The easiest way to make a donation is to simply write a check to a charity or foundation.
This allows for the individual to take a deduction in the year in which they make the donation. This strategy may not make the most sense in all cases. Here are a few more complicated scenarios:
- What if I only own stock and the stock was purchased a long time ago (low cost-basis)?
- What if my annual cash flow only comes from required minimum distributions? How do I make the gift then?
- I want to make a gift, but I still need cash flow from the gifted assets.
- I want to give money to an organization now, but ensure my beneficiaries still retain a portion of the funds.
Let’s start with a few basics as it pertains to the tax deductibility of the gifts. If you happen to itemize your deductions on your tax return, there are limitations to how much of a gift one can deduct. These rules are for 2023:
For example, if an individual has an adjusted gross income of $100,000 and the individual wants to maximize their charitable deduction, a cash gift of $60,000 is the most one could deduct. This is 60% of the individual’s AGI. An individual can gift more and carry the excess deduction for five additional years. This means that if the same client wrote a check for $80,000 to a public charity in 2023, they would deduct $60,000 this year on their return and carry the remaining $20,000 into 2024 for the potential use of a deduction then.
The table above is complicated, but we are here to help walk individuals through the best course of action.
Let’s dive into the complicated scenarios:
What if I only own stock and the stock was purchased a long time ago (low cost-basis)?
Giving low cost-basis stock in a trust account or taxable account can be a great method to accomplish a charitable goal for the current year. Let’s say a client bought $20,000 of Microsoft stock ten years ago and today the stock is worth $100,000. Rather than selling the Microsoft stock and making a cash gift (this would cause the individual to realize a large capital gain tax bill), the person can simply gift the shares directly to a charity. The long-term capital gains would not be realized, and the individual would receive the benefit for a gift of a Long-Term Capital Gain Property.
There is a second layer to this scenario: What if I need the deduction this year but I want to give to multiple charities over the course of many years? This is where a Donor Advised Fund (DAF) can be an excellent vehicle to utilize. The same Microsoft stock can be gifted to the DAF to receive the gift tax deduction. The DAF then sells the shares, and the donor directs the DAF to invest in a wide variety of funds (mix of stocks and bonds). Not only does this eliminate single stock risk in the DAF but allows for the funds to grow tax-free for the life of the DAF. Once the DAF is funded an individual can donate to multiple charities over the course of many years. DAFs are not required to make distributions every year (some do have a small requirement, but this differs among providers). Keep in mind that the gift to a DAF is irrevocable.
What if my annual cash flow only comes from required minimum distributions? How do I make the gift then?
If annual gifts are a part of your yearly budget as a retiree and most of your cash flow is received from required minimum distributions (RMDs), a Qualified Charitable Distribution (QCD) is a great tool to use. QCDs allow an individual to take a portion of the RMD and gift those funds directly to a charity. By making the gift directly from an IRA, the individual no longer must pay income tax on this portion of the distribution. The IRS allows for up to $100,000 of your required minimum distribution to be allocated towards a QCD. This is a wonderful tool to use to meet your chartable goals and be extremely tax efficient at the same time.
What if I want to make a gift, but I still need cash flow from the gifted assets?
This scenario becomes a little more complicated and an estate attorney will need to be incorporated into the implementation process. Two trust vehicles are predominately used in this scenario, a Charitable Remainder Annuity Trust (CRAT) and a Charitable Remainder Unit Trust (CRUT). Both trusts accomplish the same goal, but the annual distributions to the grantor are calculated in different manners. For a CRAT, this irrevocable trust pays the grantor a fixed dollar amount or percentage amount that is based upon the initial value of the trust. In a CRUT, the trust pays out a unitrust percentage of the annually determined value of the trust. Distributions can also be distributed to other individuals besides the grantor if the beneficiary is a non-charitable entity. These trust instruments last for the life of the non-charitable beneficiary or a maximum of 20 years, whichever is shorter. Here are a few other rules of thumb:
- The annual payout must be at least 5%
- The annual payout may not surpass 50%
- The remaining interest in the trust for the benefit of the charity must be at least 10% of the initial trust value.
Keep in mind that these vehicles are irrevocable; this means that once they are established, they cannot be undone. There are a few other characteristics that a grantor must also consider. A licensed attorney, your accountant (CPA) and your wealth advisory team should be a part of the consultation process.
What if I want to give money to an organization now, but ensure my beneficiaries still retain a portion of the funds?
The primary tool used in this scenario is a Charitable Lead Trust. There are two types of lead trusts:
- Grantor Charitable Lead Trust
- Donor receives an income tax deduction on the gift
- Donor must pay tax on the income generated by the trust
- Donor pays capital gains tax when the charity sells assets in the trust
- Non-grantor Charitable Lead Trust
- Grantor does not receive tax deduction for the gift
- The trust itself is taxed on the income produced
- Generally offers more benefits in the gift and estate planning process
The charity receives annual income for the term in the trust and the grantor’s beneficiaries will receive the remaining assets in the trust. The interest rate environment can create a headwind or tailwind on the effectiveness of the trust. Traditionally, as interest rates decline these vehicles become more effective. One reason why an individual would use these vehicles is to gift assets plus the assets’ potential appreciation to their beneficiaries at a smaller value for gift tax purposes. As in the previous scenario, an estate attorney and your wealth management team will need to be consulted to accomplish this goal.
Each one of these scenarios is complicated and a team of professionals is needed to ensure the best course of action for your individual goals. Our team at Howe and Rusling is ready to open a dialogue if charitable gifting is part of your financial goals.