Contributions to charitable organizations are often an important part of many people's personal, financial and estate planning. Charitable gifts can be as simple as an annual contribution to the charities or charities of your choosing. These are often referred to as "current" or "present" gifts. "Deferred" gifts, on the other hand, involve the contribution of an asset to a charity but the donor (or another person) retains the right to receive some benefit from the asset for a period of time or during his or her lifetime.

The primary objective of most charitable gifts is to benefit the donor's favored charities. Certain income, estate, and gift tax advantages can also be achieved through proper planning. The choice of asset to be contributed to the charitable organization, and the manner and timing of the contribution, will affect the tax consequences.

Charitable gifts may be made during the donor's lifetime, at the time of death, or in combination. As with lifetime gifts, charitable gifts at death may be either outright for the immediate use of the charitable organization or deferred for use at a later date.

Donors who desire to achieve tax advantages from their charitable giving should ask three questions. First, what organizations should be the recipients of my charitable gifting? Second, what assets may I give to these organizations? Third, what are the tax benefits that can I derive?

Qualified Charitable Organizations

Individuals may make tax-advantaged gifts to certain charitable organizations. These organizations encompass a broad spectrum of entities, including public charities, educational institutions, hospitals, and religious organizations. In addition, contributions may be made to other non-profit organizations, such as community foundations and private foundations. Gifts to governmental bodies also qualify for the charitable deduction.

However, not all non-profit organizations qualify the donor for a charitable deduction. For example, donations to lobbying groups, political parties and candidates, and most gifts to service and fraternal organizations (such as a Rotary or Elks Club) do not qualify for a deduction. If you have any question as to whether your donation qualifies for a deduction, contact your tax professional or the IRS.

Assets that May be Donated

Virtually any asset owned by the donor may be contributed to a charitable organization. Intangible assets such as cash, stock, bonds and life insurance policies are frequently donated; however, tangible assets, including real estate, artwork, and other collectibles may also be contributed.

Intangible assets are generally preferred for donation to charity because such assets are relatively easy to transfer and can be put to immediate use for charitable purposes. The value of such assets may be determined from stock market quotations, insurance company records or other published sources. Tangible assets, though also frequently donated, may be more difficult to value and transfer. For particularly large gifts in which the value cannot be easily determined (such as real estate), additional documentation (such as an appraisal) will be necessary in order to substantiate the value of the gift and the tax deduction available to the donor.

Income Tax Charitable Deduction

The income tax deduction that is available for gifts to a charity depends on the type of asset donated, the organization to which it is given, and the donor's income in the year of the contribution. These rules are complicated but some general guidelines follow.

The starting point is to determine the donor's "contribution base" which, in most situations, is the donor's adjusted gross income, with certain adjustments. The maximum amount that a donor may deduct for income tax purposes as a charitable deduction in any year is 50% of his or her contribution base. However, this amount may be further limited as described below. If the value of the donor's charitable contributions exceeds the maximum amount he or she can deduct for the year, excess contributions may be carried forward for up to five subsequent tax years.

Donations of cash and income-producing assets may be deducted up to 50% of the donor's contribution base. However, donations of appreciated property such as stock or real estate, may only be deducted up to 30% of the donor's contribution base. Thus, the type of asset contributed to the charity may affect the amount of the deduction that can be taken in any year. A donor can make contributions of both "50% property" and "30% property" in the same year.

The percentage limitations described above may be further limited based on the type of organization receiving the donation. Gifts to public charities, including community foundations, qualify for the 50% limit (unless the gift is of 30% property). These organizations are of the kind that qualify under Section 501(c)(3) of the Internal Revenue Code and, thus, are often referred to as "501(c)(3) organizations".

For example, a $5,000 gift of cash to your favorite charity will qualify for the maximum income tax deduction since the asset gifted in of the "50% property" type and the Foundation is a Section 501(c)(3) organization.

Estate Taxes and the Estate Tax Charitable Deduction

The Internal Revenue Code imposes a tax on the assets of a decedent owned at the time of death. The estate tax may also apply to assets not owned by the decedent but over which he or she had some form of legal control at death. Most states have corresponding provisions in state law for imposing an estate tax as well.

The estate tax is a "transfer tax"; that is, the estate tax is imposed on all assets owned by the decedent that he or she has the power to transfer at death, regardless of the manner of in which the transfer occurs. Thus, assets passing under the terms of the decedent's will, a living trust, joint ownership with another person or by beneficiary designation (such as life insurance or a retirement account) are subject to estate tax.

In determining the amount of tax payable, certain debts of the decedent (such as a mortgage), funeral expenses and expenses in administering the decedent's estate are deductible. In addition, in most cases any assets distributed to the decedent's spouse are deductible as well, though qualifying for this deduction can be difficult in some circumstances.

