When I was still young enough to get an allowance, my mom had one rule: give 10% first, save half and then you can keep half. My 10% always went in the form of tithes to my church. At my age, I didn’t like it much, nor did I understand its purpose; all I could see was “I had $10 and now I only have $9. No fair!” As I matured (and my allowances increased), I realized that the 10% I was giving was so minor in comparison to my earnings that I hardly missed it. I also began to understand that my giving actually was the right thing for me and I felt good about doing it. Now that I’m older and work in the financial industry, I see that there are not only more advantages to charitable gifting but there are also smarter ways to gift. I’d like to discuss some of the various ways one can donate to charity and some of the strategies used to make the most out of the donations that some are already making.
- Gift within your budget.
One of the many advantages of having a financial planner is that we can analyze goals, present and future expenses, current income and cash reserves to determine how much you have to make a sizable donation to charity and if or when it would be advantageous to do so. In doing this, we can help determine which assets are best to gift given your circumstances. Most of our clients wait until the end of the year to decide what resources are available to gift and which of those are the most tax-advantageous.
In the example above, 10% of my earnings each week went to charity before I spent a dime of it. That was one way of working gifting into my budget and making sure that I made donations regularly. As an undisciplined 10 year old, had I waited until the end of the year, there would have been nothing left to gift! Similarly, there are some clients who prefer to make smaller, more frequent gifts as opposed to larger gifts at the end of the year for various reasons. However, for those who find they have more than adequate resources for gifting year over year, the strategy of year-end gifting may work best.
- Gift in such a way that maximizes deductions and reduces taxes.
There are many ways to gift so that your deductions are maximized and so that taxes are reduced. First and foremost, you should gift to charity while you are living. If reducing the value of your estate is becoming an important factor in your decision making anyway, you will get a two-fold advantage of gifting now instead of after you’re gone: 1) you’ll get an income tax deduction each year and 2) you will reduce the value of your estate which in turn reduces the estate taxes your heirs will have to pay when you pass on (Click here for more on Why Estate Planning Is Important). If you wait until you pass away to gift to charity (perhaps you’ve set up Charitable Remainder Trusts), you won’t benefit from income tax deductions each year.
Another way to reduce taxes is to donate to charity instead of gifting to individuals. There is a current cap on lifetime gifts to individuals of $5,000,000 (in 2013 this cap will likely go down to $1,000,000). Any amount over these limits is subject to gift taxation. The advantage of gifting to charity instead is that an unlimited amount of property can be transferred to qualified charities during a person’s lifetime or at death without incurring federal transfer taxes.
For those who itemize deductions and have the resources to do so, you should consider trying to structure your gift to charity so that it maximizes the income tax deduction received. Often times, you don’t have to gift more, just gift smarter. Since the deduction received is based on the charity who receives the gift, the AGI of the client, how much is gifted and what type of asset is gifted, there are many considerations to be made.
- Consider the Type of Charity
Most clients gift to public charities. These typically include churches, educational organizations, hospitals, and other well-known organizations. Examples include the Red Cross, the University of Virginia, or the SPCA. Gifting to a public charity has an income tax deduction limit of 50% of AGI or 30% of AGI depending on the type of gift.
Private charities where support comes from a smaller group of people (for example the Bill & Melinda Gates Foundation) are limited to the lesser of 30% of AGI or 50% of AGI minus the deduction taken for gifts to public charities. Depending on the type of gift, this may be limited to 20% of AGI.
Gifts in excess of these limits can be carried forward for up to 5 years. Thus, if you hit the lottery and decide you want to donate a large chunk of your winnings to your favorite public charity, anything over the 50% or 30% limits can continue to be deducted over the next several years if necessary.
- Consider the Type of Gift
If you are considering gifting cash, you are eligible to gift an unlimited amount but can only deduct up to 50% of your AGI for gifts to a public charity in a given year. For a private charity you are eligible to gift an unlimited amount but can only deduct the lesser of a) 30% of AGI or b) 50% of AGI minus the deduction taken for gifts to public charities in a given year. Although cash is typically the easiest way to gift and you receive the larger deductions, it is not usually the most tax-efficient if you have other assets (such as long-term capital gain property or income-producing property).
