CHAPTER
18

Saving Money with Charitable Donations

In This Chapter

• The benefits of giving
• Many varieties of gifts
• Good, and better, tax implications
• Gifts after retirement

If you are generous to family and friends, and can afford the money, you are probably also generous to your favorite charities.

Can you save money while giving to a worthwhile cause? Yes, indeed. Planning allows you to arrange charitable contributions in a way that will maximize your personal objectives with appropriate tax incentives. Read on.

Tax Savings and Philanthropy

Americans have always been a generous people. In 2014, total charitable giving in the United States totaled $358 billion. Individuals gave 72 percent of that amount, and the average household gave $2,374. Our religious institutions, universities, United Way agencies, and local civic organizations, among other groups, all have prospered with such gifts.

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Not all charities qualify for income, estate, and gift tax deductions. Public charities do, such as churches, educational institutions, hospitals, and government offices (any of them—U.S. Treasury Department, State of Nevada, etc.). To see which others qualify for such deductions, check with the Internal Revenue Service (IRS) for a list of qualified charities.

Here are some of the benefits of planned giving:

• Fulfilling your charitable goals
• Providing income tax deductions for the value of the charitable gift
• Avoiding the capital gains tax when giving appreciated property
• Retaining income rights to the property donated to the charity
• Increasing lifetime income by converting low-yielding assets
• Supplementing retirement income
• Obtaining professional asset management
• Reducing federal estate and state inheritance taxes

Clearly, charitable donations should be considered part of your estate planning. The following pages point out several different methods you can use to make them fulfill your goals, from outright gifts to charitable trusts and pooled income funds.

BRIEF

Lilly Endowment, Inc., is a private philanthropic foundation based in Indianapolis, Indiana, with assets of about $10 billion. It was established in 1937 by three members of the Lilly family through gifts of 17,500 shares of stock worth $280,000 in their pharmaceutical business. Lilly Endowment is usually in the top 10 largest U.S. endowments (as measured by assets).

Which Assets to Give

What you choose to give to charity has important tax implications. After all, doing good for others does not preclude doing well for oneself.

The tax deduction for charitable gifts is usually the fair market value of the property given. But the law requires that certain types of property be deducted at what it cost the donor to purchase, not its current market value.

To explain the difference, consider Willie. He bought ABC, Inc., stock in 1995 for $40,000; it is now worth $60,000. After he gives the stock to State University, he wants to deduct from his income tax the full value of the stock contribution, rather than just the amount he paid for it.

The tax code permits individual taxpayers to deduct charitable contributions if they itemize their deductions (use Form 1040, Schedule B, “Interest and Ordinary Dividends”).

However, there are some limitations regarding the deduction:

• No deduction can exceed 50 percent of the taxpayer’s adjusted gross income (AGI).
• If you are giving appreciated property, you may be limited to 30 percent of your adjusted income.
• Ordinary income assets (inventory, for example) are deductible at the inventory cost.

Confused? An example should help. Assume Willie had an AGI of $100,000. If he wanted to take the full value of his contribution of $60,000, he would have to spread the deduction over 2 years because he would be limited to 50 percent of his AGI ($50,000) in the year he made the gift in all events and, in this example, 30 percent of his AGI ($30,000) because that is the yearly maximum for capital gains assets such as stock.

Or he could take the gift’s cost (or tax basis) of $40,000 as a deduction in the year he gives it because the 50 percent of AGI rule applies when he limits his deduction to what the stock cost him. The amount of deduction Willie cannot take in the year of contribution because of the maximum percentage rules will be available for him to take in the next tax year.

DEFINITION

The tax basis of property is the taxpayer’s investment (cost plus improvements less depreciation).

Willie, a professional landscape artist, is certainly generous to his alma mater and now donates several of his own paintings to the university. Because the sale of his works would create ordinary income for him, he can only deduct his cost in producing the works, up to 50 percent of his AGI.

Here is another consideration. Willie purchased XYZ, Inc., stock in 1990 for $20,000. The stock is now selling for $10,000. If he gives the stock to the university, he will get only a $10,000 deduction. However, if he sells the stock and then gives the proceeds to the university, he will receive a tax loss deduction of $10,000 and the charitable deduction of $10,000.

Like Willie, you might consider selling property you own that has depreciated and taking a tax loss (if available). Then make a charitable contribution of the proceeds.

