Many wealthy individuals use charitable gift planning to accomplish their charitable wishes and reduce income, gift and estate taxes. Often, these techniques can provide important benefits for family members as well. There are many different strategies for accomplishing these goals.
Among the most popular are:
- Charitable Remainder Trusts (CRATs and CRUTs);
- Charitable Lead Trusts
- Charitable Gift Annuities
- Pooled Income Funds
- Private Charitable Foundations
- Donor Advised and Donor Directed Charitable Funds.
The trusts described above are also known as split interest devices. A split-interest trust is one that includes both charitable and non-charitable beneficial interests. It is an estate planning tool if you wish to retain an interest in the trust assets, but want a current income tax deduction for the value of the charitable interest.
The “split-interest” refers to its components. First is the current interest — some sort of recurring payment of money to someone (i.e., you, a charity, or some other beneficiary) for a period of time. The second is the remainder interest which is distributed as a lump sum payment to someone else at the expiration of the period of time.
Therefore the variables to play with are:
- amount of the donation;
- that part of the donation allocated to the current interest;
- type and timing of periodic payment (e.g., annuity, percent of principal);
- time frame (not to exceed 20 years or the life of a non-charitable beneficiary);
- who is the recipient (beneficiary) of the periodic payment;
- who is the recipient of what’s left at the end of the time frame (residual beneficiary);
- applicable federal annual interest rate and factor for the age being evaluated, and
- what are the tax implications of the arrangement.
This myriad of variables makes for a flexible planning tool, especially where the recipient of either the current or residual interest is a charity. Money contributed to this gift will presumably earn interest over the designated time period, and this may be taxable. Further, if a portion of the donation is given to a qualified charity, the donor should benefit from an immediate charitable deduction. The “time frame” that the current interest is paid out can be a fixed number of years, or based on someone’s life. If the latter, IRS actuarial tables are used to fix the period for the purposes of calculating the fair market value of the remainder interest – used for the charitable deduction.
A classic use for this kind of trust is where the donor has highly appreciated real estate (free of debt) and wants to convert it to an income stream while also benefiting a charity. And the donor wants a deduction from his current income taxes. By transferring to the trust, the donor can sell the property without incurring the capital gains liability. However, it should be noted that the donor will be responsible for some taxes when he receives the annuity payment or final distribution.
Many wealthy individuals set up a private charitable foundation to accomplish their charitable goals. These foundations accomplish many different things, including obtaining income, gift and estate tax deductions; teaching your children philanthropy and money management if they become part of the foundation’s board; assuring that your charitable vision will be realized; and perpetuating your name in connection with charitable works. Following your death, family members can use a family foundation to support their particular charitable interests, which may bring them social prominence.
The principal advantage of a private foundation is autonomy and control. Subject to the limitations of the Internal Revenue Code and local law, you, the donor, can administer the foundation as you please. You may select the ultimate charitable donees, the amount and frequency of distributions, and any other matters to be decided on.
There are costs (both legal and accounting) involved in setting up a private foundation. A private charitable foundation requires ongoing administration, including the preparation of filing of annual tax returns. A private foundation generally pays a tax of 2% of its earnings. A California charity with over $2,000,000 of receipts in a year must have a certified audit, and if formed as a corporation must have a separate independent audit committee. In order to avoid these administrative burdens, some people turn to existing public charities to sponsor their charitable activities.
A donor-advised fund is a fund established by a donor as part of a large publicly supported charity (e.g., a community foundation). The fund is normally an account bearing the name of the person or family establishing it. The public charity has the ultimate legal control over the assets contributed to the fund, and distributions from the fund must meet the public charity’s criteria. The donor generally enters into an agreement with the public charity whereby the donor may “advise” the public charity on how and when distributions from the fund should be made. As long as the donor’s advice meets the public charity’s criteria, the advice is generally followed. The principal benefits of a donor-advised fund account are simplicity and favorable rules regarding income tax charitable contribution deductions. The income tax deduction for property donated to public charities is the fair market value at the time of the donation – which can be a significant advantage for highly appreciated property.
The principal benefits of a donor-advised fund account are simplicity and favorable rules regarding income tax charitable contribution deductions. The income tax deduction for property donated to public charities is the fair market value at the time of the donation – which can be a significant advantage for highly appreciated property.
This has been a very general overview of a very complex subject.