Despite the market volatility of the past year, philanthropy continues to be a top priority for Americans. The Giving Institute (formerly the American Association of Fundraising Counsel) reports that U.S. charitable giving was estimated at $307.65 billion in 2008, with an estimated 75% — $229.28 billion — coming from individual contributions. If philanthropy is a top priority in your life, you may want to incorporate giving into your wealth transfer plan. The best way to accomplish that? The answer depends in part on your goals and individual situation.
Your Philanthropic Goals
To make philanthropic decisions that will best help you accomplish your personal goals, you need to understand the motives behind your giving, says Marguerite Griffin, national director of philanthropic services for Northern Trust. Do you want to give back to the community, honor a family member, instill values in your children or simply save on taxes? How important is it to you that charitable giving creates a lasting family legacy?
“It is important to be able to articulate the ‘why’ of your giving because it will affect how your family gives, especially if your children are becoming a part of it,” Griffin says. Additionally, she suggests that you create a charitable mission statement, which is an excellent way to involve the entire family in the philanthropic process. Consider the types of activities you want to support and take the time to research and think about the causes that matter to you.
Structure Your Charitable Gifts
After you have identified the “why” of your giving and selected the types of charities you would like to support, you need to focus on the “how.” Selecting the right way to structure your giving depends on your motivation, objectives and financial situation. Your choice of vehicle can affect the tax benefits you receive from your donation, as well as the level of ongoing involvement you and your family may have.
When Grace Allison, tax strategist for Northern Trust, talks to clients about charitable giving, she encourages them to explore taxfriendly structures that benefit both the family members and the charity. “Many donors are unaware of vehicles such as charitable remainder trusts and charitable lead trusts,” Allison says.
Rules of Charitable Giving
Among the many benefits of philanthropy are the tax deductions that accompany properly structured gifts. As a result, tax rules likely will influence the structure and timing of any gifts you make. “The most basic requirement is that the recipient be tax exempt,” says Grace Allison, tax strategist for Northern Trust, adding that most publicly supported charitable organizations, such as the YMCA, United Way and American Red Cross, are tax-exempt entities. But different types of organizations are subject to different tax rules.
In fact, the tax rules on charitable giving can be quite complex. For example, while contributions to public charities and private operating foundations are generally tax deductible based on their fair market value, contributions of real estate or tangible personal property to private nonoperating foundations are not. For this reason, it’s important to work closely with your wealth transfer team to be sure you understand the rules that will apply to each gift.
Option 1: Outright Gifts/Direct Donations
The simplest form of philanthropy, direct donations result in an immediate income tax deduction of up to 50% of the donor’s adjusted gross income for cash and up to 30% for securities. If you make a direct bequest at death, your estate will receive an estate tax deduction for the full market value of the donation.
With a direct donation, the charity immediately benefits from your gift. However, Allison and Griffin advise checking with both the charity and your tax advisor when making a noncash gift. Whether a charity accepts a contribution of property will depend on the particulars of its gift acceptance policy. In addition, tax benefits for transfers of tangible personal property such as collectibles will be sharply limited if the recipient’s actual use of the gift is not closely related to the recipient’s mission.
Option 2: Private Foundations
Private foundations are one of the oldest, most popular entities used to further the philanthropic interests of a family. A foundation creates the ultimate legacy of philanthropy among family, but is also the most complicated and expensive to establish. The main advantage is control, as the founder is in position to make decisions regarding the foundation, including grant-making and investments.
As noted above, the income tax charitable deduction for gifts of cash and securities to public charities (such as the United Way or the Red Cross) is limited to a respective 50% and 30% of the donor’s adjusted gross income. In contrast, the charitable deduction for contributions to a private foundation is limited to 30% of adjusted gross income for cash and 20% for securities. The substantial set-up, annual tax returns and ongoing expenses may also factor into your decision on whether a private foundation is the right philanthropic legacy for your family.
“Most of our clients will set aside at least $2 million to start a foundation,” Griffin says. “If they plan to put more in at death, they will start with $1 million.”
Option 3: Donor-Advised Funds
If you want to involve your family members in your giving but don’t want the complications that often accompany establishing a foundation, you may want to consider a donor-advised fund, Griffin suggests. With a donor-advised fund, a sponsoring charity administers the account while appointed family members and friends serve as the fund’s advisors. You can make a transfer to a donor-advised fund during life or at death, and the transfer is treated for tax purposes as a direct transfer to the sponsoring public charity.
“A donor-advised fund is relatively inexpensive to establish, and you can make gifts through it anonymously,” Griffin says. But, ultimately, the sponsoring public charity has the final say on grant recommendations and investment of fund assets.
Option 4: Charitable Trusts
“If you want to leave a legacy of philanthropy but also want to benefit family members, you may want to consider either a charitable remainder trust or a charitable lead trust,” Allison says.
With a charitable remainder trust, the donor designates one or more beneficiaries (which might include the donor himor herself) to receive cash flow for the trust’s term; at the end of the term, one or more of the designated charities receive the remainder. A charitable lead trust works just the opposite, with the trust’s cash flow going to the charity for the term of the trust, and the remainder going to the beneficiaries thereafter.
“A charitable remainder trust can defer gain and enhance cash flow, while a charitable lead trust can leverage available gift or estate tax exemptions, particularly in today’s low interest-rate environment,” Allison says. In either case, both your designated beneficiaries as well as the charity benefit from the wealth.
Choose Your Charitable Asset
Charitable gifts don’t necessarily have to be in the form of cash. Nearly any type of asset can be used to fund your philanthropic efforts, and each may have different tax implications. The most common funding sources of philanthropy are cash, publicly traded stock or a combination of both. According to Allison, “Highly appreciated assets that are deductible at fair market value are best to give.”
She also notes that from a tax standpoint, it’s generally preferable to sell a depreciated asset, take the tax loss and then donate the cash proceeds. “Donating a long-term appreciated asset generally means avoiding or deferring capital gains tax on the sale — while at the same time garnering an income tax charitable deduction,” Allison says.
If you decide that a legacy of philanthropy suits your interests, Allison and Griffin agree that your wealth transfer team can help you choose the right charitable vehicle for each type of asset in order to maximize the effect of your giving. According to Allison, “You may be surprised by the range of opportunities available.”