Engaging in philanthropy allows you to make a positive impact on your community, instill essential values in your children, and create a legacy for your family.
So, it’s no surprise that the popularity of charitable giving in the U.S. has surged, with 83% growth over the last twenty years when adjusted for inflation.1
However, it can be challenging to know where to begin. Let’s explore three potential tax-efficient charitable giving strategies to consider as part of your legacy planning.
Charitable Giving Strategies: What You Need to Know
In addition to strengthening family bonds and supporting important organizations and causes, charitable giving can also offer certain financial and estate planning advantages.
There are numerous ways to give, so it’s important to solidify your family’s philanthropic goals, consider the tax impacts of different options, and work with your financial advisor to choose the plan that makes the most sense for you and your loved ones.
To help you get started, here are three strategies to consider:
1. Invest in Donor Advised Funds (DAFs)
A donor advised fund is a flexible giving vehicle that allows you to make an irrevocable contribution of cash, stocks, or non-publicly traded assets to a charity—and become eligible for a tax deduction. Those funds can then be invested for tax-free growth, and you can recommend grants over time to other IRS-qualified 501(c)(3) public charities as you see fit.
If you and your loved ones are passionate about the same organization, you can set up a donor advised fund in the name of your entire family—or create separate DAFs for your children and grandchildren to support their unique philanthropic interests and goals.
A key advantage of this giving strategy is the tax benefits associated with donor-advised funds. For instance, you can claim an immediate tax deduction of up to 60% of your adjusted gross income (AGI) when you fund a DAF with cash.2 This can be particularly helpful in years where you experience higher earnings or receive a significant year-end bonus.
Additionally, if you donate long-term appreciated assets (such as securities) to your DAF, you can:
- Become eligible for an income tax deduction of the full fair-market value of the asset, up to 30% of your AGI
- Potentially reduce or eliminate capital gains
- Maximize the amount the charity receives2
2. Set up a Charitable Trust
Embracing charitable trusts can be a tax-advantageous way of meeting your estate planning and philanthropic goals. There are two primary types of charitable trusts: charitable remainder trusts (CRTs) and charitable lead trusts (CLTs). Both are irrevocable and distribute assets to your charitable or non-charitable beneficiaries at the end of the trust term or when you pass.
A charitable remainder trust may be a good fit if you want to take an immediate charitable deduction—or if you or a loved one would benefit from an income stream during the trust term. You can establish a CRT during your lifetime or at your death, which allows you to financially support your heirs, with the remainder going to your designated charities. Additional benefits may include:
- Claim a charitable deduction against the income or gift tax for the present value of trust assets that will be transferred to the qualified charity.
- Diversify your investments by transferring low-basis assets to the trust and eliminating income or capital gains tax when the assets are sold. However, your non-charitable beneficiary must pay tax on the income received.
- Preserve the full value of the highly appreciated property you contribute to the trust (because the trust will be exempt from tax when it sells them).1
A charitable lead trust generates a potential income stream for your charitable beneficiary during the trust’s lifetime. Then, the remaining assets are passed on to your loved ones when it terminates. Unlike CRTs, CLTs are not tax-exempt but may be ideal if you wish to transfer appreciated property to your heirs while mitigating the burden of gift and estate taxes. Other advantages may include:
- With a non-grantor lead trust, the trust pays tax on the income and claims a charitable deduction for the amount paid to your designated charity, which can help minimize transfer taxes.
- With a grantor lead trust, you may take an immediate charitable contribution deduction for the present value of the future income stream (subject to limitations), but the investment income is taxable to you during the lifetime of the trust.
- The assets used to fund a CLT are removed from your estate, which can mitigate estate taxes when you pass and preserve wealth for your heirs.1
If you’re looking for greater flexibility, you can name a public charity that sponsors a DAF as the beneficiary of your charitable trust. Because charitable trusts are irrevocable, making changes is difficult and costly. However, incorporating a DAF makes it easier to adjust how and when you give.
3. Start a Private Foundation
Establishing a private foundation may be a good strategy if you’re willing to invest your time—and a substantial initial gift—to create an enduring family legacy. Private foundations are typically overseen by boards of directors or trustees tasked with receiving donations, actively managing and investing charitable assets, sponsoring fundraising events, and making grants to other charitable organizations. This provides an opportunity for your loved ones to work for or serve as members of the governing body of your foundation.
Considerations unique to private foundations include:
- If you follow proper IRS procedures, you are not limited to supporting only 501(c)(3) charities, which means you can support philanthropic interests undertaken by individuals, scholarship programs, and other nonprofit organizations.
- Non-publicly traded contributions may only be deductible at fair market value (not fair market value).
- Charitable deductions are limited to 30% AGI for cash contributions and 20% AGI for long-term publicly traded appreciated securities.
- Unlike with donor advised funds where you can remain anonymous, donations to private foundations are public.
- Private foundations are exempt from federal income tax, but investment income is subject to a 1.39% excise tax.3
Setting up a private foundation involves ongoing and complex administrative, legal, and reporting responsibilities, so it’s critical to factor this into your decision-making. Additionally, the upfront costs and tax treatments associated with private foundations may be less advantageous than other giving strategies.
Start the New Year Off Right
Charitable giving enables you to make a difference in the lives of others, empower philanthropy in the next generation, and reinforce what matters most.
We can answer your questions, walk you through potential implications of different options, and help you choose a tax-efficient charitable giving strategy that aligns with your family’s goals.
Let’s discuss your vision for your legacy.
Sources
1 https://www.fidelitycharitable.org/content/dam/fc-public/docs/advisors/charitable-planning-guide.pdf
2 https://www.fidelitycharitable.org/guidance/philanthropy/what-is-a-donor-advised-fund
3 https://www.fidelitycharitable.org/guidance/philanthropy/private-foundations.html
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