Charitable Gifting

Charitable Gifting

June 13, 2022

What constitutes a gift to charity?

A gift to charity is simply a gratuitous transfer of property to a charitable organization. The key is that your gift must be some kind of property, which can include a cash flow--your time or personal services do not count.

Several different types of donations can generate tax advantages. Different ways of structuring gifts have different tax advantages. However, while what, to whom, and how you may choose to gift might be limited only by your imagination, very specific IRS rules do apply if you want your gift(s) to be tax deductible.

How do you decide whether, when, and how to donate to charity?

You can certainly gift personal services to an individual or a charitable organization – and many who are motivated by genuine charitable intent do exactly that – if you are indifferent to achieving any tax benefit from your generosity. And you can generate tax benefits from charitable gifting even if you have no charitable motivation – the IRS does not require charitable intent in order to recognize a charitable tax deduction. But most people who donate to charity do have a charitable intent.

Are you – or do you want to become – a checkbook philanthropist? Many US taxpayers make deductible charitable gifts at the end of the year by writing one or more checks at to the alma mater, the church or temple, the social purpose organization(s) with beloved missions. And/or during fund-raising luncheons, balls, other capital campaigns. In memoriam gifts when loved ones pass away. There is a seemingly infinite number of charities from which to choose.

If you are a checkbook philanthropist over the age of 72, with an IRA from which you must take annual fully taxable distributions even if you don’t need or want the income (but, hey, those are tax-deferred accounts, right?), I hope you may be making QRDs, Qualified Retirement Distributions that aren’t taxable to you (or tax-deductible by you) instead of donating some or all of what’s left over after taking fully taxable IRA distributions that might boost your tax bracket up a notch.

Or, are you – or do you want to become – a strategic philanthropist? Being strategic with your philanthropic planning means devoting time and attention to your individual – or, maybe, your family – values and philanthropic purposes; doing the research necessary to identify the philanthropic organization(s) best suited to deploying your contributions efficiently and effectively, including the development of specific and measurable goals and metrics that measure their success; and engaging your trusted tax and investment advisors to structure your gifts in the ways best suited to achieve your individual and family goals while achieving measurable impact. 

There are a myriad of ways in which to structure tax-advantaged philanthropic gifts. Whether you are (or want to be) a checkbook philanthropist, or are (or want to be) a strategic philanthropist, it’s important to get good tax and investment advice from the get-go — and, to start with your own end goals in mind.

What are the tax benefits of donating to charity?

Through tax legislation, Congress encourages charitable gifting because it is good social policy. Many charities and philanthropic organizations depend on individual and family contributions to remain financially solvent, especially in this era of fewer direct government dollars. As a result, charitable giving is entwined with U.S. tax laws that change from year to year.

Congress has sweetened the pot for taxpayers who donate to “qualified” charities. First, you usually receive an income tax deduction in the year you make the gift. Sometimes, depending on how you structure your gift, this can keep on going. Second, depending on your objectives and how you structure your gift, you may reduce the size of your taxable estate since federal gift tax does not apply to charitable gifts. Third, you may want to consider gifting a cash flow for annual tax deduction during a defined period, while retaining ownership of the income-generating capital for your own retirement income purposes years from now or in your wealth transfer plan to benefit a family member.

Estate tax planning is one area where charitable giving can produce substantial tax benefits. Over the next 30 years, an estimated $8 trillion of assets will pass from one generation to the next, resulting significant anticipated estate taxation revenue to the U.S. Treasury. Retirement income planning is another. For example, a closely-held business might want to create a current tax benefit by gifting a current cash flow that reverts to a retiring owner at retirement.

 

Various Mechanisms for Donating to Charity

An outright gift

For example, year-end or luncheon/gala or capital campaign ‘checkbook philanthropy’. Writing a check to your favorite charities satisfies the general rule that a gift to charity must be paid to the charity in the form of money or property before the end of the tax year to be deductible for income tax purposes.

Split interest gift in trust

Another option is for your gift to be split between a charity and a noncharitable beneficiary. Here, one party (usually the noncharitable beneficiary) receives the use of the donated property for a specific period of time, which means he or she is paid a certain sum every year out of the donated property. Then, after this time period is up, the remaining property passes to the charity. Such gifts can be used to provide for a dependent child or a surviving spouse. In this arrangement, the charity's right to enjoyment and possession of the gift is delayed because the noncharitable beneficiary has the first interest in the donated property.