If you are considering gifting intangible long-term capital gain property (such as appreciated stock), you may deduct up to 30% of AGI for a public charity if valued at the fair market value on the date of the gift. If you make a special election to have it valued at your adjusted basis, you may increase this to 50% of AGI. For a private charity the deduction is limited to 20% of AGI. Tangible long-term capital gain property is valued at fair market value if used for the charitable purpose. If not, it will be valued at the client’s basis. Typically the recommendation here is to gift these outright. It makes less sense to sell these assets and then donate the proceeds because you are taxed on capital gains; as such, the charity gets a smaller donation and you receive a smaller deduction. Gifting outright avoids these issues and results in a larger donation and a larger deduction.
Property that has declined in value is typically not a good idea to gift. In this case, it makes the most sense to sell the property, take the tax loss against income (up to $3,000 per year) and then gift the proceeds. This gives you two deductions: deduction of the loss and the charitable deduction.
- Consider the Timing of the Gift
As of right now, the charitable deduction limits are the 50%, 30% and 20% limits of AGI that I mentioned above. That is certain but only for 2012. What we also know for 2012 is the ordinary income tax rates and the capital gains rates. Given the uncertainty of the fiscal-cliff, there is a lot that we don’t know in terms of tax and estate planning in the coming years. For example, one of the 2013 budget items proposed is capping the charitable deduction at 28% for those who make over $250,000. Do you gift this year to avoid the proposed cap on deductions? Another fiscal cliff item is the increase in capital gains rates: an increase from 15% to 20%. If you decide to gift appreciated long-term capital gain property in 2013, you would be avoiding a 20% tax instead of a smaller 15% tax. However, if you wait to gift next year there may also be a 28% cap on deductions so you will have less to deduct each year.
Given today’s uncertainty, many people are accelerating income to avoid potential tax increases in the future. If this is something you are also thinking about, it might make sense to make a larger contribution this year in order to help offset the increase in your taxable income. The same is true if you’ve converted your IRA to a Roth IRA this year. You’ll have a one-time increase in taxable income that can be offset by a larger charitable contribution. Contributing a larger amount this year makes sense because at least we know the current deductions and tax rates. On the other hand, if you will have a higher income next year as opposed to this year, it could be beneficial to wait and donate a larger amount next year to offset the higher income tax brackets.
- Gift in Such a Way to Add Flexibility
One of the ways to add flexibility to your gifting plan is to gift to a Donor Advised Fund such as the Fidelity Charitable Gift Fund instead of gifting directly to a specific charity. We have already assisted many of our clients in taking advantage of this strategy at Fidelity. One of the advantages of contributing to a donor advised fund is that you can make a gift to the fund and then decide later on in the year which charities you would like to grant the funds. Since the Fidelity Charitable Gift Fund is a public charity, you get the full benefit of the tax-deduction (subject to the deduction limits above) in the year of the contribution and can also spread out gifts over several years.
In addition, you have full flexibility to donate cash, mutual funds, appreciated stock and even complex assets into the fund and once they have been transferred and liquidated you get to decide how these funds will be invested (growth, fixed income, money market or blended investments). Most of the charities I’ve dealt with have had a hard time accepting anything other than cash or equities. The largest advantage of the donor advised fund is that once a contribution has been made into the fund, it has the opportunity to grow in the account, tax-free.
Looking at this holistically, a donor advised fund accomplishes the objectives of gifting within a budget, maximizing deductions, reducing taxes and adding flexibility.
“If what you have is not what you need, it’s not your harvest, it’s your seed.” For those of us who have it to give, I think gifting to charity is certainly something to think about doing with some of your excess assets. That said, gifting is a personal choice and should be done only when it is in your heart to do so. I hope this has provided an overview of different ways to gift. There is much more material on this topic than I could have covered so I’ve included some links below for additional information. In addition, my colleague Marilee Falco has written an interesting blog on maximizing charitable contributions in your retirement account that I hope you’ll get to read.
Additional Resources & Sources of Information: