In 2015 the President signed into law a permanent IRA Charitable Rollover provision, allowing persons aged 70½ and older to donate as much as $100,000 from IRA account assets to nonprofit organizations such as Tyler’s Hope. These donations will count as part of the IRA required annual payout (RMD). Although the amount contributed to the charitable organization is not tax-deductible, the IRA account holder will be able to exclude the amount contributed to the charitable organization from the IRA from their gross income. The provision is retroactive back to January 1, 2015 so that distributions made before December 31 can be excluded on 2015 tax returns filed next year and because the provision is now permanent, IRA Charitable Rollover distributions can be made at any time in the coming years.
Your donation to Tyler’s Hope provides resources to find a cure for Dystonia. Your legacy through Planned Giving will ensure that children with Dystonia can look forward to the future and all the joys of life. Whether for the search for a cure like Tyler’s Hope or for any other worthy cause, it is important to know the types of gifts possible, and the tax benefits for you. Although Tyler’s Hope does not offer tax advice, we can be a resource to ensure both you and the charity maximize the benefits of your donation.
Reasons for Making a Charitable Gift
People make gifts or bequests to charitable organizations for a number of reasons. Some of the more common motivations would include compassion; desire to leave a legacy; commitment to a cause; and simply a wish to use one’s fortune to benefit another’s misfortune. Whatever the reasons, U.S. tax law is designed to encourage these gifts.
Financial Benefits of Charitable Gifts
Donations to charitable organizations can:
- Provide an income tax deduction
- Reduce or delay payment of capital gains tax
- Increase personal after-tax cash flow
- Decrease the size of your taxable estate; increase the amount passed on to heirs
Gifts That Pay You Income
Do you want to make a gift right now, but worry about having enough income to support your lifestyle? Life-income gifts provide donors with an income stream and significant tax-savings, while also providing Tyler’s Hope with substantial long-term resources. The following are popular tools for life-income gifts:
- Charitable Remainder Annuity Trust: An irrevocable trust that generates a fixed income stream for you or your beneficiaries, with the remainder of the donated assets eventually going to one or more nonprofit organizations you select.
- Details: A Charitable Remainder Annuity Trust (CRAT) is an irrevocable trust typically funded with highly appreciated property. The CRAT provides that the named beneficiary receive a fixed amount each year for a period of years that can be for the individual's life or for a period not to exceed 20 years.
One of the major benefits of the CRAT is an immediate potential income and gift tax deduction for a charitable contribution for the present value of the ending balance of the trust's assets designated for the charity.
Second, a CRAT is exempt from tax on its investment income. Thus, a trustee of the CRAT can sell the appreciated assets and reinvest the full proceeds. The donor is able to diversify from a concentrated position in a tax-efficient manner. When distributions are made to the donor or beneficiary pursuant to the terms of the trust, the donor or beneficiary must report a portion of the income and gains in respect to the property distributed. However, as the tax burden is spread out over time, more money is available for reinvestment within the CRAT, benefiting both the lifetime beneficiary and charitable remainder beneficiary.
Third, a contribution to a CRAT made at death under a Will can produce an estate tax deduction, not subject to any percentage limitations, with the value of the remainder interest passing to the private foundation.
Finally, a CRAT can be an effective strategy for planning for retirement as the trust can provide that income distributions do not commence immediately. For example, the trustee can sell the appreciated assets, reinvest the proceeds, defer payment of tax and delay distribution (and income recognition) to the donor until he or she reaches age 65 and is in a lower tax bracket.
- Charitable Remainder Unitrust: An irrevocable trust that generates an income stream for you or your beneficiaries, with the remainder of the donated assets eventually going to one or more nonprofit organizations you select.
- Details: This trust is similar to the Charitable Remainder Annuity Trust but instead the donor receives a fixed percentage of the fair market value of the trust assets each year, re-valued annually. If the value of the assets increases, then the annual payout does as well, this could potentially increase the ultimate payout to the charitable remainder beneficiary.
The benefits of the Charitable Remainder Unitrust are the same as those of the Charitable Remainder Annuity Trust.
- Pooled income fund: A charitable trust established and maintained by a qualified nonprofit organization, providing you and/or your beneficiaries with a potential lifetime income stream based on a prorated share of the income earned by the fund. Remaining assets are eventually distributed to the charitable beneficiaries you have recommended.
- Details: A pooled income fund is similar in many respects to a charitable remainder trust. Donors may be eligible to take an immediate partial tax deduction, based on their life expectancy and the anticipated income stream, but must pay income tax on the income they receive from the pooled income fund each year.
Pooled income funds offer professional investment management — and a way to convert appreciated assets into income without incurring capital gains tax.
Donors recommend charitable beneficiaries to receive the balance in the fund after the death of the last beneficiary.
- Charitable Gift Annuity: A contract with a nonprofit organization, in which you provide a gift and, in exchange, the nonprofit guarantees you income for life.
- Details: The contract is between the donors and the issuing charity, where the donors transfer property (cash, securities, and real property) in exchange for a fixed dollar payment during their lifetime. Tax deductions for this type of life-income gift vary with the number of recipients and the age of the donor at the time of the gift. The issuing institution guarantees the income, as it becomes a legal obligation of the charity.
