Income Opportunities in Charitable Giving, or, Have Your Cake and Eat it Too

The IRS tax code sets forth rules and regulations under which US taxpayers remit monies to the federal government. Our taxes, along with borrowing, supply the US government with its operating funds. The tax code also encourages certain behaviors, and discourages others. For example, it encourages charitable giving through generous tax deductions. Clearly it discourages speculation by taxing short term gains at one’s marginal tax rate rather than at the more favorable long term gains rate.

There Are Many Charitable Giving Strategies

In this blog piece I want to describe some of the charitable giving strategies available to the affluent. Is there a church or synagogue you wish to favor? A university? A specific charity? The opera guild? There are many favorable ways to give, which can also produce a guaranteed income for the giver.

Charitable giving is itself a discipline within the larger discipline of estate planning. Through 2021 the estate exemption is $11,700,000 for an individual, and twice that for a married couple. As the estate exemption rises, the impetus for charitable planning becomes less and less tax driven, and more and more income and good works driven.

Choosing a Charitable Gifting Strategy

In choosing the most appropriate charitable gifting strategy, the donor needs to think through these issues:

• Is there a need for current income to the donor from this gift?
• Is there a desire to provide income to the charity?
• Are you considering a specific one-time gift, or a series of gifts over time?
• Do I want any remainder interest to go to my heirs, or to the charity?
• Do I want to remain in control of the gifted funds?

There are several charitable techniques out there, including donor-advised funds, charitable remainder trusts, charitable lead trusts, family foundations, and gift annuities, to name several.

The Charitable Remainder Trust

In a charitable remainder trust (CRT) you set up a trust – generally $500,000 is the very minimum where this makes sense – and receive an income over a period of no more than 20 years or over your lifetime. The remainder of any money left in the trust after your income is paid out goes to your stated charity. You receive an up-front income tax deduction for the present value of that estimated remainder interest.

The payments can be fixed, as in a Charitable Remainder Annuity Trust (CRAT), or variable, as in a Charitable Remainder Unitrust. With the latter, additions can be made in subsequent years, and a fixed percent of the trust, as revalued annually, is paid out as income.

If the circumstances are right, the CRAT and CRUT can effectively be paired with a life insurance policy to replace the asset in the donor’s estate. If insurable, the CRAT donor can use some of the income payments to purchase a life insurance policy. The beneficiaries of his estate, usually the children, can then receive income-tax and estate-tax free, an equivalent amount of money that was settled into the CRAT initially.

The Charitable Lead Trust

A charitable lead trust (CLT) works sort of the opposite way as the CLAT or CLUT: it is the charity that receives the income, and your beneficiaries receive the remainder interest. This provides the giver with the enjoyment of seeing the charity receive and use the income from the CLT during his lifetime. There is an upfront income tax deduction of the present value of the stream of payments to the charity.

Family Foundations

A single family establishes a foundation, and makes tax-deductible donations to it. The foundation must have an educational and/or charitable purpose. The foundation must pay out 5% of its corpus annually for the charitable purpose. There’s no direct income to the giver here, but the foundation can certainly make gifts to family members for educational purposes. $1.0M is the very minimum to establish a family foundation.

Gift Annuities

You buy a gift annuity from a sponsoring charitable organization. In exchange for a gift, the donor receives an annuity – an income, in other words. This income will generally be for less than the donor could have received had he purchased an annuity from any insurance company, so there must be donative intent for this to make sense.

Donor-Advised Funds

Although there’s no income to the donor here, DAFs are increasingly common and their use is paired with large taxable events.  By definition, donor-advised funds (DAFs) are public charities under Section 501(c)(3) of the Internal Revenue Code, and contributions to such funds are tax deductible. The donor makes a tax-deductible gift to the DAF, and then recommends grants from the DAF to charitable organizations. The tax deduction occurs at the time of the gift.

Say, for example, you’ve just sold a business and have a large liquidity event. You can make your DAF contribution and take the deduction, but wait years before recommending a gift from the DAF. Meanwhile your gift grows within the DAF, not taxed, thereby increasing the value of your eventual gift.

A donor-advised fund can accept various kinds of assets, including art and collectibles. Typically, the donor will gift low basis / highly appreciated securities, so the fund can sell the security without paying any capital gains tax. Donors are able to recommend how their contributions should be allocated among the available investment choices. Many DAFs allow for the current investment advisor to continue to manage the funds within the DAF. The convenience and administrative simplicity of a donor-advised fund allows donors to spread their grant making out over months or even years, in accordance with their own personal charitable impulses.

Pair Charitable Giving with a Large Taxable Event

Clients often have large liquidity events, which may be taxable – they’ve sold a business or piece of real property, or converted a Traditional IRA to a Roth. One of the ways to mitigate the tax bite is with a large charitable gift to offset the taxes. When you consider that the charitable gift may produce a stream of income for you – well now you’ve done some good planning.

There is Lots of Opportunity Here

Yes, there should be donative intent – you mean to make a gift in direct support of someone else’s good works. But to sweeten the deal, you can also secure a good income for yourself in the bargain, and even obtain a large up-front tax deduction.

You may find You Are Generous – Give Creatively useful as well.