Most people know that charitable donations help nonprofit organizations further their missions, doing work that assists the underprivileged, helps animals in need, or supports other causes. Additionally, many people are aware that rich individuals leverage charities to limit their tax liability. However, most don’t know exactly how that works. Here’s a look at how the rich use charities to avoid taxes.
Deducting Charitable Giving
Many people know that charitable giving to an eligible nonprofit can result in a tax deduction. However, who ultimately accesses that deduction generally skews to those with higher incomes. Primarily, that’s because the tax filer needs to be in a position where itemizing makes sense. If they don’t have enough itemized deductions to exceed the standard deduction, itemizing isn’t worthwhile. As a result, most lower-income households aren’t claiming a charitable giving deduction.
For those who many would deem rich, a charitable deduction is essentially an incentive to support nonprofits. When a donation is made, that money isn’t taxed. Depending on the amount given in comparison to earnings, it’s possible to significantly alter how much is paid in taxes annually.
Other Ways to Avoid Taxes
While deducting charitable contributions is relatively straightforward, there are other options available to the wealthy. Charitable trusts are a popular vehicle for securing the financial future of children that also comes with a range of tax benefits. Creating a new nonprofit themselves can also let the wealthy reduce their tax burden without technically losing all access to the donated assets.
Using donor-advised funds (DAFs) is another popular option. While nonprofits must spend a minimum of 5 percent of their assets annually – the bulk of which can go to operating expenses and salaries, not necessarily helping the designated cause – that doesn’t apply to DAFs. Through the donation of shares, the rich also avoid capital gains taxes and get a deduction against any income earned.
DAFs also lack some of the reporting requirements associated with operating a nonprofit. As a result, there’s little awareness of how the assets are used, creating opportunities for the rich to tap them for personal gain. For example, donations from the fund could be directed toward select colleges or universities in hopes of ensuring a child’s acceptance to the school.
In some cases, the wealthy have donated entire companies using charitable trusts. Once shifted to the trust, the business is sellable in a way that can eliminate the tax burden associated with such a sale, all while the original owners of the company get a tax break.
Ultimately, there are many ways to take advantage of charitable giving to secure tax deductions and avoid income taxes, all while potentially maintaining some control over the asset. While most are complex, wealthy individuals are incentivized to pursue these avenues, and they can often afford the financial professionals necessary to make it all work.
Do you know of any other ways that the rich use charities to avoid taxes? Do you think these kinds of tax strategies should be available, or should charitable contributions not lead to tax deductions? Share your thoughts in the comments below.
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