Charitable Giving, Part 2 – Advanced Strategies

"You must pay taxes. But there's no law that says you gotta leave a tip." -- Morgan Stanley

For many of us, the holiday season is a time for reflection and taking stock of the year. It is also a time for counting our blessings and taking an opportunity to “pay it forward” with charitable gifts to organizations that help those less fortunate (and lower our taxable income).

The 2 tax advantages of standard charitable giving

Just because we want to help others, it does not mean that we want to give the government more money than it is due in the form of taxes! In our first charitable giving post, we talked about how giving to charity is a way to deduct a portion of our Adjusted Gross Income from income taxes. Another advantage of giving to charities is that these donations are typically not subject to gift taxes either, allowing you to lower the amount of your estate tax-free if estate taxes are an issue. In today's post, we discuss several ways you can leverage your charitable giving to lower your tax bill.

Additional tax benefits with a donor-advised fund

The first strategy is a donor-advised fund. If you give on a regular basis to your favorite charities, you may find that—despite that giving—you don’t see the savings in your taxes due to the standard deduction, which was increased in 2018 by the Tax Cuts and Jobs Act. This eliminated itemized deductions for most Americans, and many end up taking this standard deduction. For 2021 the standard deduction to your income was $25,100 for a married filing jointly couple, so you need to cross this threshold with deductions to reduce your taxable income further.

The donor-advised fund may allow you to achieve this by allowing you to make a large donation in one year and directing the fund to dispense the funds over the next several years in amounts you would typically give annually.

Example of a $75K gift to a donor-advised fund saving $22,500 in taxes

An example would be if you gave $15,000 to charity each year, this would take you right to the edge of the standard deduction, but you wouldn’t exceed it, so all you could deduct would be the standard deduction. On the other hand, if you gave $75,000 to the donor-advised fund and had them dispense the $15,000 annually for the next five years (plus any applicable growth) to your charities, you would be able to deduct an additional $60,000 (the $75,000 minus the $15,000 that took you to the annual deduction limit) from your taxable income that particular year you donated. If you were in a 37.5% tax bracket, this strategy would save you $22,500 on your tax bill, whereas before you weren’t able to deduct anything with your regular annual giving amount.

2 Methods of lowering income tax, while also lowering estate value

For longer-term charitable giving, Charitable Lead Trusts and Charitable Remainder Trusts are other ways to lower income tax at the time they are established while also reducing the value of an Estate.

Charitable Lead Trusts

In a Charitable Lead Trust, A sum of money is placed in a trust with a specific amount or percentage of money paid to a charity over a period not to exceed 20 years. The present value of these payments (computed using government actuarial tables) qualifies as an income tax deduction.

At the end of the payment period, the remainder value (what’s left over after the payment period) can pass back to the donor or donor’s spouse (not taxable), or other beneficiaries (which would count as a taxable gift).

This can be a way to pay a charity for a specific period and get an up-front tax deduction, while also controlling where the remainder amount is distributed.

Charitable Remainder Trusts

A Charitable Remainder Trust pays a specified income or percentage of the trust to the donor or another non-charitable beneficiary for a specific period, while the remainder value is donated to charity. The remainder value is an actuarial calculation based on interest rates, a person’s age, and the amount payable. This value is an income tax deduction.

An example of this use would be where a retiree needs income yet wants to pass a donation to a charity afterward. Not only can you deduct the remainder value, but you can transfer a low basis stock or other security into this trust and avoid capital gains tax on it (charities don’t pay capital gains tax on donations), thus potentially harvesting income off a greater amount than if you sold it, paid the tax, and realized income off the taxed amount.

Additional methods of charitable giving

Other methods include establishing Private Foundations, Charitable Stock Bailouts, Charitable Gift Annuities, and others. It is always important to consult with an Estate Planning lawyer or professional before implementing a trust or Foundation.

A financial advisor can work with these professionals to help navigate and implement a gifting strategy that meets your needs. To schedule a free consultation, please visit us at f5fp.com.

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