Finally, consider giving your tax-deferred IRA to a charity, if you have a choice of assets to give. Consider Bill, who has two assets—stock worth $100,000 and an IRA worth $100,000. Bill wants to make a $100,000 contribution so he gives the IRA, takes a current charitable deduction, reduces his estate, and never has to report the tax deferred income of the IRA because the charity is tax exempt and has become its beneficiary.

This is an estate planning area where you will certainly want professional help. In this case, that will be the accountant who is a member of your planning team.

Getting Your Donations in Order

Timing is everything, even here. A charitable donation saves you more in taxes when your tax rate is at its highest.

Olive gave $10,000 to Healthy Hospital in 2014, her last year of employment, when she made $100,000. (Her tax rate was 28 percent.) In 2015, she gave another $10,000, but her only income then was $20,000, earned from investments. (Her tax rate was 15 percent.) For simplicity, I am just using the marginal tax rate.

Her contribution in 2014 saved her $2,800 in taxes ($10,000 gift × 28 percent tax rate), while her 2015 contribution saved her $1,500 ($10,000 gift × 15 percent tax rate), for a total tax savings of $4,300 in 2 years.

If Olive had made a $20,000 gift in 2014, she would have saved $5,600 in taxes ($20,000 gift × 28 percent tax rate). By making the gift in the year she had her highest earning, she could have saved $1,300 in taxes.

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Do you like a particular charity but are unsure if you want to give them a sizable sum? If you have the time, do some volunteer work for the group first to be certain you agree with its policies and programs and how it spends its money.

Alternating years when you make charitable donations also could save you in taxes, particularly if you don’t have many other itemized deductions (e.g., mortgage interest, state taxes). You can choose between a standard deduction and itemizing each year.

For instance, one year you would not itemize but take the standard deduction, which in 2015 is $12,600 for married persons filing jointly. Then the next year, you could make the bulk of your charitable contributions and itemize deductions.

That’s what Art and Susan did. They regularly give $6,000 a year to their synagogue. Each year they have approximately $2,000 in other itemized deductions. In 2014, they gave nothing to the synagogue, but in January 2015, they gave $6,000 and then gave an additional $6,000 later in the year.

The couple did not itemize in 2014 (and wouldn’t have anyway, even with a charitable donation, because the standard deduction was greater than their itemized deductions), but did so in 2015 because their charitable contributions plus other itemized deductions ($14,000) exceeded their standard deduction for 2015. Thus, they saved taxes by alternating years for charitable contributions.

• Outright gifts
• Charitable annuity
• Charitable remainder trusts
• Charitable lead trusts
• Pooled income funds
• Charitable remainder in residence or farm
• Charitable bargain sale

The first way to make a charitable contribution has been amply illustrated in previous pages. Most of us simply give our money to a charity. But perhaps we should consider some of the preceding alternatives.

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Keep in mind the charitable deduction is only available for the net value of property transferred to the qualified charity. If the donor retains some interest in the property, the amount of the deduction will be reduced by the value retained by the donor or given to another noncharity, such as a relative.

The Charitable Annuity

Maureen decides to give some land she owns to a favored charity. In turn, the charity agrees to pay her an annuity for her life. In essence, Maureen has made a transfer, or sale, of one asset (her land) for another asset (the charity’s annuity).

You can use IRS tables to make your calculation (see irs.gov), compute how much of the value of the gifted property will be returned to you in the form of the annuity (nondeductible), and how much of its value the charity will keep (deductible). Maureen can only deduct the net value of what the charity gets from her land.

See the “Charitable Annuity Trust” on the book’s website.

Charitable Remainder Trusts

The tax deduction for a charitable remainder trust operates on the same basic principles as the charitable annuity.

Charitable remainder trusts have a noncharity as an income beneficiary, with the remainder (the principal) going to a charity when the income interest terminates.

The person creating the trust (the grantor) often is the income beneficiary. Frequently a spouse is included as a joint/survivor income beneficiary. There is no tax for gifts to spouses because of the marital deduction. However, if anyone other than a spouse is an income beneficiary, there is a gift tax (although the annual exclusion of $14,000 per donee may be available).

There are two types of these remainder trusts: annuity and unitrust. The annuity trust is required to pay a set percentage of the initial value of the assets to the noncharitable beneficiary. The unitrust must pay a set percentage of the trust assets valued annually.

The minimum percentage of payout for each is 5 percent. Additional assets can be contributed to the unitrust but not to the annuity trust. The income tax deduction is based on actuarial and income tables prescribed by the IRS.

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To endow a hospital, college, or similar public or charitable facility is to make a grant of money providing for the continuing support or maintenance of that institution.

