High-Net-Worth Clients and Charitable Giving

If you have high-net-worth clients, you should understand the ins and outs of charitable giving. Of course, many U.S. families and individuals give to charity and are likely already aware of the general tax rules, such as needing a receipt to prove the donation and itemizing deductions. Most, however, are not familiar with more advanced charitable giving strategies.

While there are different types of giving, the tax advantages of each vary depending on the recipient, how the charitable gift is structured and the type of property given. First, here’s a quick overview of the most common ways to give:

  • Volunteering: People can give their time, but time isn’t deductible. Transportation costs related to volunteering can be, however.
  • Cash: Both large and small cash donations require a receipt in order to take a deduction.
  • Tangible personal property: Household items, clothes, cars, etc., must be in “good” used condition or better. People can deduct how much they paid for the property or how much the property’s current reasonable value is, whichever is less.
  • Short-term capital property and ordinary income property: Short-term capital assets, for example stocks held less than a year, are considered ordinary income property. Ordinary income property can include items such as inventory of a business, artwork a person has created or products a person has produced.

Note that the deduction is limited to the cost basis of the asset, which is the fair market value. However, a person can take a deduction for the full market value of the property if they include the appreciated value of the asset in their gross income.

  • Long-term capital gain property that appreciated: Long-term assets, however, can usually be deducted with full market value. All this requires is that a person has held it longer than a year. Long-term assets can include stocks, mutual funds, bonds, real estate and other assets that have appreciated in value.

Note that a person doesn’t need to pay capital gains tax on a donated long-term asset. This is why donating long-term assets such as appreciated securities can be a tax-efficient way to support charities rather than just giving cash. Giving the appreciated securities directly to a charity goes further than if a person sells the securities, pays tax on the gains and then gives the cash. However, keep in mind that the deduction is limited to 30 percent of AGI.

  • Long-term property that has decreased in value: If property has decreased in value below cost basis, a person can only take a donation deduction for the fair market value of the asset. In this case, it might be better to sell the asset, take the loss and then donate the cash to the charity. This allows for capital loss deduction against other capital gains.
  • Encumbered property: It’s difficult to find a tax-efficient way to donate encumbered property, which is a claim against a property by a party that is not the owner. For example, common types of encumbered property apply to real estate, which include properties with mortgages and property tax liens.

More Advanced Charitable Methods

As you can see, there are many methods of giving, but there are also several more advanced strategies that affluent households can turn to in order to reduce their tax bills, maximize their charitable contributions and, in some cases, shift assets to future generations while minimizing estate and gift tax implications. Here are three advanced charitable strategies you and your clients should be aware of:

1. Private Foundation

A private foundation is created when an individual or household sets up a tax-exempt organization but does not file to be recognized as a public charity. Because the foundation isn’t a public charity, tax deductions for donations to the foundation are capped to 30 percent of the taxpayer’s adjusted gross income (AGI) if the gifts are made in cash or 20 percent of AGI if the gifts are appreciated assets or securities.

A private foundation could be an excellent option for high- or ultra-high net worth individuals. A funding contribution, for example, could be 2–3 million dollars to start. The foundation must then distribute a minimum of 5 percent of the value of charitable assets, as determined on a yearly basis. However, the donor/founder keeps complete control over the funds and distributions. Many high net worth individuals fund these near or upon retirement.

If your clients are interested in retaining control of their funds and maintaining a sense of volunteerism, private foundations can offer several benefits. Many wealthy individuals will hire or have family members volunteer in the foundation in order to further their charitable pursuits.

2. Donor-Advised Funds

Donor-advised funds allow wealthy individuals to contribute to an existing organization and then direct the distributions to organizations and causes that the individual wishes to support. While the donor may advise on where to distribute the funds, they give up control over the money. There are no requirements to spend the donated money within a set period of time, though many donor-advised fund organizations require unused funds to go back to the general charitable purpose if they are not distributed within a number of years set forth in a contract.

Deductions for contributions to donor-advised funds are limited to 60 percent of the taxpayer’s AGI for each taxable year. These can be good options for high net worth individuals who want to be more intentional in their charitable contributions but don’t want the burden of managing a full charitable entity.

3. Charitable Lead Annuity Trusts

With charitable lead annuity trusts (CLATs), the donor can establish a trust with one or more charities as named beneficiaries. For the life of this trust – which may be the donor’s lifetime or a specific number of years – the trust distributes a set annuity amount to the chosen charitable organizations.

When the CLAT ends, the assets remaining in the trust pass to the beneficiaries free of estate tax. The goal here is to “zero out” the trust, meaning that the length of time the trust is in existence is enough time to distribute the full funding amount while also allowing large accumulation amounts that will be passed to the remainder beneficiaries.

Low interest rate environments are great for establishing and funding a CLAT. The lower the interest rate, the easier it is to zero out a CLAT while increasing the amount of accumulated wealth that will pass to the beneficiaries. This is because the trust funds will usually be invested and grow at a much faster rate than the low interest rate that is required to be distributed. This could be a great strategy for someone who expects assets to grow in value.

Choosing the Best Charitable Giving Vehicle

There are a variety of factors that will play into which type of giving strategy will be best for your client. While a person may have the wealth to set up a private foundation, they may not want to be involved on a day-to-day basis with it and instead opt to contribute to a donor-advised fund.

Alternatively, another client who has a taxable estate and would benefit from a CLAT may be more comfortable setting up a private foundation. Keep in mind that using one strategy does not stop someone from using another if they desire to do so.

Each of these more advanced strategies requires additional steps to implement, but all could be potentially good options for affluent individuals. Firms that provide more targeted ways of giving can maximize the impact of their clients’ philanthropic tendencies while reducing tax burdens over future years.

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