Spokane Journal of Business

Charitable giving strategies can soften tax bite

Donor-advised funds, charitable lead trusts may reduce liabilities

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Anyone looking to sell appreciated stock is unfortunately going to trigger a tax on capital gains, whether long or short term. The current legislative and political climate has produced rumblings of a potential doubling of the long-term capital gains tax. 

If such legislative action should come to pass, what potential solution exists to lessen that tax bite? The Chartered Financial Analyst Institute has referenced a solution—donating to charity to avoid the capital gains tax.

A specific solution to lessen your tax bite is a donor-advised fund.

Provided your shares have been held longer than a year, those shares can be deposited directly into a donor-advised fund, with you enjoying a tax deduction based on the full market value of the stock. This transaction allows you to save what you would have paid in taxes and instead, use the value of the shares for charitable giving through your donor-advised fund.

One of the benefits of employing the use of such a fund in charitable giving is that it can be used to separate your tax strategy from your charitable-giving strategy in certain scenarios. You always receive the tax benefits of contributing to a donor-advised fund in the year that the gift is made, which makes a donor-advised fund a viable recipient for directing charitable donations as part of an annual tax strategy.

At the same time, the distributions from the donor-advised fund to other charitable organizations can be made over time, in some cases years after the initial gift is made to the donor-advised fund. It’s this space between the original gift and the final distribution that allows for the separation of tax and charitable planning.

For those individuals who normally don’t give much thought to charitable donations, the tax bite they may be facing due to capital gains can provide the motivation they need. The opportunity to negate your capital gains tax liability, and also have the value of those appreciated shares fund causes you want to support, can provide you a good enough reason to open a donor-advised fund.

Reducing the capital gains tax isn’t the only way for a donor-advised fund to lessen your taxes.

Donor-advised funds can provide other tax savings including:

•Income tax—You receive an immediate income tax deduction in the year you contribute to your donor-advised fund. Contributions immediately qualify for maximum income tax benefits. The IRS does mandate some limitations, depending upon your adjusted gross income. The deduction for cash is up to 60% of AGI. The deduction for securities and other appreciated assets is up to 30% of AGI. There is a five-year carry-forward for unused deductions.

•Estate tax—A donor-advised fund isn’t included in the account holder’s estate.

•Tax-free growth—Investments in a donor-advised fund can continue to appreciate tax-free.

•Alternative minimum tax: If you’re subject to AMT, your contribution may reduce your AMT impact. While contributions are deductible for AMT purposes, whether it reduces an individuals’ AMT depends upon your circumstances.

Another fine way to support charitable intent is through planned gifts.

According to the Association of Fundraising Professionals, a planned gift is structured and integrates personal, financial, and estate-planning goals with your giving, regardless of whether the giving is done while you’re alive or at the time of your death. Many planned giving vehicles are available, including bequests, donor-advised funds, private foundations, and charitable trusts.

Often the best results can be attained by combining a vehicle like a donor-advised fund with another vehicle such as a charitable lead trust.

For those familiar with a charitable remainder trust, the charitable lead trust is its inverse. Like a CRT, a CLT is also an example of a split-interest trust. Such trusts are considered “split” because their value is broken into two components: a “lead” interest and a “remainder” interest.

A CLT receives cash or property from you. At the time the trust is implemented, you specify the timespan for the trust, such as your lifetime or a specified term of years, and the trust’s income beneficiary—typically a charity—that will receive income from the trust. This is income generated by the “lead” interest component.

You also specify the beneficiaries—typically your heirs—who will receive the value of the trust at the time specified. This is the “remainder” interest component.

CLTs can be of most benefit in an environment of low interest rates. The ideal candidate for a CLT includes someone who: doesn’t need current income from the trust, has charitable intent, is looking for a tax-efficient means to make a future transfer to heirs, and is concerned about income tax or estate tax exposure.

A CLT can work well in conjunction with a donor-advised fund. You can name your donor-advised fund as the income beneficiary of the CLT. This provides you and your family the flexibility as to whom and how they direct their charitable giving.

Your financial adviser can continue to oversee the investment management of the remainder assets.

In short, the donor-advised fund enhances the CLT and provides you considerable flexibility to engage in planned giving during your lifetime, as well as providing a nest egg for your heirs when the term of the CLT concludes.

You should consult a legal or tax professional regarding your individual situation.

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