Mahatma Gandhi said, “The best way to find yourself is to lose yourself in the service of others.” A 2008 study by Harvard Business School found that giving money to someone else lifted participants’ happiness more that spending it on themselves. These good feelings are reflected in our biology. In a 2006 study, the National Institutes of Health found that when people give to charities, it activates regions of the brain associated with pleasure, social connection, and trust, creating a “warm glow” effect. Scientists also believe that altruistic behavior releases endorphins in the brain, producing the positive feeling known as the “helper’s high.” A December, 2014 study in the Journal of Economic Psychology showed that giving to others reduces the stress and strengthens the immune system, and that tax subsidies for charitable giving may have positive spillover effects on health.
So why not try to help the world and your own well-being in the most tax efficient manner possible? Fortunately, the tax laws are still written so that we can get a tax deduction when we give money to charities we support, so it makes sense to plan accordingly.
State Tax And Federal Tax Effects
The new tax laws passed in late 2017 can affect the ability to claim charitable itemized deductions for many filers. The new maximum of the aggregate of state and local total tax and property tax (SALT) allowed is $10,000. Miscellaneous itemized deductions have been eliminated. At the same time, the standard federal deduction (married filing jointly) has grown to $24,000, increasing to $26,600 if both parties are age 65 or older. This means that many filers will not be able to itemize their charitable deductions the same way they did in 2017.
Example of TCJA Changes
Let’s assume a married couple, under age 65, with a house and modest mortgage. Their itemized deductions are now something like:
State, Local, and Property Tax Limit $10,000
Mortgage Interest $10,500
Charitable Donation $3,300
While it is close, this filer would use the higher $24,000 standard deduction. In that case, the $3,300 charitable donation provides no tax relief. Furthermore, by using the higher federal standard deduction, they must by law (in Maryland) use the lower state standard deduction. While the 2017 Maryland itemized deduction would be $13,800 (mortgage interest plus charitable), in 2018 the standard deduction it is now only $4,500, yielding a net $9,300 at about 8.95% or about $832 more. Now suppose the donor decides to make a slightly higher charitable donation.
State, Local, and Property Tax Limit $10,000
Mortgage Interest $10,500
Charitable Donation $3,550
Now the federal deduction is $24,050, only slightly higher than the standard, and the charitable donation is barely helpful for federal tax purposes. But, the filer can now use the state itemized deduction of $14,050 rather than the state standard deduction of $4,500, netting $9,050 x 8.95% or about $810. By donating $250 more, they saved $810 in state tax.
Another useful strategy for even more impact is grouping of charitable donations. Say you donate $6,600 every other year, rather than $3,300 every year. In the “off” year, the first example would remain the same, as the filer would use the standard deduction, but in the donation year, deductions would be:
State, Local, and Property Tax Limit $10,000
Mortgage Interest $10,500
Charitable Donation $6,600
Now the federal deduction is $27,100 and is in excess of the standard deduction, so the filer would save in federal tax because of a charitable contribution. Plus, this would allow the savings on state tax already discussed above. Consider this strategy if your deductions are close to the federal standard, it could yield some benefits.
The easiest way to give monetarily is to write checks to the charities of your choice. If, and only if, you can itemize your deductions, these amounts are subtracted from your taxable income, up to a maximum of 60% of your adjusted gross income (AGI). If you are in the 24% federal tax bracket, for a $10,000 donation, you save $2,400 in federal taxes, making your out-of-pocket cost $7,600. While the easiest, this is the least tax efficient way to give.
Giving Shares of Stock, Mutual Funds, or ETFs
In addition to cash, there are several other ways to give to charity. From a tax efficiency standpoint, gifting appreciated securities is far more advantageous. If you invested $2,000 in a stock several years ago and it is now worth $10,000, and you sell it, assuming a 15% cap gain rate, you would owe $1,200 in capital gains tax, netting $8,800 after tax. Assuming you can deduct your charitable contributions and applying the same 24% bracket, you could then give the charity $8,800, and get a $2,112 deduction. Instead, if you give the shares directly to charity, you’ll receive a $10,000 tax deduction, which will save you $2,400 in federal income tax and save the $1,200 in capital gains tax. You are saving the world and $1,488 by giving shares rather than cash! Everybody wins!
It is important to note the maximum deduction for giving appreciated securities is 30% of your AGI (vs. 60% for cash) in any one year. More than that, and the extra amount can be carried forward for up to five more years. If you own an appreciated security and feel it still has upside potential, you can buy more of it, and then gift the older, appreciated shares. Consult a professional before doing this!
It is crucial in these gifting strategies, that you identify which shares you are giving to charity in order to gift the shares with the lowest cost basis, so that you are removing the maximum in capital gains from your portfolio. Broker/dealer firms do not do this by default like we do, so we recommend you instruct them in writing, as they may not even have a place on their forms for it. Also, donated shares must be held for more than one year, or you only get credit for your cost basis of the security rather than the appreciated amount.
Qualified Charitable Distibutions (QCD)
Another method of making charitable gifts is to do so directly from your IRA’s Required Distribution. While you do not get a possible deduction, the income from the distribution is not recognized. You must be at least age 70½ when the distribution is made, it must be made directly to a qualified charity from the taxable portion of an IRA, and the amount is limited to $100,000 per person. One important point: If you do this you must inform your tax preparer. There is no special 1099-R code for a QCD from an IRA, so the only way to report this to the IRS is for your tax-preparer to be aware of it and put QCD on the write-in line where your IRA distributions are shown.
