Charitable Giving: Do Good and Get Tax Breaks, Too
Written by Ana Perez-Arrieta
Posted on Nov 29, 2015
You might think that corporations give the most to charity, but it’s actually every day Americans who keep charities going. In 2014, individuals gave $258.51 billion (or 72% of total giving) compared to corporations, which gave $17.77 billion (or 5%). Many donors cite “giving back to the community” as their primary motivation for giving to charity. Whether you’re drawn to religion, education, human services, grant-making foundations, health, arts, culture or the humanities, there is something for everyone. As of May 2015, there were approximately 1.5 million charitable organizations in the U.S. So, what are the main vehicles for charitable giving?
You can make an outright gift to charity during your lifetime or upon your death pursuant to the terms of your Will or Trust. If you make a charitable gift during your lifetime, you may qualify for an income tax deduction if you itemize your deductions. In general, you may deduct contributions to charitable organizations, up to 50% of your adjusted gross income, but certain contributions are limited to 20% or 30% of your adjusted gross income.
If you make a charitable bequest effective upon your death under your Will or Trust, then the amount of the gift will be deducted from the taxable estate in calculating your estate tax liability. Since the estate tax exemption is so large these days (each person has an exemption amount over $5 million), your estate benefits from the charitable estate tax deduction only if your estate is taxable (meaning that your estate is greater than the exemption amount).
Whether you make the gift during your lifetime or upon your death, you can donate just about any kind of asset to charity, such as cash, securities, real property, tangible personal property, retirement plan assets, intangible property (e.g., patents, royalties and copyrights), or cash value in a life insurance policy. However, different assets are subject to different limitations on the amounts you can deduct.
Charitable Gift Annuities
A charitable gift annuity is basically an agreement in which the charity promises to pay the donor an income stream in exchange for the donor’s contribution of cash or securities. The income stream to the donor is a fixed amount that is paid for a term of years or the donor’s lifetime. The present value of the future benefit to the charity is tax-deductible for income tax purposes, and the assets that the donor gave to charity are removed from the donor’s estate for estate tax purposes. Two disadvantages of this arrangement are: (1) the donor loses control over the funds that are contributed, and (2) the charity’s obligation to pay the donor is unsecured, so the donor is relying on the charity’s continued financial health to fulfill its promise to pay the donor. Additionally, if a donor greatly survives their life expectancy, there may be no real residual value to the charity.
A private foundation is a nonprofit corporation (or it can be set up as a trust) that is typically created by a single donor, a high-net-worth family, a group of individuals, or a business. Most private foundations are family foundations that are supported and controlled by the donors, their descendants, advisors and friends. The private foundation, like any corporation, has a board of directors. The directors decide which charities receive distributions each year. In general, a private foundation must distribute at least 5% of its net value each year to one or more charities. There are excise taxes that are designed to make sure that donors do not benefit from the foundation’s income or assets. A private foundation can be a useful way to achieve significant tax benefits for both estate and income tax purposes while maintaining control over the assets, but it has significant restraints and complex rules.
Charitable Remainder Trust (Unitrust and Annuity)
The charitable remainder trust (CRT) pays either a fixed percentage of the trust assets’ value (charitable remainder unitrust) or a fixed amount (charitable remainder annuity trust) each year to the donor or some other person that the donor designates for a certain number of years or for a lifetime, and at the end of that period, the remainder goes to charity. The value of the remainder is calculated when the trust is created based upon the amount of the initial contribution, the amount of the payments, and the term or life expectancy of the income beneficiary. The donor gets an income tax deduction for that remainder interest value. The donor may either serve as trustee or select the trustee, and the donor can retain the power to change the charitable beneficiary, but the payments cannot be changed. Since the assets are owned by the trust, and the trust is tax-exempt, the trust and donor avoid the capital gains tax, making CRTs an attractive vehicle for assets with large built-in capital gains. The asset is also no longer a part of the donor’s estate so it avoids estate taxes as well.
Charitable Lead Trust
Charitable lead trusts (CLTs) are similar to charitable remainder trusts, except that the charity retains the income interest and the remainder is distributed to a non-charity, such as the donor’s children. The donor does not receive an income tax deduction when the charitable lead trust is created, but there may be estate tax and/or income tax benefits that vary depending on how the trust is structured. The donor can maintain control over the trust by serving as trustee. With a CLT, the donor must be able to afford giving up the income interest and the principal in the donated property, and thus, CLTs are generally used only in very large estates.
Pooled Income Funds
A pooled income fund is created and maintained by a public charity. Many different donors can contribute to the fund. The assets are pooled and invested together. Each donor is paid a proportionate share of the net income earned by the fund. These income distributions are paid to the donor for his or her lifetime. The income that each donor receives depends on the fund’s performance. Upon the death of each income beneficiary, the charity receives an amount equal to that donor’s share of the fund. Contributions to the pooled income fund qualify for charitable income, gift and estate tax deduction purposes. The donor’s deduction is based on the discounted present value of the remainder interest to charity.
Donor Advised Funds
A donor advised fund (DAF) is a separate account that is owned by a sponsoring charity. Often, the sponsoring charity is a community foundation or a large public charity, such as a hospital or university. The donor can make recommendations to the sponsoring charity about how to invest the assets in the DAF, and the donor has the power to recommend charitable grants from the DAF. The donor may work with younger family members to recommend grants, making philanthropy a family affair much like a family foundation, but it’s much easier because the family is only managing that one DAF, as opposed to running its own nonprofit organization. Upon the donor’s death, the DAF can either terminate by distributing its funds to a charity or continue under the advisement of successor advisors, selected by the original donor. The biggest advantage of a DAF is that all of the administrative work is handled by the sponsoring charity; the sponsoring charity handles the record-keeping, tax returns, and other requirements while the donor (and typically the donor’s family) gets to recommend distributions of income and principal to charitable organizations. A gift to a DAF is treated for tax deduction purposes as a contribution to a public charity.
A conservation easement involves a deed from a donor or an estate to a qualified conservation organization. The donor imposes certain conservation restrictions on real property, and the qualified conservation organization agrees to enforce the rules. If the easement is conveyed during lifetime, the donor is eligible for an income tax deduction. The easement may also be conveyed at death, which could reduce the estate taxes of the decedent because the easement lowers the value of the property.
Last by not least, some people feel as if they’d love to give to charity, but they don’t have the money to do it. One way to contribute without donating money is to volunteer your time. Don’t underestimate the value of volunteering your time to an organization that you care about. Charities are often understaffed and underfunded and will gladly accept your help with activities, such as fundraising, general labor, transportation, tutoring, and teaching, among other things. And besides, research has shown that people who volunteer their time tend to live longer than those who don’t. If you live longer, you may accumulate enough funds to donate money as well!