These days, many Americans are donating to their favorite charities or to their communities.
But let’s face it: unless you are Warren Buffett or Bill Gates, your charitable decisions need to take into account plans to leave a legacy for your children—while making sure you have enough money to help meet your own needs. Fortunately, there are ways you can do meaningful philanthropic work while simultaneously saving on taxes and transferring wealth to your heirs.
Tale of Two Taxes
Ordinary income is taxed on the federal level at rates as high as 39.6%. Estate-tax rates can go as high as 40% as well. This means that about one-third of what you earn while you are alive and nearly one-third of your net worth above the allowable exclusion amount could go to the government instead of to your heirs. No estate tax is due if your net worth at the time of your death in 2013 is $5.25 million or less.
Perhaps you share the view that a well-run charitable institution can do a better job of allocating your wealth to worthwhile causes than the government. If so, there are several ways to give, with varying degrees of sophistication that can help minimize your tax burden while maximizing your charitable impact.
Tax-Smart Giving
One of the most straightforward methods of giving that produces a positive tax result is to donate appreciated securities to a charity. You’re allowed an income-tax deduction for the market value of the public stocks or bonds you give away, and you also reduce your estate in the process. As with most types of charitable giving, just be sure that you’re giving to an IRS-approved 501(c)(3) public charity, as other private charities could yield a different result.
More sophisticated strategies involve creating trusts or foundations to hold assets and to direct the giving. One of the most popular vehicles is the charitable remainder trust (CRT), an irrevocable trust that pays the donor a lifetime stream of income now and then passes the remainder to charity later. You receive an income-tax deduction for the present value of the eventual charitable gift when you gift the assets to the CRT, and you reduce the value of your estate along with any future appreciation.
To leave a legacy for your family, you can use the tax savings and a portion of the income stream from the CRT to fund the purchase of life insurance, which is held in a separate trust and payable upon your death—free of estate taxes—to the beneficiaries.
This is a great way to liquidate a highly appreciated concentrated stock position and not pay taxes right away. You gift shares to the trust which then sells them at the market price and invests the proceeds in a diversified portfolio. You eliminate the risk of holding that concentration while locking in a stream of lifetime income.
Another charitable trust is the charitable lead trust (CLT), which essentially reverses the payments and original asset gift. Here, you gift the cash flow or income stream from the appreciated assets to the CLT so the charity receives the stream of income now, and the depreciated original asset goes to your heirs later. If structured properly, the remaining value of this original asset will be substantially reduced as would any estate taxes that would have been levied against it.
An even more sophisticated vehicle is a family foundation, which is a private charity set up by you that’s generally required to spend at least 5% of its endowment each year on giving to public charities. Gifting appreciated assets to a charity or family foundation results in the availability of an immediate income-tax deduction while reducing the value of your estate. Family foundations are a great way to perpetuate your values and to gain greater control over giving decisions—potentially for generations to come.
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