We understand that sometimes you can’t give a contribution all at once. If you are able to contribute the entire asset during lifetime, you may want to consider a split-interest, deferred gift.
The ownership interests in an asset can be split or divided into two parts, stream of income payable for one or more lifetimes or a term of years (the income interest) and the principal remaining after the income term (the remainder interest). In a split-interest gift, one portion is given in trust for the charity and the other portion is retained.
Gift to Charity Now, Family Later
- Charitable Lead Trust: The opposite of a Charitable Remainder Trust, an irrevocable Charitable Lead Trust generates an income stream for the nonprofit organizations of your choice, with the remaining assets eventually going to family members or other beneficiaries.
- Details: A CLT is often created for lifetime giving and for estate planning purposes. Generally, the income tax benefits of a CLT may not be as significant as the estate and gift tax benefits, as described below.
The tax benefits of a CLT vary depending on its precise form. For income tax purposes, a CLT can be structured as a grantor trust, meaning the income earned by the trust is taxable to the grantor, or a non-grantor trust, meaning the income earned by the trust is taxable to the trust. In a grantor CLT, the grantor can take an immediate charitable contribution deduction for the income interest, subject to applicable percentage limitations depending on whether a public charity or a private foundation is the beneficiary. However, this benefit is mitigated by the fact that the income is taxable to the grantor during the term with no offsetting of future charitable deductions as the amounts are paid to the charity. In a non-grantor CLT, the income is taxable to the trust as earned and the deduction to the trust for the charitable donation subject to the percent limitations described above, a very important benefit of CLTs.
For estate and gift tax purposes, there are other benefits of a CLT. If the contribution to the CLT is made during the donor's lifetime, then they will also be eligible for a gift tax deduction with the interest going to charity. If the remainder beneficiary is not the donor, then the donor could be subject to gift tax on the actuarial value of the remainder interest.
It is possible to structure the CLT so that the gift tax is zero, as long as a certain type of CLT, non-grantor charitable lead annuity trust (CLAT), is used. If the assets in the trust return more than the IRS-assumed rate when the CLT was established, then the donor can effectively transfer wealth to his or her heirs at minimal or no gift tax cost. If the contribution is made at death, the donor will be eligible for an estate tax deduction for the value of the interest passing to charity. As with the gift tax, it is possible to structure the bequest so that there is no estate tax related to the interest ultimately passing to heirs.
Although there can be significant tax benefits to establishing a CLT, the donor should be aware of the potential implications of the generation-skipping transfer tax. If the remainder beneficiaries are or could be the donor's grandchildren, when a distribution from the trust is made to these beneficiaries, the distribution will be subject to this tax unless the donor or the donor's estate is able to allocate the donor's generation-skipping tax exemption to the transfer or bequest. This tax can be significant. If the donor is considering such a transaction, they should consult with their advisor to determine the most effective structure of the CLT to enable the donor to take best advantage of their available generation-skipping tax exemption.
Create a Foundation
- Private Foundations: A nonprofit organization you or your family establishes, typically through a substantial initial gift.
- Details: A private foundation is a form of tax-exempt organization that must be organized and operated exclusively for charitable purposes. The charitable activities of a private foundation generally concentrate on receiving charitable contributions, managing its charitable assets, and making grants to other charitable organizations to support its charitable activities.
Foundations are overseen by directors and trustees, generally called the "board" — often family members, friends, or advisors. This board is responsible for determining, with the help of professional advisors, the affairs of the foundation, including how foundation assets are invested, where and when grants are distributed, and how large these grants should be.
Private foundations accept many types of assets, eliminate capital gains tax for gifts of long-term appreciated securities, and potentially provide an immediate tax deduction up to 30% of adjusted gross income for cash gifts and 20% for appreciated assets.
- Community Foundations: A nonprofit organization, supported by many donors, that typically focuses on benefiting a specific community. Offers multiple types of funds, frequently including donor-advised funds, often with the ability to remain anonymous.
- Details: A community foundation is a permanent charitable public benefit organization supported by local donors and governed by a board of private citizens who speak for the needs and well being of the community. The Internal Revenue Service designates community foundations as public charities because they raise a significant portion of their resources from a broad cross section of the public each year.
These foundations are organized to channel gifts from donors to a variety of charitable organizations in a local community. Individuals, families, businesses and organizations create permanent charitable funds that help their region meet the challenges of changing times. The community foundation generally invests and administers these funds.
Community foundations accept many types of assets, eliminate capital gains tax for gifts of long-term appreciated securities, and potentially provide an immediate tax deduction up to 50% of adjusted gross income for cash gifts and 30% for appreciated assets.
Donate Your RMD
If you are receiving required minimum distributions (RMD) from an Individual Retirement Account (IRA) or other distributions from retirement plans, please consider contributing any excess funds above your necessary expenses to Tyler’s Hope. This strategy allows you to forgo the income tax on those funds.
