Using Charitable Contributions as a Tax Planning ToolNovember 19, 2013
How to use charitable contributions as a way to support the community, secure monetary benefits for donors and family members and reduce income.
Charitable contributions represent one of the most common - and in some cases, valuable - tax planning strategies with regard to giving to charity, securing monetary benefits for donors and family members and reducing income, estate and gift taxes. Charitable remainder trust and charitable lead trusts are two proven and efficient tools individuals utilize to accomplish several goals simultaneously.
Understanding the mechanics and tax implications of each type of trust can help existing and potential donors make more informed decisions to maximize their tax benefits. As each exhibits different attributes that will have an impact on potential tax advantages, individuals should assess their goals in relation to the type of benefits offered.
Charitable Remainder Trust
A CRT is characterized as a gift of cash or other property to an irrevocable trust. The trust pays amounts to non-charitable beneficiaries - including donors, spouses and heirs - and a remainder to charitable beneficiaries. Under this structure, the trust generates income for donors and their beneficiaries, with the remainder of the donated assets eventually going to one or more nonprofit organizations the donor selected.
One of the primary benefits of CRTs is that they are tax-exempt. As the Journal of Accountancy explains, the tax-exempt status of these trusts make CRTs highly popularized vehicles for asset diversification. Most clients strategize to transfer low-yielding assets, sell the stock and later defer the gain. In the event that low-yielding assets are transferred and sold, no income tax will be generated on the sale and the assets can then be reinvested into other portfolio options. Additional benefits of CRTs are as follows:
- Potential elimination of capital gains tax for gifts of long-appreciated assets
- Many types of assets are accepted
- Income may be for life or a fixed term of up to 20 years
There are two types of CRTs among which taxpayers can choose: Charitable remainder annuity trust and the Charitable remainder unitrust. CRATs distribute a fixed amount each year to non-charitable beneficiaries, while CRUT’s annual payments are calculated as a fixed percentage of the fair market value of the trust’s assets. These assets are valued on an annual basis.
In addition to tax exemption benefits, donors also receive an income tax and gift tax charitable deduction in the year of contribution, allowing for an income tax deduction. However, the Internal Revenue Service does place restrictions on deductions based upon the donor’s adjusted gross income. The limits are as follows:
- Upfront charitable income tax deduction is limited to 50 percent of AGI for cash gifts
- Deductions are limited to 30 percent of AGI for gifts of long-term capital gain property
- Deductions are limited to 20 percent of AGI for gifts of long-term capital gain property to a private foundation
Charitable Lead Trust
CLTs are similar to CRTs, in that distributions are paid to both a qualified charity and non-charitable beneficiaries. Unlike the latter, however, CLTs are not tax-exempt and the trust generates income for the nonprofit organizations of the donor’s choice, with the remaining assets eventually going to family members or other beneficiaries.
There are two types of CLTs: Grantor and non-grantor. Grantor CLTs denote that income earned by the trust is taxable to the grantor. Under non-grantor structures, the income earned by the trust is taxable to the trust. The differences between the two greatly impact the type of deductions allowable under the law. For grantor CLTs, donors receive an income tax charitable deduction for the actuarial value of the income interest given to charities. For non-grantor CLTs, donors do not receive an income tax deduction, but do receive an estate/gift tax deduction for the actuarial value of the income interest given to the charity. Those considering CLTs may enjoy several benefits, such as:
- CLTs may eliminate capital gains tax for gifts of long-term appreciated assets
- Donors can choose the term of the trust and the annual payout to charity
- Donors are not taxed on income earned by trust
- Donors may donate various types of assets
For additional information about charitable contributions and year-end tax planning, please contact any member of our Tax Services Team at 888-KLR-8557 or email email@example.com.