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Charitable Aspects of Estate Planning


August 20th, 2012

Many of our clients have minor children, or adult children with special needs, who are dependent on the parents’ support and who would need continued financial support even after the parents were gone.  For most of our clients, however, their children are grown and self-sufficient.  Some of our clients express concern that their family members will receive too much of an inheritance, which they will not likely appreciate nor manage well.

While it is natural to think of your family members when developing your estate plan, other institutions that you may have been involved in and supported for years, or whose principles you support even though you have never previously had the opportunity to get involved with, should also be considered. 

Most people think of charitable estate planning as something for only the rich and famous.  Regardless of the size of your estate, however, any charitable gift is helpful to the charity and a meaningful final statement of your personal values and beliefs.

If a drop in market values and/or increased taxes would reduce your estate by 10%, you would probably feel confident that your family members would still be able to get by on the remaining 90%. Consider, then, the joy that you would feel if that 10% went to one or more of your favorite charities instead.

If you have any charitable inclination, there are a number of techniques, either during your lifetime or upon your death, to use.  Some are more tax-effective than others.  All things being equal, we would of course want to use those techniques that provide the most bang for your buck.  In some unusual circumstances (e.g., a highly valuable asset with a large potential capital gain that is generating little or no income), you and your family can actually come out ahead by giving assets away through a properly-structured charitable device.

Here is a rundown of various types of charitable contributions, and a brief discussion of their tax implications:

Gifts of Cash – Writing a check is probably the most common and easily understood manner of making a charitable gift.  For gifts during your lifetime, you receive a current income tax deduction for cash contributions to charity.  For “publicly supported” charities, the deduction in any one year is limited to 50% of your adjusted gross income (“AGI”).  Excess deductions can be carried over for as long as five succeeding years.  For gifts upon your death, your estate receives a deduction for estate or inheritance tax purposes, with no percentage limitation on that deduction.

Gifts of Services – Generally, the value of services you perform for charity are NOT DEDUCTIBLE.  One limited exception:  you may deduct the cost of transportation or travel expenses incurred in the performance of services away from home on behalf of a charitable organization.  Your mileage back and forth to attend church on Sunday is not incurred on behalf of the church, and is not deductible.  If you deliver food baskets to the needy on behalf of the church, that mileage is deductible. The standard mileage rate for charitable activities is 14 cents per mile.

Gifts of Appreciated Securities – If you bought or inherited some stock a long time ago, you may feel locked into that stock now because you would pay a large capital gains tax by selling.  Consider fulfilling your pledge to charity by donating that stock directly to the charity – you avoid the capital gains tax and you still get to claim a charitable contribution deduction based upon the fair market value of the stock.  The deduction in any one year is limited to 30% of your AGI.  The unrecognized gain (i.e., the difference between the amount of your contribution claimed and your tax basis in the property) is a “tax preference item” for purposes of the alternative minimum tax (“AMT”).

Charitable Remainder Trusts – If you are leaving money to a charity in your will, consider setting up a charitable remainder trust now and get an income tax deduction today for your future gift.   The charitable remainder trust works particularly well with highly-appreciated assets (e.g., stock or real estate) because it also allows you to sell those assets (and perhaps diversify your holdings and increase your income) without paying a large capital gains tax up front.  Here’s how it works in a nutshell:

1.      You transfer assets to the charitable remainder trust.

2.      The trust sells the assets you contributed to the trust.  Because the charitable remainder trust is tax-exempt, it pays no capital gains tax on that sale.

3.      The trust pays you (and/or your designated beneficiary) a variable or fixed income in a percentage or amount that you select.

4.      You get an income tax deduction this year for a portion of the value of the property contributed to the trust.  The income tax deduction is equal to the value of the property contributed to the trust, minus the actuarial value of the income payments retained by you (and/or your beneficiary).  The amount of the income tax deduction in any one year is limited to 50%, 30% or 20% of AGI, depending on (1) whether the designated charity is publicly supported or a private foundation, and (2) whether cash or appreciated property is contributed to the trust.

5.      Upon the death of the last surviving individual beneficiary, the trust terminates and the balance is paid to the charity.

You may also reserve the power to change the identity of the charity(ies) to which the trust will ultimately pass.

Charitable Gift Annuity – A charitable gift annuity is similar in concept to a charitable remainder trust, except that you give cash or property to a charity, and the charity pays you (and/or your beneficiary) a fixed amount periodically for the balance of your life (lives).  Unlike the charitable remainder trust, however, the charity itself has contractually agreed to make the annuity payments to you out of its general assets, not necessarily from your funds only.  Because of this greater risk to the organization, charitable gift annuities are not usually offered by smaller organizations.

Pooled Income Funds – A pooled income fund is like a charitable gift annuity, except that the contributions of multiple donors are placed in a single fund (or pool), and each donor receives a periodic payment based upon the fund’s actual investment performance.  Thus, payments can increase during good times, and fall during bad times.

Charitable Lead Trusts – A charitable lead trust is the conceptual reverse of the charitable remainder trust.  The charity receives a periodic payment for someone’s lifetime or for a certain term, and at the end of the term the balance in the trust is paid over to one or more individual beneficiaries.  Special income tax rules apply to charitable remainder trusts that do not apply to charitable lead trusts.  Therefore, their usefulness for income tax purposes is much more limited.  Charitable lead trusts are very useful for estate tax purposes, however, and are often used by very wealthy individuals (e.g., Jacqueline Kennedy Onassis) to reduce or eliminate their estate taxes.

Life Insurance Payable to Charity – One way to make a significant bequest to charity is to designate the charity as the beneficiary of your life insurance.  If you make an irrevocable gift of an insurance policy to a charity during your lifetime, you may claim an income tax deduction for the current value of the policy.  If you continue to pay premiums on that policy, those premium payments are considered charitable contributions as well.

Qualified Retirement Plan Benefits Payable to Charity – A person who receives a payment that constitutes taxable income if it had been received by a decedent recognizes taxable income to the same extent and in the same manner as the decedent would have had the decedent actually received that payment.  The Internal Revenue Code refers to this as income in respect of a decedent (“IRD”).  Probably the most common items of IRD are individual retirement accounts (“IRAs”) and pension plan balances.  Items which constitute IRD do not get a “step up” in basis at the decedent’s death.

If you want to make a gift to charity upon your death, your family will keep more money if you have that gift paid by designating a charity as the beneficiary of (part or all of) your IRA rather than have that charitable gift paid by a gift from your general estate under your will.  Why?  If your family members are the designated beneficiaries of your IRA, they pay income tax on that money as it is distributed from the IRA.  But the charity is exempt from income tax, so it pays no income tax on that IRA gift anyway.  Satisfying your charitable gift from the IRA frees up more income tax free property to go to your family.

As you can see, there are number of techniques that you can use to incorporate your favorite charity(ies) in your estate plan.  As you have probably realized also, one or more of these techniques may (or may not) be the right approach for you.

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