- I need income now: A 60-year old nearing retirement, John, is charitably inclined but will need income throughout retirement. John has $500,000 in Apple stock that he purchased 10 years ago for $100,000 ($400,000 of capital gains). John gifts the stock to a charitable remainder annuity trust (CRAT). The CRAT can sell the Apple stock and diversify the risk without paying capital gains tax on the $400,000 gain. John can receive a 5% ($25,000) annuity payout for the rest of his life and also creates a $423,787 tax deduction. At John’s death, the charitable beneficiary will receive the remainder of the trust ($423,787). This example assumes a 6% rate of return for the CRAT.
- I don’t need income now, but I want to pass on wealth to my children: Now pretend John has plenty of current income, wants to gift to charity, and pass the remainder on to his children. John could gift the highly appreciated Apple stock to a Charitable Lead Annuity Trust (CLAT). The CLAT could realize the capital gain ($400,000), diversify the asset, provide an annual income stream to a charity ($25,000), and pass on the remainder of the trust ($423,787) to John’s children at his death. John’s tax deduction would be $76,212. This example assumes a 6% rate of return for the CLAT.
- I want to make a big impact down the road: A 50-year old committed to giving $5,000 annually for 10 years could leverage the $50,000 gift into a $360,000 gift using life insurance. The life insurance premiums will be deducted against regular income.
There are numerous creative ways that donors can use life insurance for charitable giving, here are a few more:
- Make an absolute assignment (gift) of a life insurance policy currently owned, donate a new life insurance policy, or have the charity purchase life insurance on the donor's life and pay the annual premiums (assuming insurable interest and state law permits). Each of these allows a current income tax deduction.
- Name a charity as the primary or contingent beneficiary of an existing or new life insurance policy. Although this will not yield a current income tax deduction, it will result in a federal estate tax deduction for the full amount of the proceeds payable to the charity, regardless of policy size. This can be particularly applicable in situations where there is only one logical beneficiary, or where insurance is used to fund a supplemental retirement benefit and the death benefit is of little importance to the insured.
- Most estate planning techniques become even more effective when coupled with other techniques. By giving appreciated long-term capital gain property to the charity (e.g., stocks, real estate, mutual funds, etc.), the donor avoids capital gains tax and receives a deduction for full-market value (with notable exceptions). Using this cash to then fund a life insurance policy provides even more leverage, creating an even larger gift.
- Perhaps one of the most popular ways to utilize life insurance in charitable planning more indirectly is through "wealth replacement." In this situation, life insurance makes it possible for a donor to make an immediate or deferred gift of land, stock, or other property while still providing an acceptable family inheritance.
Qualified and non-qualified retirement plans are one of the best assets to give to charity because they are exceptionally inefficient in passing wealth to heirs. This is due to the fact that they face both income and estate tax, in some cases leaving only about 20% to 30% of the asset for the remaining family. Many families choose to leave the retirement plans directly to charity and then use life insurance as a way to "replace" the wealth contributed. Another option that may be considered is taking a distribution from the qualified or non-qualified plan and using it to purchase a life insurance policy in an irrevocable life insurance trust (ILIT); the donor can then give the remaining plan assets to charity. Not only does the charity receive a gift, but also the donor's heirs may receive more than they would have if the donor attempted to pass the retirement plan assets directly to them.
A charitable remainder trust (CRT) is especially powerful for those who have highly-appreciated assets and a desire for increased income. These assets are often non-income generating and property tax-draining land or low-yielding stocks.
A life insurance policy equal to the original gift, but owned in trust, allows the heirs to receive the full value of the assets without paying estate taxes. Properly structured, the premium can often be paid with the income generated from the tax deduction and/or a portion of the excess income, which results from the avoidance of capital gains tax.
Bequests should also prompt one to consider using insurance to replace the assets. The donor may want to leave a gift by will to charity, but he/she may be concerned about disinheriting heirs. Since life insurance benefits can be received income and estate tax free if structured properly, the donor might choose to provide a death benefit equal to the charitable gift, or the amount the heirs would have received from the bequest after taxes.
- While life insurance is most commonly thought of only as a wealth replacement vehicle for CRTs, it can also be used as a funding asset inside the CRT in certain situations where it serves the following purposes.
- The life insurance death benefit can substantially increase the remainder value of the trust, thus providing a larger gift to the donor's selected charities when the trust terminates.
- In a two-life unitrust scenario, life insurance proceeds can "balloon" trust corpus when the first income beneficiary dies, creating a much larger income payout for the surviving income beneficiary.
- The donor is able to make partially tax-deductible premium payments for a personal insurance need.
- Purchasing life insurance for estate liquidity has been a standard life insurance technique for many years. Another option, however, has been gaining increased attention in recent years as a more exciting way to control assets your clients will not be able to keep: The "Zero-Tax Estate Plan." Properly structured, this can also allow the donor to assure that his or her heirs will become actively involved in philanthropy, and thus pass on family values as well as family wealth. Below are some simplified calculations to illustrate the concept.
These are a few of the more popular techniques used to donate to charities like Tyler’s Hope. We understand each personal financial situation is unique and should be reviewed individually. If you are interested in learning more about Planned Giving strategies, let Tyler’s Hope help. Our executive board consists of some of the area’s top CPAs and financial planners who specialize in Planned Giving.