard deduction in order to “feel the effect” of their charitable giving.
As such, many practitioners recommend that clients bunch their annual gifts to take advantage of the deduction. For example, let’s say you have a single client who gives $5,000 to charitable organizations annually and has the necessary cash flow. She could bunch three years’ worth of $5,000 gifts into one gift that would qualify her to itemize her charitable deduction this year, take the standard deduction for the next two years, make additional bunched gifts in the following year, and so on.
When looking into charitable giving vehicles, there are two broad categories of gifts to consider: (1) irrevocable gifts, where the donor cannot retain any benefit from the dollars donated, and (2) split-interest gifts, where the donor or another party retains some benefit.
Irrevocable gifts. The two vehicles that are discussed most often in the irrevocable gift category are private foundations and donor-advised funds (DAFs).
Split-interest gifts. Three gift types included in the split-interest gift category are charitable remainder trusts (CRTs), charitable lead trusts (CLTs), and charitable gift annuities (CGAs).
Wealth replacement trusts. For clients who balk at giving away a large part of the wealth they could pass along to their heirs, a wealth replacement trust may be their best option of these charitable giving solutions. The client purchases a life insurance policy with a value equal to the asset transferred to a charitable vehicle. That insurance policy is purchased within an irrevocable trust that benefits the client’s family—similar to an irrevocable life insurance trust. Often, when used in conjunction with a CRT or CGA, the premiums for the insurance policy within the trust can be paid using the income generated from the CRT or CGA.
Beyond cash and securities, clients may hold valuable specialty assets that they would like to gift to a charity. Some of the most common specialty asset gifts include shares in a closely held business and real estate (e.g., a vacation home). Art, wine, livestock or farm crops, and even collectibles like stamps or baseball cards also have potential as charitable gifts.
Gifts of specialty assets come with their own rules and restrictions. The most important thing to consider, however, is that clients can unlock value in some of these assets by contributing them to a charitable vehicle. If you have clients thinking about donating these types of assets, be sure to consult with a charitable giving expert who can help you analyze the opportunity.
In an investment management space that has become much more crowded and competitive, having regular philanthropic discussions with your clients can help you demonstrate your value as a financial planner. By understanding the technical aspects of charitable giving solutions, you can provide your clients with effective methods to meet their tax, estate, and legacy planning needs.
Commonwealth Financial Network® does not provide legal or tax advice.
Do you think the Tax Cuts and Jobs Act will have a noticeable impact on your clients’ charitable giving? How are you helping your clients maximize their charitable deductions? Please share below!