Tax & Estate Planning via Charitable Donations

Charitable donations are something that Americans are inclined to do more so than citizens of virtually every nation on earth. This is in part a result of the fact that the US is the wealthiest nation on earth and has the largest per capita GDP per citizen of any of the large industrialized nations of the world. Being charitably inclined can mean volunteering one’s time or their financial resources. In the case of monetary contributions, charitable donations can offer some financial planning benefits that can impact an individual’s estate and tax planning in positive way. In order to qualify for these benefits the contribution must be made to a registered 501(c)(3) organization, which is a qualifying status the IRS gives to non-profit organizations.

One common benefit of donating to a charity is the tax deduction available which can be used against an individual’s income tax liability. In order to take the deduction you must itemize deductions on your IRS form 1040 rather than take the standard deduction. However, there are limits to this deduction. As a general rule, you can deduct a donation of cash up to 50% of your Adjusted Gross Income (AGI). In the case of property, the limit is typically 30% of your AGI. In the case of a donation of stock, mutual funds or property, the amount donated will be based on the fair market value of the asset at the time of the contribution.

In some cases the main motivating driver of the charitable contribution is not necessarily the immediate reduction in income tax liability, but rather the reduction in the size of an individual’s taxable estate. This is particularly common in the case of individuals who may have no direct heirs or have an estate large enough that they have little concern for the heirs being left in good financial condition upon their passing. Estate planning to limit the exposure to estate taxes has become substantially easier in recent years for the average American when evaluating their Federal Estate tax liability. The Applicable Exemption amount for 2014 is $5.34 million. Because of the new rules permitting portability, that is a joint credit of more than $10 million for a couple if an IRS 706 form is filed within 9 months of the deceased passing. However, when looking at the individual State laws the thresholds are not always so forgiving. As an example, in NY State any estate in excess of $1 million will have an estate tax levied that can range as high as 16%. Additionally, portability rules which allow you to claim a credit for your deceased spouses Applicable Exemption do not apply in the State of NY. Each state has their own tax law pertaining to the taxation of an estate and/or an inheritance.

Those individuals who are charitably inclined and would prefer to see their assets pass on to what they may deem to be a worthy cause rather than the State or Federal gov’t should consider a number of potential estate planning strategies. Among them would be a Charitable Remainder Trust. These types of trusts are drafted in more than one form.

One such form is called a Charitable Remainder Unit Trust (CRUT). Under this type of trust, the assets that are placed into the trust will eventually go to the eligible charitable organizations upon the termination of the trust, which is commonly the death of the grantor of the assets. The trust is then required to pay back to a non-charitable beneficiary (also commonly the grantor) a fixed percentage of the trust’s assets annually until it is terminated. The termination of the trust can be triggered by the death of the grantor or be based on a specific number of years. This is technique that permits the grantor to continue to receive income from the trust while removing the principal assets from their taxable estate to later be paid to a charity. The payments are typically required to be between 5%-50% of the trust assets.

Another strategy is the Charitable Remainder Annuity Trust (CRAT). This trust operates in a similar manner, but rather than pay back a fixed percentage of the trust assets annually, it pays a fixed annuity payment of a specific dollar amount annually.

Yet another option is what is called a Net Income with Makeup Charitable Remainder Unit Trust (NIM-CRUT). In the case of the NIM-CRUT the trust also pays a fixed percentage of the trust assets not to be less than 5% back to the stated income beneficiary. In the event that the trust assets generate less income in a given year than the stated minimum percentage of the trust payement, then the payment is made as the lesser figure of income. The reason for this is that a NIM-CRUT does not permit the trust to invade the principal value of the investments for the purpose paying the non-charitable beneficiary the annual income payments.

Another option available is a Charitable Pooled Income Fund. In the case of this type of charitable contribution, the grantor pools his or her donation with that of other investors. These types of funds are commonly created by large financial institutions who manage the assets for you or directly by a charity themselves. The disadvantages are that the investment options are limited to those available in the fund and high minimum investments may be required. Additionally, while you may be saving on the expense of having to obtain an attorney to draft a trust for you, you will incur the annual expense of the financial institution to manage the pooled income fund on your behalf with very limited investment options.

Another benefit associated with each of these strategies is that assets which are donated to any of these forms of charitable trusts will eliminate the capital gains assessed on appreciated assets. Unlike a gift to a relative, friend or some other non-charitable organization, the capital gain will not be levied because the asset was donated in kind without having been sold until it was part of the trust. Since the charities which must be registered as 501(c)(4) non-profit organizations are the ultimate beneficiary of the donated assets, they are not subject to capital gains tax.

An additional strategy which was available is the use of Required Minimum Distributions (RMD). An RMD is a mandatory distribution that an individual must take from an IRA/401k/403b once they reach age 70 1/2. If the distribution from an IRA that is within the RMD amount is paid directly to a qualified charity, there is no income tax assessed on the distribution up to $100,00.00. This is called a Qualified Charitable Distribution. This was originally enacted as part of the Pension Protection Act of 2006. The provision was set to expire numerous times and was extended repeatedly. The provision expired in 2013, and it remains to be seen whether or not it will be reinstated for 2014 as benefit for charitable contributions.

These are a few of the commonly used estate planning techniques that can help one minimize both their current and future tax liabilities, while still donating to a worthy cause of their choosing. Estate planning can be a very complex topic, and should be taken seriously. It is something that each individual should address with a competent estate planning attorney who is willing to work in conjunction with their tax advisor and financial planner.