Here, I’ll review the goals of strategic charitable planning, deduction basics, and important charitable giving vehicles.
Simply put, the goal of strategic charitable giving is to help your clients maximize their gifts while reducing their personal tax liability. For example:
There are complex rules surrounding charitable deductions, and it’s vital that your clients include their tax advisor in their planning. Still, there are a few basics when it comes to making charitable deductions.
Now that we’ve covered the goal behind charitable deductions, let’s review the basics.
1) Gifts must be made to a qualified organization. As defined by the IRS, there are eight general categories of qualified organizations. To check on the tax-exempt status of a specific organization, use the Tax Exempt Organization Search tool on the IRS website.
2) The maximum deduction is 60 percent of adjusted gross income (AGI). This applies to gifts made to public charities or private operating foundations (e.g., churches, certain educational organizations, hospitals, and some medical research facilities). Contributions made to organizations outside those categories are capped at 30 percent, including contributions to veterans organizations, fraternal societies, nonprofit cemeteries, and some private nonoperating foundations.
Contributions of long-term capital gain property are capped at 30 percent if the property is given to a 50 percent organization and at 20 percent for organizations that do not qualify as 50 percent organizations.
3) Property contributions are generally valued at fair market value. Exceptions include short-term capital gain property, in which case the deduction is equal to the donor’s basis. The rules regarding valuation of property are complex. IRS Publication 561 offers a basic guide, but your clients should work with a tax professional (and possibly a valuation expert) to ensure that a proper deduction is taken.
4) Clients may carry over contributions that they aren’t able to deduct in the current year for up to five years, if they continue to itemize their deductions. The Pease limitation, which previously put a cap on itemized deductions for certain individuals, was suspended under the Tax Cuts and Jobs Act.
5) Maintaining proper paperwork is essential to fulfilling the IRS’s strict recordkeeping requirements. For cash contributions, your client needs a record reflecting the name of the organization, as well as the date and amount of the contribution (e.g., a check or credit card statement or a receipt from the organization). For noncash contributions, the requirements vary based on the contribution amount.
In all cases, your client must maintain written records, whether a simple receipt or a detailed appraisal prepared by a qualified appraiser.
Again, it’s vital to enlist a tax professional to ensure that requirements are met. Otherwise, your careful planning can quickly go to waste.
Next, let’s look at some of the charitable giving vehicles available to today’s donors.
Direct gifts. This is the most straightforward charitable giving option and may be made directly to a charity with cash, stock, or personal or real property.
Private foundations. These are nonprofit philanthropic organizations set up with a single primary donation from an individual or family.
Charitable remainder trusts. There are two main types of charitable remainder trusts:
Both are an irrevocable transfer of cash or property and are required to distribute a portion of income or principal each year, to either the donor or another beneficiary. At the end of the specified lifetime or term, the remaining trust assets are distributed to a charitable remainder beneficiary.
Also, keep in mind that income distributions to the noncharitable beneficiary are taxed based on the four-tier system: (1) ordinary income, (2) capital gains, (3) tax-free income, and (4) return of principal.
Charitable lead trusts (CLTs). A CLT pays trust income to a charitable beneficiary for a specified term and then distributes the remaining assets to a noncharitable remainder beneficiary, which can be the grantor or his or her heirs. The charitable distributions can be made based on a fixed annuity amount or a variable unitrust amount. There are two types of CLTs:
A nonreversionary lead trust names someone other than the grantor as the remainder beneficiary, and there is no federal income tax deduction upon its creation.
A grantor lead trust reverts to the grantor or his or her spouse as the remainder beneficiary.
Donor-advised funds (DAFs). A low-cost alternative to a private foundation, a DAF is a charity established to distribute funds to other charities. A DAF contribution is generally tax-deductible in the year that it’s made. Typically, the maximum deduction is capped at 60 percent of the donor’s AGI if cash is donated. If a donation of highly appreciated assets is made, the deduction is typically capped at 30 percent of AGI.
Strategic charitable planning, like minimizing taxes, plays a large role in meeting the goals of many of your mid- and high-net-worth clients. With thoughtful planning, you can help ensure that your clients find an appropriate vehicle to carry out their charitable intentions. Plus, talking with clients about their goals and the various strategies available to facilitate giving adds real value, helping you capture more of their investable assets and building stronger relationships that may span generations.
Do you include the charitable giving discussion as part of your client meetings? What charitable giving vehicles are most popular with your high-net-worth clients? Please share your thoughts with us below.
Commonwealth Financial Network does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation.
Editor’s Note: This post was originally published in December 2015, but we’ve updated it to bring you more relevant and timely information.