Ordinarily, this delay would mean no tax deductibility for your gift. However, Congress has voiced its approval of such arrangements as long as the gift is set up as one of a number of special trusts expressly created for this purpose. If your split interest gift is set up as one of these trusts, you receive federal income, gift, and estate tax deductions.

CRAT (charitable remainder annuity trust)

A CRAT is a split interest gift between a noncharitable beneficiary and a charitable beneficiary. The noncharitable beneficiary has the first interest, and the charity has the remainder interest or second-in-line interest. The trust pays out a fixed amount of income every year (an annuity) to the noncharitable beneficiary for the term of the trust, and the remaining assets pass to the charity the end of the term.

CRUT (charitable remainder unitrust)

A CRUT is a split interest gift between a noncharitable beneficiary and a charitable beneficiary. As with a CRAT, the noncharitable beneficiary has the first interest, and the charity has the remainder interest. However, instead of paying out a fixed amount each year, a CRUT pays the noncharitable beneficiary a fluctuating amount each year, depending on the value of the trust assets for that year. This amount is calculated as a percentage of the assets in the trust on a specified date each year. At the end of the trust term, the remaining assets pass to the charity.

Tip: There are several varieties of CRUTs (NI-CRUT, NIMCRUT, or Flip CRUT), each with slightly different rules regarding how the noncharitable beneficiary is paid.

Pooled income fund

A pooled income fund is a split interest gift between a noncharitable beneficiary and a charitable beneficiary. Like the CRAT and CRUT, the noncharitable beneficiary has the first interest and the charity has the remainder interest. A pooled income fund is managed by the charity (much like a mutual fund) and is made up of donations from several donors. The charity pays the noncharitable beneficiary a fluctuating amount each year, depending on the value of the fund in that year. These income distributions are made to the noncharitable beneficiary for his or her lifetime, after which the portion of the fund assets attributable to the noncharitable beneficiary is severed from the fund and used by the charity for its charitable purposes.

Charitable lead trust

A charitable lead trust is a split interest gift between a noncharitable beneficiary and a charitable beneficiary. Here, the charity has the first or lead interest and the noncharitable beneficiary has the remainder interest. The charity is paid a certain amount every year for the term of the trust, and then the remaining assets pass to the noncharitable beneficiary at the end of the trust term.

Bargain sale

A bargain sale in the context of charitable giving is a sale to charity at a bargain price (i.e., a price below the fair market value of the item sold, fair market value being the price a willing buyer would pay a willing seller in an arm's length transaction). The difference between the sale price and the actual fair market value of the asset equals your donation to charity. A bargain sale involves two separate transactions for tax purposes: a sale and a charitable gift. The IRS treats each event as a separate transaction. Consequently, each is reported separately on your income tax return.

Private foundation

Donors with sufficient resources may want to create a private foundation. A private foundation is a separate legal entity (often named for the donor) than can endure for many generations after the original donor's death. The donor creates the foundation, then transfers assets (typically appreciated assets) to the foundation, which in turn makes grants to public charities. The donor and his or her descendants retain complete control over which charities receive grants.

Community foundation

A type of organization related to a private foundation is called a community foundation. A community foundation concentrates its activities within a defined geographic area and is typically controlled by a representative group of community members, which may include the donor. In practice, a community foundation is a public charity, though it appears to share some of the characteristics of a private foundation.

Donor-advised fund

Similar in some respects to a private foundation, a donor-advised fund (DAF) offers an easier way for a donor to make significant charitable gifts over a long period of time. A DAF actually refers to an account that is held within a charitable organization. The charitable organization is a separate legal entity, but the donor's account is not--it is merely a component of the charitable organization that holds the account. Once the donor has transferred assets to the account, the charitable organization becomes the legal owner of the assets and has ultimate control over them. The donor can only advise--not direct--the charitable organization on how the donor's contributions will be distributed to other charities.

 

 

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal professional.

LPL Financial Representatives offer access to Trust Services through The Private Trust Company N.A., an affiliate of LPL Financial.