What if you have an appreciated stock, want to give to charities now, but don’t want to decide which charities to give to right now? You can give your appreciated stock to a donor-advised fund (DAF), which qualifies as an intermediary charity. You can deduct the full market value in the year that you give the stock to the DAF (up to the 30% AGI limit). The DAF establishes a fund in your name. Thereafter, the DAF makes gifts to charities from your fund. Legally, you cannot control these distributions since you gave the stock permanently and irrevocably to the charity. However, you retain the right to make “suggestions” as to who receives the distributions. The DAF is entitled to accept or reject those suggestions, but in practice it will not usually reject proper and reasonable suggestions. As always, investigate and compare before selecting a donor advised fund. Generally, DAFs are established with gifts of $5,000 and more, and can offer immense benefit by taking the deduction now and having charities receive donations over time.
At the top of the charitable giving pyramid are Private Foundations. This is basically an organization usually funded and controlled by one family created for the purpose of managing a large sum of money to be distributed to charities over a very long period of time, even ad infinitum. They can be created as a trust or a non-profit corporation. This structure allows the most long-term flexibility and control and can instill charitable inclinations in a donor’s descendants and elevate the family name in the community. It also is the most complex of charitable structures with are many rules that must be followed, some of which are mentioned here. A private foundation requires at least 5% of investment assets be distributed each year and requires a 990-PF tax return to be filed each year. Cash can be deducted as donated to the foundation up to 30% of AGI and appreciated assets up to 20% of AGI, with a five-year excess carryover. Private foundations usually need a minimum of $1-$2 million in initial donations in order to run cost efficiently
As charitably inclined as you might be, you may not be able to afford to give away stock or cash to charity. Instead, there are various ways you can give to charities and let them provide you with lifetime income. Included in this group is a pooled income fund, a charitable gift annuity and, a charitable remainder trust.
Pooled income funds usually are for gifts of $20,000 and up. Charitable gift annuities are generally used for gifts above $10,000. Charitable remainder trusts are typically for larger gifts of $200,000 or more and is the only choice where the person giving wants to continue to control the investments.
In each case, you give your shares to a recognized charity and, in return, you receive income of at least 5 percent of the value of the trust each year for life and possibly the life of your spouse or beneficiary. In the year you give your shares, you will be entitled to an income tax deduction. The amount of the deduction is determined by your age, if the income is for your life, and the life of your spouse and the amount or percentage of income you are projected to receive. After you (or you and a designated beneficiary, such as your spouse) die, the remaining principal goes to the designated charity. It is this remainder on which the tax deduction is determined.
In the case of the pooled income fund and charitable gift annuity, you give the shares to a specific charity. It is important to realize all charitable gifts are irrevocable– that is, you can’t change your mind as to the gift or the recipient. With a charitable remainder trust, however, you can have the flexibility to designate the charities you want to benefit from your gift and can also reserve the right to change the beneficiaries later. For additional details on these first two strategies, contact your Wealth Manager.
Charitable Remainder Trust (CRT)
The Charitable Remainder Trust (CRT) is a more complex way to gift and is really more suitable for larger gifts ($200,000 or more). If you want to give the money to just one charity and don’t want to reserve the right to change your mind as to the beneficiary, the charity will often provide you with sample documentation and may even serve as trustee of the trust.
If you want multiple charities to benefit, or if you might want to change the charities at a later date, then you will need a lawyer to draw up the document for you. (It is important to consult a lawyer skilled in charitable tax planning matters as this is a complex area.)
The CRT will pay you income for your lifetime (plus that of another beneficiary, if you so wish), or for up to 20 years. At the end of this period, the CRT terminates, and the assets go to the named charity or charities. (Under a 1997 law change, the charitable interest must have a value equal to at least 10 percent of the amount placed in the trust.) Once the CRT has been established, you can give either appreciated property or cash to the CRT.
There are two types of CRTs—the unitrust and the annuity trust. Ask your Wealth Manager or your Attorney to review the differences with you and help you make an appropriate choice.
Once the CRT is set up, you must name a trustee. You may be your own trustee, but if so, you must name a successor trustee for the disposition of your assets after your death or in the event of your disability. Of course, if you choose to serve as your own trustee, you will be subject to fiduciary limitations in investing and otherwise managing the trust, with potential liability for mistakes. The CRT must file a tax return each year and this, too, is the trustee’s responsibility.
If you exchange your shares for an interest in a pooled income fund or a charitable gift annuity, you have given up all control over the investments. The same is true if you give your money to a CRT run by a charity—in other words, your gift is irrevocable.
Using one of these planned giving techniques is an excellent financial planning strategy. You can avoid paying capital gains on a stock gain, receive a current tax deduction, obtain regular income (usually at a higher rate than your investment is currently paying) and benefit your favorite charities.
Charitable giving is not a simple matter, particularly since once you have given the money away you can’t take it back. Therefore, it is imperative you seek independent professional advice before giving to charity. Also, remember to identify which shares are to be gifted without exception, and that any gifted security had been held for more than a year. Your financial planner, working with your estate planning lawyer, tax counsel and your charity, should be able to provide you with the necessary specific advice.
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