Big Picture, Financial Planning, Millennials

Estate Planning Series Part 4: Charitable Strategies

Welcome back for part 4 of my Estate Planning Series. If you have not, make sure to check out:

Those will help get you up to speed for this blog post.

Now moving on to part 4. We are going to talk about some of the different charitable strategies that exist that can help you give more away to charity while also lowering your taxes. These strategies are the more complex one’s. You obviously can give to charity in any given year and can deduct up to 60% of your adjusted gross income (AGI) via charitable donations, but you may be limited to 20%, 30% or 50% depending on the type of contribution and the organization.

You also could deduct highly appreciated securities which would allow you a deduction against your income and you would avoid the capital gains tax on the sale by donating presale. These are the most simple forms of utilizing charitable donations. The rest of this post will be on the more complex options you have.

Let’s get into it.

Top Charitable Strategies Being Used

Donor Advised Fund

A Donor Advised Fund (DAF) is an account used to give to established charities. It allows donors to make a charitable contribution to this account, receive a tax deduction in that year, and then actually give the money to charities in the future. With a DAF, you can continue to contribute as often as you like.

Here’s how it works:

  1. You Setup a Donor Advised Fund at a custodian of your choice
  2. You make an irrevocable contribution to the DAF
  3. You then get to take that deduction in this given year
  4. It can be invested and grow for the future and any of the growth is tax-free to the donor
  5. Then you can make grants to qualified charities when you want to

Donor Advised Funds are one of the most commonly used charitable strategies as they are low maintenance, easy to setup, and have tons of tax benefits.

Many business owners facing a liquidity event will leverage a Donor Advised Fund or another charitable strategy by donating ahead of the sale some of the highly appreciated equity in the business so they can avoid the capital gains tax and also get a deduction against their income. It’s a super powerful tax strategy.

Charitable Remainder Trusts

A Charitable Remainder Trust (CRT) is an irrevocable trust that generates an income stream back to you, the donor of the CRT (or another beneficiary), while the rest of the donated assets go to the charity of choice.

This is a really powerful strategy for those who want the tax benefits and to give to charity, but worry they might need some money back overtime for their life, retirement, family, etc.

A CRT works like this:

  1. You setup the Trust and pick a beneficiary
  2. You donate cash, securities, etc. to the trust
  3. You set the term for the potential income stream (no more than 20 years). Must be at least 5% paid yearly but no more than 50%.
  4. You name the charity or charities you want to receive the remaining assets
  5. You get the partial tax deduction in the year you create it

Here is a great graphic to show how this works:

CRT’s are a great tool for those who want to give but also want an income stream back for themselves or another beneficiary.

Charitable Remainder UniTrusts

Charitable Remainder UniTrusts (CRUTs) are very similar to CRT’s that we talked about above. The one main difference is that instead of it being a set annuity that comes back every year, a fixed percentage (based on the balance of the trust assets) is distributed. This gets reset annually. Other than how you or the beneficiary is paid out, it is basically the same tool.

Many people choose to combine a CRT or CRUT with a donor advised fund by making the beneficiary the donor advised fund. This ultimately gives you more flexibility so you are not limited by the number of charities you can select.

I did not include a graphic here as it would look the exact same as the CRT.

Charitable Lead Trusts

Charitable Lead Trusts (CLTs) are irrevocable trusts that are designed to benefit one or more charitable organizations for a period of time, then the remaining assets go to the named beneficiary.

CLTs are pretty much the opposite of a Charitable Remainder Trust since CLTs operate for a set term which could be the life of an individual. Payments are then made to the charity or charities for the set term and whatever is leftover goes back to the non-charitable beneficiaries. This differs from a Charitable Remainder Trust because CRTs provide an income stream for the term of the trust and the rest is transferred to the charities. This is why many see them as opposites.

Charitable Lead Trusts can be funded while alive or upon death via will. CLTs also provide estate tax benefits and an income tax deduction.

In the most simple terms, here’s how it works:

  • You setup the trust
  • You make a contribution to the trust
  • You get the partial tax deduction which is calculated by the term of the trust
  • Payments are sent to the charity/charities you choose
  • Once the term is over, the remaining assets are given to the non-trust beneficiary

With CLT’s, you can have grantor and non-grantor. With grantor, this means you can take the income deduction for the present value of the future payments (subject to limitations). However, it is important to note that the investment income is taxable to the grantors trust. With non-grantor, the trust, not the grantor, is considered the owner of the assets. This means the grantor is not able to take the income tax deduction. The trust itself pays the tax on undistributed income but the trust also gets to claim an unlimited income tax deductions for the distributions to charity.

Charitable Lead Trusts are also often combined with a donor-advised fund for more flexibility.

Private Foundations

A Private Foundation is basically setting up your own charity. You need a board of directors who:

  • Oversees the donations you get
  • Manages the investments
  • And makes grants to charities

Because of this, Private Foundations are the most intensive of all the options listed above. We often do not think about them unless someone is going to donate at least $5mil AND wants to do this as a job.

Every 501(c)(3) is either classified as a public charity or a private foundation. A good example would be Bill & Melinda Gates Foundation. Foundations have more intense laws and regulations to ensure they are used properly.

Most create private foundations as they are a great way to leave a legacy, get a tax deduction (up to 30%), eliminate capital gains taxes (if appreciated assets are put there presale), etc.

Here are some other facts to note:

  • The deductions are 30% of AGI for cash or 20% for appreciated securities. Where as a donor-advised fund gets 60% and 30%.
  • Investment income is subject to 1.39% excise tax (donor advised fund has none)
  • Donations from an estate to a foundation receive the same unlimited deduction as donations from an estate to a public charity or donor-advised fund.

Private foundations can be great for those who have a lot of extra money, who want to be really involved and put in a lot of time, and who really want to help a specific cause.

As you can see there are many options that allow you give to charity while also taking benefit on income, capital gains taxes, and estate taxes. Make sure you are working with your team to pick the right tools for you!

And for my fellow business owners who are planning to sell, start thinking about this NOW, before the capital gains hit happens.

If you need help with your financial, tax, and estate planning, head on over to our website and apply to work with us.

Disclaimer: None of this should be seen as advice. This is just for informational purposes. Consult your legal, tax, and financial advisor before making any changes to your financial plan.

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