Janet Ginn, president of the Heifer Foundation, takes a donor-centric look at the world of planned giving and the tax advantages of this type of philanthropy.
There are only three places where you can distribute your assets or income: family, charity and the government. It’s up to donors how they want that distributed, and it’s important they plan ahead.
You should always consult with a financial advisor to determine if the tax consequences of a particular contribution are best for you before deciding to make a gift. Most people are familiar with income and capital-gains tax, but many are less aware of gift tax, estate tax and generation-skipping tax.
With gifts or estates, the government can indeed have as many as three bites out of the apple: gift tax, capital-gains tax and generation-skipping tax. A major portion of your estate could go to taxes if you do not plan ahead.
There are five main kinds of taxation.
Income tax can be as low as 15 percent or as high as 35 percent at the federal level, with applicable state taxes in addition.
Capital-gains tax occurs when you sell an appreciated asset, such as land or stock. The rates are currently 15 percent federally for taxpayers above the 15 percent marginal rate, and you can have an additional state tax.
Gift tax is incurred whenever you give cash or an asset to another individual. You can give up to $12,000 a year tax-free, and up to $1 million over your lifetime, but when you include graduations, birthdays and other special gifts, that can eat up those exclusions pretty quickly. For amounts exceeding these limits, gift tax can be as high as 41 to 45 percent on a gift given during the donor’s lifetime.
Estate tax applies to estates over $2 million and can be as high as 45 percent.
Generation-skipping tax, which is incurred if you want to give something to your grandchildren or your great grandchildren, also can be 45 percent.
With combined taxes eating up as much as 70 to 75 percent of your estate, your family could be left with only 25 percent to cover debts and living expenses. And there are always additional taxes.
Charitable instruments can be the wealth-management solution for those who would prefer to distribute their assets to family and charity and minimize the amount of taxes they are required to pay to the government.
Basic income tax deductions
Many donors are confused about what percentage of their charitable gifts they can deduct on their taxes. Though an outright gift or an endowment gift to a public charity is 100 percent deductable, there are limitations on the amount an individual can claim as an income tax deduction in any tax year.
A donor who makes a gift to a public charity generally is entitled to a federal income tax deduction in the year of the gift. If you cannot use the total deduction in one year, the law allows you to carry forward the remainder for five additional years, for a total of six years.
For a cash gift, the basic limit on deductions is 50 percent per year of the adjustable gross income for that gift. Donors of land or stock or tangible, “moveable” assets like cars, art or jewelry, can deduct only 30 percent annually.
In each of these cases, the donor must take the largest deduction possible on a particular gift each year. Deductions cannot be “saved” artificially to target a larger tax deduction to a later year when the donor needs it more. For that reason, if a donor needs a deduction in a specific year, we encourage the donor to wait and give in that year.
Life-income and inheritance gifts
If you need income for living expenses, or if your family needs such income after your death, there are many charitable instruments you can use to minimize taxes.
The simplest is a charitable gift annuity. With this contract between the donor and the issuing charity, the donor receives a guaranteed fixed income on the assets donated. The charity is required by law to have an annuity reserve to guarantee that they will always be able to pay the fixed payments for the lifetime of all beneficiaries.
The donor also receives a partial federal income tax charitable deduction, approximately 40 to 50 percent. Additionally, he or she avoids capital-gains tax and removes the property from his or her estate, which could save estate taxes.
Then there are charitable remainder trusts, of which there are many types that meet different tax needs. Each case is unique with different considerations depending on the donor’s age, the donor’s gift assets, and the donor’s tolerance for complexity and need for control.
With a basic charitable remainder trust, also called a unitrust, the donor transfers assets to the trust, which the trustee can then sell tax-free. After the trust matures, the assets remaining go to the charity.
The donor retains the right to receive income from the trust or create income for others.
The donor is also entitled to a partial federal income tax charitable deduction in the year of the gift or an estate tax deduction for trusts funded at death. The donor incurs no immediate capital-gains tax. The assets of the trust are outside the estates so taxes may also be saved after death.
A charitable remainder annuity trust is very similar to the standard type, except that the annual income payment is fixed. Valued at the time of the initial gift, the income stream will not fluctuate with the market. This type of planned gift differs from a charitable gift annuity, however, in that the assets are invested in the market and any growth will benefit the charity. Again, you get a tax deduction, bypass capital-gains tax, and potentially reduce estate taxes.
Another category of planned giving is the charitable lead trust. With a grantor lead trust, a donor essentially gives the money to a charity for a certain number of years. The primary purpose of establishing a grantor lead trust is to accelerate a deduction for future charitable gifts into the current year. With this type of trust, however, the ceiling on federal income tax deductions are lower. If the donor uses cash or ordinary income property to fund a grantor lead trust for the benefit of a public charity, his or her deduction is limited to 30 percent each year of adjusted gross income within a five-year period.
In a family lead trust the assets and associated interest will benefit a charity – but not the donor – for a number of years, after which they will be passed on to a family member. This type of lead trust helps a donor make a major gift to a charity and at the same time, save estate, gift, and generation-skipping taxes.
The goal of using this type of trust is not to get an income tax deduction, but to offset the otherwise potentially high estate or gift taxes that would apply to a transfer of property that exceeds the gift or estate tax lifetime exemption.
A super lead trust combines the benefits of both a family and a grantor lead trust, helping the grantor with income taxes and leaving assets tax-free to the grantor’s family at the end of the trust period.
Retirement unitrusts are very popular with our younger donors, age 45 and up. Assets put into a retirement trust cannot be touched until the donor reaches a certain age. If you’re 45 and you put assets into that trust, you get a charitable tax deduction, bypass capital-gains taxes, and when you retire, you have 20 years of tax-free growth on those assets.
The amount of time allowed for growth to occur in the market will provide a greater income for the donor and ultimately a larger charitable contribution. This is truly a win-win situation for both donor and charity
And finally, especially popular in flat housing markets, is the zero-tax trust. If a donor has a piece of property that is not producing income and he or she needs cash up-front, putting that property into a zero-tax trust allows the donor to bypass taxes on a portion of the property’s sale.
The portion of the property sold within the trust bypasses capital-gains tax, and the donor also receives an income-tax deduction. For any portion sold outside the trust, the donor does have to pay capital-gains, but these trusts are calculated in such a way that the charitable deduction most likely will offset these taxes.
Your charity’s planned-giving officers cannot give legal or tax advice, and with all of these types of planned gifts, the donor has to look at his or her entire estate picture.
For as many taxes as the government provides us opportunities to pay, there are as many charitable solutions, always remembering every donor is unique. So it’s important that everyone involved in a donor’s wealth-management plan – planned giving officers, accountants, attorneys and financial advisors – unite as partners to find the best instruments to a donor’s needs, so they can then take care of their family, financial and social legacy.
Janet Ginn is president and CEO of the Heifer Foundation, a not-for-profit partnering with people in the global movement to end hunger and poverty and care for the earth.