In addition, a credit (referred to as the "applicable credit") is also available to offset the estate tax payable. The applicable credit is currently equal to $1 million. The applicable credit is reduced by any lifetime gifts made (with certain exceptions) known as "taxable gifts". Thus, a person who makes no makes no taxable gifts during lifetime can effectively "exempt" $1 million from estate tax at death.

Another important deduction is the estate tax charitable deduction. Like the income tax charitable deduction, an estate is allowed to deduct from the assets of estate subject to taxation any amount that is distributed to a qualified charity. The types of organizations that qualify for the estate tax charitable deduction are substantially the same as those that qualify for the income tax charitable deduction.

However, unlike that income tax charitable deduction, the estate tax deduction allows the decedent's estate to reduce the assets subject to estate tax on a dollar-for-dollar basis, without limitation. Thus, if the decedent leaves the amount of his remaining applicable credit (currently, $1 million) to his family and the remainder to charity, no estate tax will be payable.

Gift Taxes and the Gift Tax Charitable Deduction

The Internal Revenue Code taxes transfers during lifetime in much the same manner as transfers at death. As with the estate tax, the donor can offset any gift tax by applying his or her applicable credit (currently equivalent to $1 million) to the transfer. Note that, unlike the estate tax credit equivalent amount, the gift tax credit equivalent amount ($1 million) does not increase over the remainder of the decade under the 2001 Tax Act.

Consistent with the estate tax rules, a donor to a charity will be able to take a deduction for any gift tax on the transfer making gifts to qualified charities essentially making the gift to the charity tax free. However, depending on the form of transfer, a Gift Tax Return (IRS Form 709) may nonetheless be required. In addition, certain "split interest" transfers, such as charitable remainder trusts and charitable lead trusts, will result in a gift tax where someone other than the donor and the charity receive some benefit from the trust.

Deferred charitable gifts

Many people desire to make significant contributions to favored charities but wish to retain the right to use or receive income from the property donated. This can be accomplished through a variety of structures. For example, a person may give their home or farm to a charity but retain the right to reside in the residence and continue to use the farm for his or her lifetime (referred to as a "life estate"). Assets may also be contributed to a charitable trust (known as a "charitable remainder trust") allowing the donor to retain a stream of income from the trust for a term of years or life. A current income tax charitable deduction is allowed for such gifts, and the assets will not be included in the donor's estate for purposes of calculating the estate tax due on a donor's death.

Charitable Remainder Trust

A charitable remainder trust (CRT) is a form of deferred giving strategy that allows the donor to make a charitable contribution but retain the right to use the donated property (within certain limitations) for a term of years or for life. The CRT is divided between an "income interest", usually for the benefit of the donor, and the "remainder interest" for the benefit of one or more charitable organizations. A CRT is often referred to as a "split-interest trust" for this reason.

A CRT may be in one of two forms: a charitable remainder unitrust (CRUT) or a charitable remainder annuity trust (CRAT). The choice of CRT to be used will depend on a variety of factors including the benefits to be received by the donor during the term of the CRT and the type of asset contributed to the CRT.

The CRT may be established to pay to the donor an income for a term not to exceed twenty years or for the donor's life (which may exceed twenty years). In addition, the CRT may be established to benefit successive lives (for example, for the lifetime of the donor and then for the lifetime of the donor's spouse) or may benefit someone other than the donor altogether (although the income interest for someone other than the donor will be subject to gift tax).

The income interest reserved by the donor is generally fixed under the terms of the CRT as a percentage of the trust assets. Once fixed, the percentage may not be changed. The minimum percentage payout is five percent of the value of the trust assets. The maximum payout is also fixed based on several factors including the age of the donor, term of the CRT and prevailing interest rates.

The primary distinction between the CRAT and the CRUT is the determination of income interest paid to the donor. If the donor selects a CRAT, the trust will pay an "annuity" to the donor, based on the value of the assets contributed to the CRT at the time it is created. For example, if $100,000 is contributed to a CRAT with a five percent income interest, the donor will receive an annual payout of $5000. This amount will not change regardless of any change in the value of the trust assets over time. This approach may be preferred when the donor wishes to have an income stream that he or she can rely on for the trust term.

Alternatively, if the donor selects a CRUT, the income interest will be determined each year based on the value of the trust assets. If the CRUT increases in value, the income interest will also increase. In the above example, if the trust assets increased from $100,000 in the first year to $120,000 in the second year, the payout in the second year would be $6000 (five percent of $120,000). The CRAT, on the other hand, will continue to pay $5000 regardless of any change in value.

