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Wealth Management, Tax Planning and Charitable Donations

By Nancy Faussett, CPA
Publication date: 10/2008

No one will argue the fact that tax planning is an essential component of wealth management. Indeed, good tax planning can provide clients with a multitude of opportunities to save on both income taxes and estate taxes.

This article will focus on how charitable donations, if properly structured, can minimize both income and estate tax exposure as part of a wealth management plan. Here are some possible strategies:

• A transfer of highly appreciated property may avoid taxable capital gain from a sale of such property while, at the same time, allowing a charitable deduction for its fair market value (FMV).
  
  Be aware that due to changes in the tax law, this strategy is not as easy as it once was. The FMV amount of the charitable deduction may need to be reduced under the rules of Sec. 170(e):
  • If it is “ordinary income property,”
  • If it is capital gain property that is also tangible personal property and if it is to be used by the donee for other than the donee’s charitable function, or
  • If the use of the property relates to the donee’s tax-exempt purpose and the donee disposes of the property after the year of the contribution but before the end of the three-year period starting from the date of the donation.

  Note: Generally, no gain is recognized on a donation of appreciated property unless one of two exceptions apply: 1> if it qualifies as a “bargain sale” or 2> if the charity sells the property shortly after the transfer and it is determined that the sale was part of an overall plan.

• A charitable lead trust (CLT) enables a donor to assist a charitable organization for a period of time (either for a specified term of years or for the life of certain specified individuals living at the date of the transfer), after which the asset reverts to the donor or donor’s estate.
  • A charitable lead annuity trust gives a fixed dollar amount or a fixed percentage of the initial value of the trust’s assets to one or more charities for the term of the trust.
  • A charitable lead unitrust gives a fixed percentage of the trust’s assets, as redetermined annually, for the term of the trust.
  An income tax deduction is allowed for the donation of an income interest in trust when the charity’s interest is in the form of either a guaranteed annuity interest or a unitrust interest and the donor is treated as the owner of the interest under the grantor trust rules (Under the grantor trust rules, the income of the trust is taxed to the donor). A grantor charitable lead trust is an excellent tax reduction tool when the donor has a large amount of income in one year but expects less income in future years, as in the year the trust is created, a charitable deduction is generated. The amount of the income tax deduction is the present fair market value of the guaranteed annuity or unitrust interest.

  Aside from a deduction for the charitable donation, a charitable lead trust can reduce the transfer tax cost of passing the property to children or grandchildren.

• A charitable remainder trust (CRT) is another tool for making charitable contributions. A charitable remainder trust (Sec. 664) allows an immediate tax deduction and provides a retirement income. It is the opposite of the charitable lead trust in that a noncharitable beneficiary receives the income interest and the charitable beneficiary receives the remainder interest.

  With a CRT, you transfer property to a charity but retain the right to the income generated by the property for your lifetime (or a period of time not to exceed twenty years), at which point the property’s ownership transfers to the charity. Also, you can specify successive or concurrent beneficiaries to receive the income, the payment of which must be made at least annually.

  • A charitable remainder annuity trust (CRAT) gives a fixed dollar amount or percentage of the initial value of the trust’s assets annually to a noncharitable beneficiary, with the remainder given to a qualified charity.
  • A charitable remainder unitrust gives a fixed percentage of the trust’s assets, as redetermined annually, to a noncharitable beneficiary, with the remainder given to a qualified charity.
  • A pooled income fund gives an irrevocable remainder interest in property to a charity (which maintains the fund) while retaining an income interest in the property for life.

  The amount of the income tax deduction is the present value of the charitable remainder interest upon the creation of the trust.

• Under a gift annuity the donor transfers money or property to a charitable organization in return for an annuity for life, without using a trust. This ensures a fixed stream of income for the annuity period while allowing a charitable donation. An income tax deduction is allowed for the excess of the value of the property transferred to the charity over the FMV of the annuity at the time of the transaction.

So how do you select the best charitable donation vehicle for your client, knowing that every client is unique? One way is to obtain good software, from a reputable vendor that will give you the ability to create multiple scenarios – what-ifs – all on one screen, with precise calculations and up-to-date tax law. Further, you’ll want to make sure the software is easy and efficient for you to use, and has good visual presentation capabilities that can help you explain the available choices to your client.