Philanthropy and Your Taxes

Smart, effective philanthropy can bring about great change, promote passionate causes and help people in different walks of life. Indeed, the ability to help make the world a better place provides a powerful incentive for wealthy individuals and families to become philanthropists.

In a 2017 study by U.S. Trust, respondents indicated their primary reason for wanting to give back to society is to support the interests and causes that matter most. More than half (52%) say the reason they give back is to support issues that affect the less fortunate, while 62% seek to address local needs. 7 in 10 think their parents are not as committed to giving as they are. Meanwhile, nearly one in three Baby Boomers and Silent Generation individuals believe the younger generation is not as inclined to give back. Millennials and Gen X-ers are more likely to support issues that personally affect them. Boomers and Silent Generation members are more inclined to give to charities geared toward those less fortunate. And Millennials are three times more likely than Baby Boomers and the Silent Generation to view the jobs and solutions they create through business ownership and social enterprises as their way of giving back.¹

Yet amid their desire to do good for others, it’s important for philanthropists not to lose sight of their own long-term financial goals and needs, says Gillian Howell, Philanthropic Solutions and Family Office National Consulting and Advisory Executive at U.S. Trust. “A variety of strategies exist today tohelp donors navigate towards their philanthropic and personal objectives in a tax efficient way,” Howell says. “A tax-aware approach to philanthropy could even help you give more.”

The vast majority of giving in this country comes from individuals. When taking into account charitable contributions and bequests, this accounts for 72% of all giving.²

Of course, choosing the right strategy is a balancing act between personal priorities, passions and long-term goals, and a combination of strategies may be appropriate to fully accommodate your needs. This is not always easy, but deciding on the right giving solution is essential to maximizing both the social impact and your own benefit.

Here are four options you may want to consider, depending on your situation.

OUTRIGHT GIFTS

An outright or direct gift is one of the most basic and popular forms of philanthropy. Outright gifts may involve direct transfers of cash, securities or other assets to a qualified 501(c)(3), nonprofit organization.

Outright gifts are the easiest way of giving, as there are no setup costs or lasting considerations, such as ongoing management. Yet there are pros and cons when considering the taxes on gifts. Yes, the full fair market value of the gift can potentially be written off of the donor’s return, making it clear and tax-efficient. But it’s important to remember that whatever the donor receives in return — even small perks — must be excluded from that value. For instance, says Howell, if you buy a $5,000 ticket to a gala in support of a foundation and the fair market value of the ticket is determined by the charitable organization to be $500, the $5,000 contribution would be reduced by $500 to account for the benefit you received (e.g., the food, drinks and attendance at the gala). “So even when you’re doing direct giving,” she says, “you must understand that you may not be able to deduct it 100% from your tax return.”

And giving based on your occupation can matter as well. Take, for example, the artist versus the art collector, says Howell. If you have an art collector who donates a painting from their collection to a museum, they can deduct the fair market value of the painting from their adjusted gross income. “But if an artist paints a new masterpiece and gives it to the same museum,” she says, “the artist can only deduct the cost of the paints and brushes.”

DONOR-ADVISED FUNDS

A donor-advised fund (DAF) is an easy-to-establish, irrevocable-and-final giving program that generates charitable tax deductions for the donor (up to 50% of adjusted gross income). Run by a manager with non-profit 501(c)(3) status, DAFs are designed for long-term giving and provide presentday tax deductions. They are easier to administer than a private foundation and often fit the needs of clients who may not know where or when they want to donate, but know they want to give in the years ahead. Some philanthropists use DAFs as a handy way to teach younger family members about giving, in preparation for taking on the duties of a family foundation.

A DAF can be a useful vehicle for those wishing to make anonymous gifts or wishing to lighten or avoid the responsibilities of a family foundation. A DAF may also provide a good way for individuals who receive a large lump sum—say, from a bonus—to lessen their tax exposure in a given year. At the same time, these vehicles aren’t right for every situation. While giving from a DAF allows for anonymous gifts and all DAF records can remain private, there is less day-to-day control for the donor who set up the fund. As part of having lesser administrative duties, there is less direct involvement for the donor: an administrator or manager is managing the actual giving after your initial donation, filing tax returns and making distributions from the DAF in compliance with 501(c) (3) regulations. While managers will generally honor the donor’s requests, so long as they meet DAF requirements, philanthropists seeking greater hands-on control often use family foundations.

PRIVATE FOUNDATIONS

Private foundations may best suit an individual seeking greater control and who has more time and capital to invest.

The trade-off for that control is expense and complexity. Foundations start with a sizeable initial investment, and require ongoing oversight and a management infrastructure, including a board providing administration oversight and grants and scholarships management. (The individual who starts the foundation and his or her family members may serve as board members, trustees and staff of the foundation, and receive reasonable compensation for their services.) A foundation must distribute 5% percent of its assets each year in accordance with its purpose, and deductions for anything other than marketable securities are generally on a cost basis rather than full-market value. The foundation must also file tax returns and pay an excise tax (up to 2% of net-investment income). Tax deductions are based on what goes into the foundation. Fair market value for marketable securities is the same as a DAF, but the percentage of deductions against an investor’s adjusted gross income is not as much (up to 30% versus 50% for a public charity donation). As a result, donors sometimes consider establishing a private foundation in conjunction with a donor-advised fund.

CHARITABLE REMAINDER TRUSTS

Charitable remainder trusts (CRT) provide income to the donor or beneficiary while potentially eliminating capital gain taxes if the contributed low-basis assets are sold by the CRT or are distributed to the charitable organization at the end of the CRT term. CRTs can be an effective strategy for higher-net-worth individuals who want to offer longterm support for a charitable organization, while at the same time realizing tax deductions, repositioning an investment portfolio, and creating a source of personal income during their lifetime.

When establishing a CRT, an individual moves cash, securities or other appreciated assets into the trust, where the assets may grow protected from capital gains taxes if such assets are later sold by the CRT or distributed to the remainder charitable organization at the end of the CRT term. The donor may take an income tax deduction for a portion of the fair market value of the assets placed in the CRT. And, for the term of the CRT (which is often the life of the donor), the donor receives income from the trust at least annually (in the form of an annuity or unitrust amount). Assuming that the CRT is structured to last for the life of the donor, then upon the death of the donor, the remaining assets go to a pre-chosen charity, while the donor’s estate is granted a corresponding charitable estate tax deduction.

Distributed cash flow and the amount of tax deductions are both calculated at the current applicable federal tax rate, which is determined by life expectancy and a government-established implied interest rate. CRTs have gained popularity with couples planning to retire who are looking for a reliable, low-risk source of retirement income to cover travel, potential health care costs, or other expenses.

TODAY’S NEED FOR TAX-EFFICIENT PHILANTHROPY

As the world’s needs continue to expand, wealthy philanthropists will undoubtedly rise to meet those needs. Fortunately, says Howell, “More options for tax-efficient giving exist today than ever before.” Taking full advantage of those efficiencies may involve sitting down with your financial and tax advisors to devise a new approach to your generosity. It’s an approach that looks at giving not as a series of individual gestures, but as part of a concerted philanthropic strategy aimed at fulfilling that age-old mission— doing well by doing good.