This article was updated November 1, 2023.
Charitable giving is an often-overlooked component of estate planning, but it can provide rewarding experiences and significant donor benefits.
If you’ve considered making a charitable donation, changes introduced in the Tax Cuts and Jobs Act (TCJA) make it a good time to revisit charitable strategies and determine if there are opportunities you or your family can benefit from.
Before donating, however, it’s important to understand giving logistics—such as philanthropic limitations, strategies, and structures—and the benefits different approaches provide.
Generally, the amount of charitable contributions an individual can deduct in any one tax year is limited by the kind of property donated and the type of organization receiving the donation.
The TCJA doesn’t change taxpayers’ abilities to take charitable deductions, but it does introduce a few new giving approaches.
In general, for tax years after December 31, 2017, an individual taxpayer is provided a deduction for cash contributions made to public charities—including a donor-advised fund—equal to 60% of their adjusted gross income (AGI) for the current tax year. For example, if a taxpayer has an AGI of $1,000,000 in 2023 and donates cash of $700,000 to a public charity, their charitable deduction for 2023 will be limited to $600,000—or 60% of his AGI.
If a taxpayer makes contributions of capital gain property to a public charity, they may deduct contributions equal to 30% of their AGI for the current tax year if the securities were held long-term.
Contributions of cash to certain private foundations, veterans’ organizations, fraternal societies, and cemetery organizations are limited to 30% of AGI. Contributions of capital gain property to certain private foundations, veterans’ organizations, fraternal societies, and cemetery organizations are limited to 20% of AGI.
There are various exceptions to the above rules that relate to the type of entity that receives the donation and the type of property contributed. Donors should review the rules as the method for determining fair market value of the property donated may vary. It’s important to consult with an accounting professional before making a large donation.
Many individuals benefit from donating low-basis publicly traded stock to a public charity or a donor-advised fund—see more information on donor-advised funds below. This provides them the ability to achieve the following goals:
- Offset ordinary income. Donors receive a charitable deduction equal to the FMV of the publicly traded stock—held long-term—without having to recognize the gain on the appreciation in the value of the stock. That means the taxpayer can offset other items of ordinary income or other capital gains for the current tax year.
- Benefit from appreciated stock. The donor-advised fund or the public charity gets the economic benefit of the appreciated stock. The stock can either be sold immediately for cash, which is typically what happens, or the fund can hold onto the position to potentially benefit from future appreciation until cash is needed at a later date.
Additionally, a taxpayer can enhance donations though retirement plans. Donors 70½ or older can make qualified charitable distributions of up to $100,000 annually, directly from an IRA to a qualified charity instead of taking their required minimum distributions (RMD). This may keep a donor from being pushed into a higher income tax bracket.
There are many structures for philanthropic activities, and it’s important to determine which is a better fit for your philanthropic goals.
Private foundations can provide a beneficial structure for individuals who donate large amounts over the course of their lifetime but who also want to maintain some level of control over the property donated—such as the ability to help manage how the private foundation invests the donation or to determine grant recipients.
However, these benefits come with potential challenges; private foundations can be expensive to maintain due to administrative costs, annual legal and tax compliance costs, and mandatory annual 5% distributions. These requirements can cause cash-flow problems if a donor doesn’t want to cover the costs on an annual basis. Usually, private-foundation donations are only economically feasible if the donor wants to make larger donations that cover annual costs.
Charitable deductions for private-foundation donations are subject to the 30% and 20% AGI limitations discussed above. Individuals who give large amounts will need to properly plan annual donations to the private foundation based on these lower AGI limitation thresholds. If donations aren’t properly planned, there’s a risk the charitable deduction won’t be used within the five-year carryforward period.
While donor-advised funds require set-up time, they’re considerably low maintenance with minimal annual costs and few management requirements. As is suggested by the title, donor-advised funds don’t allow a donor authority over contributed funds, but they do allow the donor to advise the sponsoring organization on how funds should be granted. For some individuals, this lack of control can be an issue, while others find it very appealing for someone else to manage the grants.
In terms of charitable deductions, donations to donor-advised funds are subject to the 60% cash and 30% non-cash AGI limitations, the same as donations to other public charities. The donor-advised fund can be particularly advantageous for a year when a donor is prepared to set aside a larger amount of income for charitable purposes but isn’t quite prepared to distribute it directly to a particular charity.
Consider the charitable organizations you’re interested in supporting when determining if a donor-advised fund is right for you. Donor-advised funds cannot support some types of organizations.
Charitable trusts can be utilized as a tax-efficient way to make charitable gifts. Two of the most common charitable trusts are the charitable remainder trust (CRT) and the charitable lead trust (CLT).
Charitable Remainder Trust
CRTs pay out income to one or more beneficiaries for a set period or for the life of a beneficiary. After the income payments have ended, the remaining assets in the CRT are transferred to a qualified charity.
Donors may be able to take a partial income tax charitable deduction when they fund a CRT, and the CRT's investment income is exempt from tax. If highly appreciated assets are contributed to a CRT and sold, generally, there will be no capital gains tax on the sale at the trust level.
For the duration of the CRT, the income beneficiaries will receive a distribution, at least annually, and similar to other trusts, those distributions push out deferred income from the trust that’s taxable on the beneficiaries’ personal return.
Under current law, a donor-advised fund can be named as the ultimate beneficiary of a CRT, giving the donor some control over the ultimate charitable beneficiaries of a CRT.
Charitable Lead Trust
CLTs are the reverse of CRTs. They make annual distributions to a qualified charity for a set period or for the life of a beneficiary, with the remaining assets eventually being distributed to one or more noncharitable beneficiaries. Unlike CRTs, the annual income of the trust is taxable, but the trust also receives a charitable deduction for the annual distribution to charity.
CLTs are often used for estate or gift tax planning, as they can potentially reduce the taxable value of assets transferred to remainder beneficiaries. Donors may also be able to claim an income tax deduction for the value of the charitable lead interest in the year it’s formed.
Following are strategies to consider before making charitable donations.
One of the most important giving strategies is to include beneficiaries in conversations about charitable giving. A common giving setback occurs when donors don’t tell beneficiaries how to operate their private foundation after they pass away.
When this happens, many beneficiaries—usually the donor’s children—don’t know how to maintain the foundation and often don’t want to commit the time or energy to learn the intricacies of management. The private foundation is then either abandoned or managed improperly, making it a burden on the family instead of a vehicle to promote the family legacy.
Collaborate with a Tax Professional
Working with your tax advisor to properly track your charitable contributions also provides important advantages—helping you plan with your AGI limitations and reduce potential limitations on your charitable contribution deductions.
For example, some donations need to be restructured for a donor to fully benefit from associated charitable deduction carry forwards. In these instances, it’s helpful to plan donations by speaking with your tax advisor and making sure current-year donations don’t impact prior-year gifts that have been carried forward to your current-year tax return.
Additionally, if a charitable contribution isn’t used in the tax year when a donation is made, it’s allowed as a deduction on subsequent tax returns for five years following the donation. Once the five-year period has passed, any charitable deduction that isn’t used in the allotted timeframe will be disallowed. It’s important to track these amounts to make sure any charitable deduction that’s carried forward to subsequent tax returns can be used during the five-year period.
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To learn more about charitable-giving strategies, benefits, and limitations, contact your Moss Adams professional.