When the CRT income interest ends (either at the end of the set number of years or the death of the donor or other designated non-charitable beneficiary) the remaining assets pass to the designated charitable organization(s). Even though the CRT is an irrevocable trust, the donor may retain the right to change the charitable beneficiaries. The donor may also serve as his or her own trustee during the trust term (with certain limitations) or may select someone else to be the trustee.

One of the most significant benefits of the CRT is that the donor receives an immediate income tax charitable deduction for the present value of the remainder interest gift that will pass to the charity when the income interest ends. This deduction is limited under the same rules set out in the above discussion. In essence, the income tax charitable deduction is equal to the value of the assets contributed to the CRT, reduced by the value of the income interest. This value is determined under certain provisions of the Internal Revenue Code. Thus, the longer the payout to the donor or the higher the payout percentage, the smaller the charitable deduction.

Another important benefit of a CRT is that the sale of appreciated assets contributed to the trust or purchased by the trustee will not result in taxation of the capital gain. A CRT is a tax exempt entity. For example, if the donor contributes a highly appreciated asset (such as stock or real estate) to the CRT, the asset may be sold and the donor will not have to pay the capital gains tax on the sale. Thus, the trustee may reinvest the full amount of the sale proceeds from the sale of the appreciated asset. This will likely increase the income interest compared with selling the same asset and reinvesting the proceeds from the sale after paying capital gains taxes.

The payout of the income interest is taxable income to the recipient (either as ordinary income or capital gain) unless the distribution is from the donor's basis in the property contributed to the CRT. Specific rules apply to the order of priority that apply to the tax characteristics of the payout.

Finally, the CRT assets will not be included in the donor's estate for purposes of determining the estate tax due. Thus, the donor's estate tax liability is reduced. However, as indicated above, if the CRT is designed to benefit a person other than the donor (either during the donor's lifetime are at death) the value of the income interest that benefits someone other than the donor will be considered a taxable gift and may affect the available "applicable credit amount" to offset estate taxes in the donor's estate.

Charitable Gift Annuity

Similar to a CRAT, a donor may establish a charitable gift annuity with a charitable organization that is authorized to issue annuities. The donor receives substantially the same income and tax benefits as a CRAT. However, the donor may not manage the assets contributed to the charity in the form of a charitable gift annuity. It is nonetheless a valuable alternative to the complexities associated with a CRT, especially for smaller deferred charitable gifts.

Charitable Lead Trust

Another form of split-interest trust is a charitable lead trust (CLT). As with a CRT, a CLT may be either in the form of an annuity or unitrust. However, unlike a CRT, the CLT is not a tax-exempt entity and there is no minimum or maximum payout requirement.

A CLT is the reverse of a CRT. The income interest is paid to a charitable organization for a term of years and the remainder interest is paid to non-charitable beneficiaries (such as the donor's children). The value of the remainder interest payable to the non-charitable beneficiaries is a taxable gift of a "future interest".

The determination of the charitable deduction will depend on the type of CLT selected by the donor. If the CLT is designed to be a "grantor trust" for income tax purposes, the donor receives an income tax charitable deduction for the present value of income interest payable to the charity over the term of the trust. This deduction may be used in the year in which the CLT is established and funded, and is subject to the five year carry forward rules discussed above. However, as a grantor trust, the income of the CLT will be taxed to the donor as well. If, on the other hand, the CLT is designed to be a "complex trust" for income tax purposes, the income of the CLT will be taxed to the trust (not the donor) and the income tax payable can be offset by each year's distribution to the charity as a charitable contribution.

The primary advantage of the CLT is that the value of the transfer to the non-charitable beneficiary is reduced by the value of the income interest paid to the charitable organization. A CLT is beneficial to donors who wish to make a commitment to a charitable organization for a period of years but have non-charitable beneficiaries (such as children) be the ultimate recipient of their estate. An added advantage of the CLT is that the appreciation of the assets in the CLT will pass to the non-charitable beneficiaries without any additional gift or estate tax.

Community Foundation

In general, a community foundation is an grant making organization that receives donations from donors living or otherwise having some connection with the community in which the foundation is located, and makes distributions to charities on a periodic basis. A community foundation may hold and invest the contributions in either common or separate accounts, and may serve as the trustee of trusts (such as a charitable remainder trust) established by donors. A community foundation is a Section 501(c)(3) Organization such that donors to the foundation receive the most favorable tax benefits. Generally, though not exclusively, a community foundation makes grants to charities in the community in which the foundation is located. For example, the donor may direct that the income from his or her contribution be used to fund a scholarship or program on an annual basis.

One of the principle advantages of making contributions to a community foundation is that the donor receives the most favorable income tax deduction for his or her contribution. Contributions of cash or income producing property are subject to the 50% limitation and contributions of appreciated property are subject to the 30% limitation.

