“Philanthropy” is defined as the act of making gifts of personal resources to charities. These resources can include donations of one’s time, energy, money and property. Millions of Americans perform simple acts of philanthropy, such as donating clothing to homeless shelters. This article focuses on how individuals can plan philanthropic activities so that they can help their favorite charities, while maximizing the advantages of their philanthropy – from an estate- and tax-planning perspective – for themselves.
Tax Benefits of Charitable Giving
Some of the ways that donors receive tax benefits from charitable giving include:
- Estate Tax Reduction—A charitable gift made during the donor’s lifetime removes the gifted assets (and any future appreciation related to those assets) from the donor’s estate.
- Avoidance of Capital Gains—By donating appreciated assets, such as stocks, investors may be able to avoid capital gains taxes1 that might have been imposed if those assets had been sold.
- Current Income Tax Deduction—The fair market value of a charitable gift may qualify for a current income tax deduction.2 This can reduce the donor’s income taxes in the year the gift is made.
Tax Deductions for Charitable Work/Activities
While most charitable gifts of cash or property qualify for a federal income tax deduction, the value of time donated does not. Some personal expenses incurred while working as a charitable volunteer can be deducted by taxpayers who itemize. Here are the details, according to the IRS:
- Taxpayers may deduct the costs of traveling to locations where they work as an unpaid volunteer at a mileage rate approved by the IRS.
- The cost of uniforms, books, or tools used in volunteer activities may be deducted if they are required of the work and used solely for the work.
- Purchases at charity auctions are deductible to the extent that the price paid exceeds the fair market value of the purchased item.
- Taxpayers may deduct the fair market value of property contributed to charity, such as used clothing or furniture. If the amount claimed is more than $250 per contribution, a statement must be obtained from the charity documenting the value of the donated items.
Other Ways to Practice Philanthropy
There are numerous other ways individuals can practice philanthropy. A few charitable vehicles you may wish to consider include:
- Donor-advised funds;
- Charitable Remainder Trusts (CRTs); and
- Charitable Gift Annuities
This type of fund enables a donor to realize current tax benefits for charitable giving while potentially deferring the choice of which charity will be the recipient. Here’s how it works:
- The donor makes an outright gift of cash or appreciated securities to the fund and receives a charitable tax deduction for the year in which the gift is made, subject to limitations based on the donor’s adjusted gross income.
- If the gift is too large for the deduction to be used in one year, the balance may be carried forward for five years.
- After the gift is completed, the donor then can make grant recommendations to the fund – which are considered by the fund’s board of directors before the money is distributed to the designated charities.
One drawback to these funds is that the gifts are irrevocable: Once given, the gift cannot be rescinded.
Charitable Remainder Trusts (CRTs)
A CRT is an irrevocable trust that names one or more qualified charities as beneficiaries. Here’s how it works:
- The CRT is ordinarily drafted by an estate planning attorney.
- A CRT may be funded with appreciated securities, real estate or other appreciated property. By transferring such assets to the CRT, the donor avoids paying capital gains tax on any sale of these assets.
- Once the property is in the trust, it may be sold by the trustee and the proceeds repositioned to increase income and diversification. Since the trust is a tax-exempt entity, no capital gains tax is due on the sale of trust assets.
- Because the transfer is irrevocable and the grantor gives up control of the donated assets, they are removed from the grantor’s taxable estate.
- The trust generates an income tax deduction for the grantor/donor in the year the gift is made.3
- The trust can pay out lifetime income to one or more income beneficiaries. At the death of the last income beneficiary, the remainder (i.e., the remaining assets) passes to charity and the trust terminates. While the CRT does not pay income tax, the income beneficiary is generally required to pay tax on trust distributions as they are received.
Because a CRT is a relatively complex way to make gifts to charity, this solution works best for fairly large lifetime gifts.
Charitable Gift Annuities
Many leading charities offer an alternative to a CRT that is easier to set up and provides similar advantages – the charitable gift annuity. Here’s how it works:
- The donor makes a completed gift to the designated charity – which the charity immediately receives. The charity then pays a lifetime income back to the donor.
- The charitable donation that may be claimed is equal to the difference between the fair market value of the property donated and the present value of the lifetime income stream.
- Like a CRT, the income beneficiary may be required to pay taxes on the income stream received.
There are many ways that philanthropic individuals can support their favorite charities – while simultaneously achieving their estate- and tax-planning goals. Be sure to consult your own financial or tax professional for advice about which philanthropic approaches may work best for you.
1 If market quotations are readily available.
2 Charitable income tax deductions are subject to adjusted gross income (AGI) limitations and the taxpayer must itemize deductions to claim a charitable income tax deduction.
3 The income tax deduction would be equal to the present value of the remainder interest that goes to charity.
Prepared by The Guardian Life Insurance Company of America. The information contained in this article is for general, informational purposes only. Guardian, its subsidiaries, agents or employees do not give tax or legal advice. You should consult your tax or legal advisor regarding your individual situation.