Charitable giving, especially during the holidays, can be personally rewarding, but it can also fit well with your financial goals by providing valuable deductions from income, gift, or estate taxes. There are many available options when you choose to give, including making cash gifts to an existing charitable organization and creating a new entity designed to facilitate wealth transfer. It is up to you to choose the best strategy for your financial goals, including the type and value of assets you want to give, the expected time horizon for your gifts, and your appetite for complexity.
Gifts of Cash and Appreciated Property
Outright cash gifts to charities represent one of the simplest methods of giving and donations of appreciated property are only slightly more complex. Typically, cash gifts may provide you with an income tax deduction and remove assets from your estate. The deductibility of a cash gift is only limited by the classification of the charity (public or private) and your adjusted gross income. Donations of appreciated property are generally allowed at the time the gift is given, but the amount of the deduction may be subject to limits based on the type of property, its use before it is donated, and certain elections you make on your tax return. While donations of appreciated property may have a few more planning opportunities than donations of cash, due to the timing of the deductions, these gifts cannot offer as many tax planning opportunities as more complex giving strategies-such as charitable remainder trusts, donor advised funds, and private foundations. There are many other forms of charitable giving, but this newsletter will highlight these particular methods, with a focus on private foundations, which are a powerful tool at your disposal.
Charitable Remainder Trusts
Charitable remainder trusts (CRTs) are a popular choice for gifting highly-appreciated assets that are subject to federal estate tax. A CRT is an irrevocable trust that pays a stated amount or percentage of the value of the property each year to one or more individuals either for the life or lives of those individuals or for a specified term of years up to a maximum of 20 years. The CRT process involves the transfer of assets into the trust, sale of the asset by the trustee without capital gains taxation, and reinvestment of the sales proceeds into an income generating portfolio that grows income tax-deferred from within the trust. Charitable remainder trusts are popular because they allow you to receive an income stream, enjoy current income tax deductions, and ultimately leave a substantial financial legacy for your chosen charity.
A donor-advised fund (DAF) gives you control over the timing and recipients of your charitable giving, without the income stream that a CRT provides. A DAF is a philanthropic vehicle established at a public charity. Under this arrangement, the donor transfers assets to a 501(c)(3) charitable organization that sponsors DAFs. The charity holds and manages the assets in a separate account that is governed by a fund agreement that names individuals who may suggest the amounts that should be distributed to which charities and for what purpose. Contributions to a DAF are irrevocable, but allow for an immediate tax deduction, along with tax-free growth of assets inside the DAF. No federal laws or regulations require the donor to grant any minimum sum from the fund at any time, allowing the donor complete freedom to decide when to recommend grants to a favorite charity.
Another type of charitable giving tool is the private foundation, which offers a cornucopia of benefits. Private foundations are created when a person or family funds a new non-profit organization; such organizations are exempt from regular income tax, capital gains tax, estate tax, and gift tax. Upon making a donation to a private foundation, a person or entity becomes eligible for an income tax deduction. Additionally, private foundations may receive allocations of an estate without incurring estate tax.
Private foundations provide a useful, long-term vehicle for families to closely manage their charitable activities, and they offer the founding person or family more control than any other means of charitable giving. Private foundations can help donors achieve several goals, including transferring important philanthropic values to the next generation, fostering stewardship of the family's giving, and setting a path for future giving. As opposed to a direct charitable gift, a gift to a private foundation allows the donor family to maintain control over how the funds are spent throughout the life of the foundation. The private foundation invests donated funds and makes direct charitable distributions under the direction of the donor or the donor's family; the foundation can be structured for a near-term focus, to accomplish a broader goal in perpetuity, or anywhere in between.
When you decide to establish a private foundation, you may choose to structure it as a trust or as a non-profit corporation. Although both structures will allow you to closely manage the activities of the foundation, each structure brings potential benefits and drawbacks. Your specific circumstances will affect which option is best suited to achieve your philanthropic goals.
Private foundations formed using a trust require that the trust be irrevocable. Consequently, you or your family will surrender certain rights relating to the charitable donation. However, this structure offers the founding donors relative flexibility and certainty because the initial trust agreement can be designed to fit your particular expectations. A trust will have one or more trustees responsible for administering the assets in the trust solely for the purpose specified. The trustees have a fiduciary duty to the beneficiaries of the trust, which is a higher standard than the business judgment rule that applies to corporate directors in the case of a private foundation in corporate form; this could make it more difficult to attract outside directors, but otherwise is usually not a drawback.
Alternatively, private foundations structured in corporate form require the usual corporate filings to the state of incorporation, along with annual meetings, minutes, and financial reports to the Board of Directors. Instead of shareholders, a non-profit corporations may have members that elect the Board of Directors, which appoints the officers. The advantages of corporate form include limited liability for officers and directors and a greater ability to subsequently modify the organizational structure compared to a trust. In any case, either a trust or a non-profit corporation can be a perfectly adequate structure for a private foundation.
Finally, a private foundation may be classified as operating or non-operating, which simply refers to whether the foundation is actively conducting its own charitable activities. Each classification results in its own set of conditions and obligations. The majority of private foundations are non-operating. Non-operating private foundations are those that distribute money to other charities. Because non-operating foundations are designed to support other charities, they are required to make minimum distributions of at least five percent of the value of their assets each year. The charitable contribution deduction from an individual to a non-operating foundation is generally limited to a lower percentage of the individual's adjusted gross income than other charities. Individual contribution deductions are higher for contributions to operating foundations, although operating foundations include the fiduciary duty to oversee the operations of an active charity.
Although every charitable gift mentioned above is potentially deductible, the precise amount of the contribution that is deductible for federal income tax purposes depends on a variety of factors, including the type of gift, the classification of the charitable recipient, and the donor's adjusted gross income. The attorneys at HMS Law Group LLP are happy to assist you in finding a type of charitable giving that best meets your goals.