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'Tis the Season for Charitable Giving

Nancy B. Crowley, CPA

As the end of the year approaches, your focus may be on the holidays; however, you also may be thinking about your favorite charities and donations that you want to make before December 31st.  You may be surprised to know that you have many options to accomplish your philanthropic goals, ranging from direct cash donations to more complex vehicles such as private foundations and charitable trusts.  Charitable giving not only serves your philanthropic desires, but also has the added benefit of reducing your current year taxes and may even reduce your estate taxes as well.

A donation must be made to a “qualified charitable organization.”  A qualified charitable organization is a nonprofit that qualifies for tax-exempt status according to the Internal Revenue Service.  Qualified charitable organizations must be operated exclusively for religious, charitable, scientific, educational, or humanitarian purposes.  Donations to specific individuals, political candidates, and most foreign charitable organizations are examples of organizations that are not considered qualified charitable organizations.  To determine if an organization is a qualified charitable organization, contact your RINET advisor, the organization directly, or you can access the Exempt Organizations Select Check Tool hosted by the IRS to search for qualified organizations.

Below is an overview of the various methods and vehicles for making charitable donations:

Cash Contributions

Cash contributions are those made in cash, check, or by credit card.  They are the most direct, least complicated way of making a donation.  However, there are documentation requirements.  For a donation of less than $250, you must have a bank record that shows the date of the contribution, the amount, and the name of the qualified charitable organization.  . For cash contributions of $250 or more, an acknowledgment of the contribution from each qualified organization or certain payroll deduction records are required to substantiate the deduction.

Non-Cash Contributions

Non-cash contributions are somewhat more complicated than cash contributions. There are specific rules governing non-cash contributions based on the type of property or asset contributed. Donating long-term, publicly-traded appreciated securities is one of the best charitable contribution methods. Not only do you avoid incurring the capital gains tax on the appreciation of the securities, but you also get a charitable deduction based on fair market value rather than on the cost of the securities.  To be considered long term, the securities must have been held for more than one year, otherwise the donation is valued at cost. 

Other common non-cash donations include clothing and household items, which must be in good, used condition or better.  Automobiles are another popular donation item type.  They are valued at the lesser of the gross proceeds from the sale of the vehicle by the charitable organization or the vehicle’s fair market value.  Real estate, easements, and artwork may also be donated, but may require an appraisal.

Non-cash contributions must meet specific documentation requirements.  Differing requirements occur when the non-cash contribution is less than $250; at least $250 but not more than $500; over $500 but not more than $5,000, and over $5,000. 

Qualified Charitable Donations (QCDs)

A qualified charitable distribution (QCD) generally is a nontaxable distribution made directly by the trustee of you IRA (other than a SEP or SIMPLE IRA) to an organization eligible to receive tax deductible contributions. You must be at least 70½ when the distribution was made.  Also, you must have the same type of acknowledgement of your contribution that you would need to claim a deduction for a charitable contribution.

The maximum annual exclusion for a QCD is $100,000.  If you file a joint return, your spouse also can have a QCD and exclude up to $100,000.  A QCD counts towards your required minimum distribution.

Donor-Advised Funds

A Donor Advised Fund (DAF) is a charitable vehicle established as a qualified public charity which allows you to make an irrevocable charitable contribution and take a tax deduction up to 60% of adjusted gross for cash and 30% of adjusted gross income for long-term appreciated assets in the year of the contribution.   Your contribution is placed in a donor-advised fund account where it is invested and grows tax free.  The donor-advised fund owns and controls the assets, thereby making the investment decisions. You, as the donor, can recommend grants be made from your account to qualified charities at anytime.  Keep in mind that you have already received your tax deduction and therefore are limited to making recommendations for grants from the DAF. 

Donor-advised funds are often compared to private foundations. Below is a summary of the major differences between these two vehicles:

  Donor-Advised Funds   Private Foundations    
Start-Up Time Immediate Several weeks or months
Start-Up Costs None Substantial legal and other fees 
Investment Management  Limited to available investment pools  Complete control over investment management (with adherence to specific rules) 
Privacy Grants can be made anonymously Must file detailed public tax return (990-PF)
Administrative Responsibilities  Recommend grants to favorite charities  Investment management, grant distribution, expense management, and tax filings 

Private Foundations

Private foundations are nonprofits that are established with funds from a single source or specific sources, such as an individual or family.  The foundation is managed by its own trustees or directors and it is an independent entity.  Contributions to the foundation are tax deductible up to 30% of adjusted gross income for cash and 20% of adjusted gross income for long-term publicly traded appreciated assets.  Once a contribution to the foundation has been made, the principal is invested and used for making charitable distributions.  There is a 5% annual distribution requirement.  Tax returns, which are public, must be filed with the IRS and the state. There is a 2% (or possibly 1%) excise tax on yearly net investment income.

Donors have chosen to set up private foundations as they allow them to leave a legacy and involve other family members in philanthropy.  Private foundations are ideal if you want the control and flexibility to invest the foundation’s assets in a wide array of investment options.  They are also a good option if you wish to maintain control over the administrative aspects of the private foundation, such as expense management and making grants.  The majority (67%) of all private foundations have less than $1 million in assets, making it a vehicle used by donors of all wealth levels.

Charitable Trusts & Annuities

Charitable Remainder Trusts.  A charitable remainder trust (CRT) is an irrevocable trust that provides you or your designated beneficiaries with an income stream for a period of time (not to exceed twenty years) or for the life or lives of such individual or individuals, and then the remaining assets go to a chosen charity.   CRTs are usually funded with appreciated property, including appreciated stock or real estate.  The benefit of donating appreciated assets is that they are then sold within the CRT, which is exempt from tax, and you avoid the capital gain tax on the appreciation.  The only income taxed for the duration of the CRT is the annual income stream distributed to you or your designated beneficiaries.   In addition, you receive an immediate, but partial, charitable deduction based on the value of the eventual gift to the chosen charity.

Charitable Lead Trusts.  A charitable lead trust (CLT) is basically a charitable remainder trust in reverse.  The charity receives the income stream first and then, at the end of a specified term, any income and principal remaining either reverts back to you or to your other non-charitable beneficiaries named in the trust.

Charitable Gift Annuities.  A charitable gift annuity is a contract between you and the chosen charity.  You donate a certain amount to the charity. In return, the charity agrees to make regular fixed payments to you for your lifetime.  Upon your death, the charity retains the balance.  When the gift is made, you receive a tax deduction for the estimated amount that is donated to the charity.  A portion of the payments you receive will be tax free as a return of principal until you reach your statistical life expectancy.

Traditional IRAs and Workplace Retirement Plans

Another good tax-saving strategy is designating a charity as a beneficiary or a contingent beneficiary of all or a portion of your traditional IRA or workplace retirement plan (i.e. 401(k), 403(b) and 457 plans).  Traditional IRAs may be subject to significant taxes as not only will a traditional IRA be included in your estate for federal estate tax purposes, but there will be income tax owed when IRA withdrawals are taken by your estate or heirs, and a state income tax may be due as well. The benefit of this strategy is that these taxes can be avoided at the time of withdrawal, when charities are named as beneficiaries of your retirement plans.

It is important to note that this strategy does not apply to Roth IRAs since you would be sacrificing the favorable tax treatment which allows your beneficiaries to receive distributions tax-free.

Take Action Today

As you can see, there are many ways to accomplish your philanthropic goals.  Each charitable giving method or vehicle has advantages and should be considered based on your specific philanthropic objectives while evaluating the income and estate tax benefits. If you have any questions, please contact your RINET advisor.