Another advantage of contributions to a community foundation is that the donor or the donor's family may have a significant level of involvement in the process of selecting the charitable recipients of the distributions from the community foundation. For example, the donor may make recommendations each year regarding how the income from the donor's fund will be used in achieving the donor's charitable objectives in the community. However, the donor's input is in the form of advice only; the final decisions rest with the community foundation's board of directors.

Private Foundations

Donor's wishing to be able to exercise substantial control over the use of the donor's charitable contributions will often select a private foundation for this reason. Unlike a community foundation, a private foundation is not publicly supported. Generally, a single donor (or a small number of individuals close to the donor) will be the sole source of support for the private foundation. Donor's will often establish a private foundation in a year in which the donor wishes to "pre-fund" his or her charitable giving for a several years in advance in order to achieve the most economic income tax result.

The primary advantage of the private foundation is that it will allow the donor almost complete control over the use of the donated funds. The process of selection the charitable organizations and uses of the funds distributed from the private foundation is completely within the control of the board of directors of the foundation. The donor, his or her family members and other close family and friends will often comprise the board of directors of the foundation. For this reason private foundations are often used by parents to instill the sense of charitable giving and commitment to the community within their children.

However, this level of control and flexibility comes with a cost. Private foundations are subject to a myriad of rules regarding the operation of the foundation including prohibitions against using the foundation to achieve non-charitable purposes (so called "self dealing") as well as the imposition of certain taxes that public charities are not subject. In addition, the private foundation must qualify as such by filing with, and approval by, the Internal Revenue Service. Annual reports to the Internal Revenue Service and the state in which the corporation or trust is established are required as well.

Private foundations are also subject to special limitations with regard to the income tax deduction available to the donor. Cash and income producing assets are limited to 30% of the donor's contribution base and gifts of appreciated assets are further limited to 20% of the donor's contribution base. However, certain contributions (such as stock in a closely held business) are subject to additional limitations.

Finally, if the donor is allowed to participate in the decisions of the board of directors regarding the recipients of the distributions form the foundation, the contributions to the private foundation may be includable in the donor's estate for estate tax purposes. The Internal Revenue Code provides that assets that are gifted but subject to the donor's control will be included in the donor's estate at death. Thus, certain additional steps must be taken to shield the donor's estate from this result if the purpose of the gift to the foundation is to achieve both income and estate tax savings.

Charitable Gifts at Death

Making charitable gifts at the time of death is a preferred approach for many individuals. During lifetime the donor may have the full use and enjoyment of the property. At death, the donor's will or living trust must describe the terms of distribution to the charitable organization. For example a donor's will may set out a specific amount or asset to be distributed to the charitable organization. Alternatively, the donor might state that a percentage of his or her estate will be set aside for charitable purposes. Donors should discuss these options with their advisors.

In addition, the split-interest trust options (charitable remainder trust or charitable lead trust) outlined above may be utilized at death, but with somewhat different tax consequences than as previously discussed. For example, a donor may include provisions in her will to establish a CLT at the time of her death. The CLT will benefit the designated charity for a term of years. At the end of the term, the CLT terminates in favor of the donor's children (or other non-charitable beneficiaries).

If the contribution meets certain qualifications, the donor's estate is entitled to a deduction for the full fair market value of the assets passing to the charitable organization and is not limited in the same way as the income tax charitable deduction. Thus, the estate tax can be substantially reduced or eliminated by making a contribution to a charitable organization.

Certain assets such as retirement plan benefits, individual retirement accounts, tax deferred annuities, contracts for the sale of appreciated assets and deferred compensation agreements have income tax consequences that survive the decedent. These assets are known as "income in respect of a decedent" or "IRD". The heirs of the decedent (or, worse, the decedent's estate) must pay the income tax. Often the income tax consequences to the heirs of the decedent will be far greater than if the decedent had paid the tax during his or her lifetime. The income tax on such assets, when combined with the estate tax, can exceed eighty percent of the value of the asset.

One estate planning opportunity for donors with assets that constitute IRD is to designate such assets for charitable purposes. For example, donor may name a charity as the beneficiary of his or her the retirement plan, individual retirement account or tax deferred annuity. Since the charity is a tax exempt organization, it will not have to pay the income tax that a non-charitable beneficiary (such as the donor's heirs) would have to pay.

Coordinating the estate plan to take into consideration assets that constitute IRD is highly complicated, particularly where the donor has both charitable and non-charitable beneficiaries. The donor should seek the advice of a qualified tax advisor before implementing a estate plan under such circumstances.

Conclusion

There are may strategies available to achieve a donor's charitable giving objectives. The tax rules regarding charitable giving are complicated. However, with proper planning, you can promote the mission of your preferred charities and achieve tax benefits as well.

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©Copyright 2003, Landerholm, Memovich, Lansverk & Whitesides, P.S.