Let’s say Carl establishes a charitable remainder trust with $1,000,000. He and his wife, Jennifer, are income beneficiaries. When they die, the trust will terminate and the charity will receive the remainder of the trust assets.

If this is an annuity trust, the amount Carl and Jennifer will receive as income will be fixed, based on the payout percentage and the initial contribution to the trust.

But if this is a unitrust, the amount Carl and Jennifer will receive as income will vary each year, based on the payout percentage and the annual valuation of the assets.

The unitrust can be structured more flexibly than the annuity trust because later contributions and contributions of appreciating assets will increase the income available and could be timed to increase the payout when the donor has retired and is in a lower tax bracket.

Charitable Lead Trusts

A charitable lead trust is essentially the flip side of the remainder trust. In the lead trust, the charity gets the income for a set time period, and the donor or some noncharity receives the principal after that time period. The longer the term for the income payments to the charity, and the higher the payout, the greater the income tax deduction.

Beth establishes a charitable lead trust and contributes $500,000. Her church is to be the income beneficiary for 10 years, and the remainder will go to her daughter.

The income from the trust will be taxed to Beth only if it exceeds the amount of income paid to the charity. Because her daughter receives the remainder interest, there is a gift to her that is subject to the gift tax. (But there is no annual exclusion because she does not have a present right to the property.)

Pooled Income Funds

Many charities have established pooled income funds. Here the donor gives cash or property to the fund, which is made of contributions from other donors, and in return receives income for life (or lives, if a spouse is included). This is similar to the gift annuity you read about earlier.

A pooled income fund may provide several advantages to the donor in addition to the tax deduction. The charity provides professional management, and there is now a diversified investment portfolio, which could mean a higher return if the donor contributed a low income-yielding asset.

WATCH OUT

There’s a way to learn as much as possible about your favorite charity—its history, programs, use of funds, tax exempt status (if any), percentage of fundraising that goes toward programs and percentage used for administrative costs, and more. The Better Business Bureau’s Wise Giving Alliance shares tips on charitable giving at give.org.

Other Charitable Gifts

The list of charitable gift options goes on. Tax law permits you to deed your personal residence or farm to a charity, while you retain a life estate in that property and receive an income tax deduction for the actuarial value of the charity’s remainder interest. The personal residence doesn’t have to be the home in which you are currently residing, either.

Tony, for example, lives most of the year in Ohio but spends a good part of each winter in Florida. He may deed either or both homes to a charity while retaining a life estate so he can use the residence(s) and receive a tax deduction.

Here’s another way to give: if you have an asset you would like to convert to cash and then keep some of the proceeds and give the rest to charity, you might enter into a bargain sale with a charity. A bargain sale is a sale of property to a charity or another person for less than its fair market value, with the difference as a gift to the purchaser.

If Tony, for example, sells some land he purchased several years ago to his college for less than its appraised fair market value, he only will be taxed on a portion of the gain (the difference between what he paid for it and what it’s worth now) and also receive an income tax deduction on the “gift” portion of the sales price.

Any mortgage on the sold/gifted property will increase the bargain seller’s gain. It’s treated as if the debt is released when the seller transfers it to the charity—that is, the charity assumes his debt.

Retirement and Beyond

Most of us buy life insurance to protect our families while the children are growing up. As we grow older, the life insurance becomes more expensive and less important, particularly if our estate will be ample for the rest of our lives.

If you like, you can change the primary or contingent beneficiary of your insurance policy and name a qualified charity. If the charity is the primary beneficiary, you can receive a charitable deduction for the premiums you pay. Upon your death, the charity will receive the proceeds.

So for a relatively modest premium payment, you can leave a substantial amount of money to charity. (The charity must be the owner of the policy for you to receive the tax deduction.)

Perhaps you can’t spare anything now to give to a charity, but after your death, your estate could part with some money. You can leave a specified amount or a percentage of your probate estate to one or several charities through your last will and testament.

QUOTE, UNQUOTE

Posthumous charities are the very essence of selfishness when bequeathed by those who, when alive, would part with nothing.

—Charles Caleb Colton, Lacon (1825)

The Least You Need to Know

• Gifts to charities may qualify for an immediate income tax deduction.
• Charitable gifts are usually valued at their fair market value at the time of the gift.
• Gifts in a charitable trust or pooled income fund can create income and a tax deduction for the donor.
• Life insurance policies and devises in a will allow the donor to make a substantial gift at little or no expense.