July 12, 2016
Written by Mary Ann Hennelly-Favata, Senior Client Advisor
Many people donate regularly throughout the year while others prefer to accelerate their charitable donations at year-end. Either way, giving can help the community and take advantage of tax benefits available at the state and federal levels. In Arizona, for example, there are various tax credits that offset one’s state tax liability when donating to benefit the working poor, public schools, or private school tuition programs.
The wealthy have a vast array of charitable options available to them depending upon the amount of the gift as well as its intended purpose. Several options include private foundations, charitable remainder trusts (CRTs), or charitable lead annuity trusts (CLATs), or charitable gift annuities to name a few. But, unless you are looking at donating assets valued at $1M or more, these options can be cumbersome and expensive to implement and only make sense in certain circumstances.
An alternative to the private foundation is a donor advised fund (DAF). These funds can be opened through your local community foundation, or managed through your preferred brokerage firm. The DAF allows you to donate assets when it makes sense from a financial perspective, and then gradually distribute assets to charities as you decide what to support. Thus, you can donate to get the tax deduction in 2016, but distribute assets to charity in 2017 or beyond. These DAFs have investment options available for the assets so they can grow while they are in the charitable giving fund. This is a great option for achieving longer term philanthropic goals by donating strategically to reduce taxes, and then distributing assets to charity over time.
The ability to donate individual retirement account (IRA) required minimum distributions (RMDs) to charity is a wonderful addition to the charitable toolbox that was recently made permanent in our tax code. This provision allows clients who are at least 70 ½ years of age and subject to RMDs to donate some or all of their RMD amount – up to $100K per year – to charity. The key income tax differential in this type of donation is that you eliminate the need to include the RMD as taxable income. Before this provision, you would record the RMD as income on your tax return (above the line) and then take a “Schedule A” itemized deduction (below the line) for the donation.
A conversation about charitable donations would not be complete without discussing the popular method of donating “appreciated securities” to charity. The wonderful thing about this strategy is that you get to deduct the current market value of the security that was donated “in like kind”. Let’s say you bought a stock 20 years ago and paid $20 per share, and today it is trading at $100 per share. Thus, you could donate 100 shares of the stock, which cost you $2,000 and you would get a charitable deduction of $10,000 plus you would never have to pay the capital gains tax on the difference between the $2,000 cost basis and the $10,000 market value donated. These type of donations of appreciated securities take time and several steps to process, so it is a good idea to start the process in the beginning of December to ensure it can be completed before year-end.
I have found that many people have charitable goals, but they are reluctant to gift assets during their lifetime for fear that they may need the funds later in life. In these instances, one can provide for specific charitable bequests in their will or trust documents.
An excellent asset to leave to charity is one that is tax “inefficient.” For example, if you had both a taxable account and an IRA and you were deciding which type of assets to give to charity, the IRA is the best asset to give. This is because both the taxable account and the IRA assets could potentially be subject to estate tax; however, only the IRA will be subject to income tax as well. Tax-deferred accounts, like IRAs and annuities, do not get a tax basis step up at date-of-death, and as funds are withdrawn they are subject to ordinary income tax rates. By leaving tax-deferred assets to charity, you will be reducing any potential estate tax and eliminating any income tax. Just be sure that you are leaving the assets to a qualified 501(c)(3) charity. The qualified charity will then have full advantage of the tax-deferred account value, as they are not subject to income tax.
And last but not least, there are many opportunities for people, including children, of all means to donate to charity. Summer is a great time to donate water to the local charities that serve the homeless in Arizona. Phoenix Children’s Hospital just teamed up with St. Mary’s Food Bank to provide cereal to families in need during the summer months. The Cereal Drive helps to feed the children who are no longer getting free or subsidized lunch meals at school.
Summertime is also a great time to take stock of what is in your closets, attics and garages. Those old clothing items, bicycles, toys, and household items could be vital to someone in need. So remember to annually purge your household of unnecessary clutter and donate to your local charities.
Philanthropy benefits the donor, because it helps to reduce estate taxes, income taxes and household clutter. Philanthropy benefits charities, religious organizations, schools and the community in need. Exploring your philanthropic side truly is a “win-win” proposition that will leave you feeling good inside.