Many of our clients set aside charitable funds each month, periodically, or directly from their IRA each year as required distributions must be made.
When you give, you want your charitable contributions to be as effective as possible. We have introduced Donor-advised Funds for many families who already know what they will tithe or contribute to their charity of choice as this is a vehicle which helps with the accounting and organization of charitable gifts and is very easy to administer.
Donor-advised funds are one of the easiest and most tax-advantageous ways to give to charity. When you donate to your donor-advised fund, you're making a tax-deductible donation to the organization sponsoring the fund. But because your account is a donor-advised fund, you advise the organization on how to grant the money out to your favorite charities. Your donation is also invested based on your preferences, so it has the potential to grow, tax-free, while you're deciding which charities to support.
While gifting cash and appreciated securities can be “quick and easy” strategies, there are more complex strategies available that can better serve a donor’s interests.
1. Closely Held Stock Gift and Redemption
A donor may have a block of shares of a closely held company in which they are the owner or operator of the company. Often there may be a strong personal attachment to the shares. Perhaps the shares were inherited. While it would be better to have a diversified portfolio, the emotional tie or impact of capital gains may make that difficult.
Often, after receiving the shares from the donor, the Donor Advised Fund can approach the closely held company about repurchasing the shares. This can allow the closely held company from to avoid putting the shares on the open market.
2. Roth Conversions and Charitable Planning
At the beginning of 2010, the $100,000 MAGI (Modified Adjusted Gross Income) limit on Roth IRA conversions was lifted. However, Roth IRA holders were still resistant to convert because of the tax liability that would be created. A donor can establish a donor advised fund as a companion to the converted Roth account and fund the DAF with cash or a variety of appreciated asset types that they may have outside of the conversion assets. The income tax deduction on the DAF contribution offsets the increased tax liability resulting from the Roth conversion.
Inversely, many philanthropic families support numerous organizations in their communities and give enough so that they cannot use the full tax benefit of their gifts in that year. Consequently, the donor may need to carry forward those deductions. This situation may create an opportunity to initiate the discussion about converting a standard IRA to a Roth IRA without a tax liability by using the charitable carryforward deductions.
3. Leveraging Life Insurance for Charitable Legacy
Purchasing life insurance for estate liquidity has been a standard life insurance technique for many years. Here are some other “giving while living” strategies that include life insurance with a donor advised fund:
A) Direct Donation of Existing Policy for Surrender/Settlement:
Donors who have old policies once acquired for other reasons (mortgage/debt risks, education for children, survivor income security, veterans’ policies, etc.) may no longer need the coverage and can gift the policy directly into a donor advised fund (DAF). By donating the policy to a DAF for the purpose of having the DAF surrender or settle the policy, the donor can create charitable liquidity while they are living without a lot of “out of pocket” expense.
B) Direct Donation of Life Insurance Dividends:
The annual dividends of the policy can be assigned into a DAF. This eliminates out-of-pocket contributions while still creating a deduction as dividends are paid. This process can be amplified by using the dividends to purchase a new policy of which the DAF administrator becomes the irrevocable owner and beneficiary.
4. Using Current Appreciated Assets to Increase Leverage:
By giving appreciated long-term capital gain property to the donor advised fund (e.g. stocks, real estate, mutual funds, etc.), the donor avoids capital gains tax and receives a deduction for full-market value of the assets. Using all or a portion of this cash to then fund a life insurance policy provides even more leverage, creating an even larger gift that can help heirs become actively involved in philanthropy, and thus pass on family values.
5. Illiquid Asset Leverage
An estimated 90% of the personal wealth in the U.S. is comprised of illiquid assets, such as real estate and closely held stock (primarily S-corp and C-corp shares.) This will cause most of the Baby Boomers to experience what may be the largest transfer of wealth in U.S. history. By gifting these illiquid assets to a DAF, donors can often structure these gifts so they can receive the best tax benefits, support their favorite causes, and still maintain operational control of the asset.
After a donor establishes a donor advised fund, they irrevocably transfer a small percentage of real estate or closely held business shares/interests (typically non-voting interests) into the DAF. The donor may be eligible for an immediate federal tax deduction equal to the Fair Market Value (FMV) of the asset, up to 30% of his adjusted gross income (AGI) with up to a five year carryforward. After the asset has been transferred to the DAF, the client can still be engaged in facilitating the sale of the asset. Once a sale has been completed, the cash proceeds for the portion owned by the DAF would be placed in the fund.
6. Charitable Trusts
Charitable trusts are being “reinvigorated” as a strategy to offset net investment income as well as being used in the leveraged and discounted sale and buyouts with family limited partnerships (FLPs) and family limited liability companies (FLLCs.) The combination of a donor advised fund as the charitable beneficiary in these trusts can allow donors the ability to easily change their charitable affinities as well as include their heirs in their charitable decisions.
Here are a few areas where synergy exist between charitable trusts and DAFs:
Charitable Remainder Trusts receive cash property from the donor, make payments for the donor’s lifetime or specified term of years, then distribute the remainder to charity. A Charitable Remainder Annuity Trust (CRAT) pays a fixed dolar amount each year. By contrast, a Charitable Remainder Unitrust (NICRUT) pays an amount equal to a percentage of the trust at the beginning of the each year.
Furthermore, a Net Income Unitrust (NICRUT) pays the lesser of the trust’s net income or the standard amount. A Net Income with Makeup Unitrust (NIMCRUT) is like a NICRUT but can make up distributions. Finally, a FLIP Trust pays like a NIMCRUT until a certain date or event then “flips” to pay out like a standard unitrust.
Charitable Lead Trusts receive cash or property from a donor and make payments to charity for a specified period, then distributes the trust property to a designated beneficiary. The gift and estate tax deduction is equal to the present value of the income to charity. When the 7520 rate approaches 4% or lower, lead trusts paying 6% to 8% provide a very significant gift or estate tax deduction.
Another typical Lead Trust is a Grantor CLT. A Grantor CLT receives property that ultimately returns to the donor, who gets an income tax deduction when the trust is created. However, the donor has to report trust income on his or her personal income tax return each year.
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