It’s Better To Give…

In 2001, Americans gave an estimated $203 billion to charities. Since many of you contributed to this figure, it might be worth reviewing some charitable giving options that also carry favorable income and estate tax advantages.

One income tax advantaged strategy appreciated that we can all employ is the gift of appreciated stock. By giving stock to a charity, you are permanently avoiding any built-in capital gains. For example, say you want to contribute $1,000 to a local charity. You own stock in ABC Company that you purchased for $100 and is now worth $1,000. If you sold this stock, you would pay tax on capital gains of $900. However, if you give the stock to the charity instead of cash, you get the same $1,000 charitable deduction for income tax purposes, and you will never pay tax on the $900 capital gain. If you are in a 35% tax bracket, your deduction saves you $350 plus the capital gain saving of $180, a total of $530 tax savings; this means the gift cost you $470, while the charity has its full $1,000.

For those who have loftier charitable goals, charitable trusts are an excellent way to get both an income and estate tax benefit. Depending on the type of trust chosen, there may also be a cash flow benefit.

A Charitable Remainder Trust (CRT) provides the donor with a current income tax deduction, an estate tax benefit and a current income stream for a number of years over the life of the donor. The size of all three benefits depends on the type of trust, the amount contributed to the trust, the term of the trust and the amount of the desired income stream.

In designing the trust, there is a minimum amount of the initial contribution that must pass to the charity at the end of the term. Likewise, there is a minimum amount that must be paid out each year to the donor. Depending on the design of the trust, the income stream to the donor can be “turned on and off.”

The trust can be designed as either an annuity trust, which establishes the yearly payout at a fixed amount upon the funding of the trust, or as a unitrust, which varies the yearly payout based on the dollar value of the trust at the end of the previous year. If the value of the trust increases, the yearly payout increases. If the trust declines in value, the yearly payout decreases.

A CRT works well for an individual who contributes highly appreciated assets to the trust because there is no tax on the sale of assets inside the trust. The payout from the trust may or may not be taxable, depending on the investments inside of the trust.

A second type of charitable trust is a Charitable Lead Trust (CLT). This trust works in the opposite manner of a CRT in that the charity gets the yearly payout and the donor or a designated beneficiary gets the asset back at the end of the term.

The availability of an income tax deduction depends on the type of CLT formed. A grantor CLT provides a current income tax deduction. However, the donor will also pick up any income generated by the trust. For this reason, proper investment of the trust assets is important. Tax-exempt investments inside the trust means tax-exempt income for the donor. If the donor establishes a non-grantor CLT, there is no current income tax deduction and the donor will not pick up any income generated by the trust.

Unlike a CRT, a CLT is not a tax-exempt trust. However, income generated by a non-grantor CLT can be offset by payments to the charity. A CLT can be set up either as an annuity trust or as a unitrust. The distinctions between an annuity trust and unitrust are the same for a CLT as for a CRT.

A CLT is appropriate for individuals who want to support a charity for a number of years but do not want ultimately to give away the underlying asset. It is also ideal for someone who does not need the income produced from a certain asset. You can shift the income from your tax return to the trust, where it can be offset by contributions to a charity.

In addition to CRTs and CLTs, tax-advantaged charitable giving can be done through private family foundations and donor advised funds, which are typically set up through major mutual fund companies.

— Walter Reed

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