While it's too late to save on 2010 taxes, it's not too early to start thinking about 2011. With the right charitable-giving strategy, you can do the most good while making the most of available tax deductions.
While it’s too late to save on 2010 taxes, it's not too early to start thinking about 2011. With the right charitable-giving strategy, you can do the most good while making the most of available tax deductions, says Eric Meermann, CFP, client service manager with Palisades Hudson Financial Group, a financial advisor in Scarsdale, N.Y.
“The best method can be as simple as giving cash or as creative as a setting up a trust,” he says. “It all depends on your situation.”
Give more when you make more, Meermann advises. For instance, if you receive a large bonus in 2011 that would push you into a higher federal tax bracket, give more this year than next, when you expect your income to be lower.
From simple to complex, here are ways you can give:
Cash. If you itemize, you can deduct cash gifts to public charities up to 50% of your adjusted gross income (AGI) during any tax year. But don’t use paper money -- give “cash” via a check or credit card, because you’ll need proof if you’re ever challenged by the IRS, Meermann says. If you give $250 or more at any one time, you’ll also need a letter or receipt from the charity showing the date and the amount you gave.
Appreciated Securities. You can donate appreciated shares of stock, mutual funds or other publicly traded securities directly to the charitable organization. The donation limit on securities is lower: 30% of AGI annually.
“This is a powerful strategy because it accomplishes both income-tax-planning and charitable objectives,” Meermann says.
Suppose a stock you bought years ago for $2,000 is now worth $10,000. You would have an $8,000 gain that you would pay capital gains tax on if you sold the shares and gave the cash to charity -- a bad idea. Instead, give the shares directly to the charity, pay no gains tax and get a $10,000 tax deduction. It’s usually simple to arrange this through your broker holding the securities.
If you have a security with a loss you want to get rid of, do the opposite. Sell it first and take the capital loss. You can donate the proceeds to charity and take a deduction just like any other cash contribution.
It’s important to note that the 30% limit applies to any property, including land, works of art, etc., that would produce a long-term capital gain if sold by the donor. To further complicate things, the rules distinguish gifts "to" a charity from gifts "for the use of" a charity, with lower limits on the latter. And there are appraisal requirements for larger gifts. To protect yourself, consult an expert before giving when large sums are involved.
Securities Donated to a Donor-Advised Fund. Suppose you’re not sure which charities you wish to support or you want to spread your donation over time. Consider giving securities to a donor-advised fund. This is a charitable-giving vehicle that lets you make an irrevocable tax-deductible contribution. Your money then grows tax-free inside the fund. At any time, you can recommend distributions to qualified charitable organizations -- and make them anonymous if you prefer.
Many companies, such as Fidelity Investments and Vanguard, run simple and easy-to-use donor-advised funds at low cost.
For most people most of the time, giving cash and/or securities is the simplest, best method for charitable giving. But for a few, it makes sense to consider a trust or a foundation, Meermann says.
Charitable Remainder Trust (CRT). With a CRT, the donor receives a stream of income for a term of years, or the remainder of his or her life, from a trust established as a split-interest trust. After the term expires or the donor dies, the assets remaining in the trust pass to one or more charities, which can be selected when the trust is created or later, Meermann says.
In a CRT, a charitable deduction is allowed when the trust is funded. The deduction is equal to the present value of the remainder interest that will pass to charity. The size of the deduction depends on the structure of the trust and the level of IRS-mandated interest rates at the time of the contribution.
Charitable Lead Trust (CLT). Someone who has ample money to leave can consider a CLT, which works the opposite way of a CRT. Here the income stream is paid to the charity over a term of years, or your lifetime. Any assets remaining in the trust can revert to the donor or pass to the heirs, he says.
One advantage of a CLT is that the remainder can be structured to pass to your heirs. If there are outsized gains in the securities within the CLT since the contribution, a portion of the excess appreciation will pass to your heirs free of gift and/or estate tax.
Your Own Foundation. You don’t have to be a Bill Gates or a Warren Buffet, but a foundation makes sense for people who can afford to give away millions, Meermann says. Private foundations sponsor or aid charitable, educational, religious or other activities serving the public good, primarily by making grants to other nonprofit organizations.
Besides providing a tax deduction, up to IRS limits, a foundation can create visibility and influence for family members, and remind everyone of the family’s generosity. But foundations can be expensive to run and administer, with required startup legal fees, ongoing meeting expenses, administration fees and investment-management costs.
“With a smart strategy, you can maximize the impact of your dollars on charity and your wealth,” Meermann sums up. “With lower taxes and more wealth, you’ll have more to give away next year.”