Estate planning often has multiple goals, especially in this era when most people don’t have to worry about federal estate taxes. Estate planning should be coordinated with your income tax planning and your income needs as well as your charitable gift giving plans. These needs and goals should be included in your estate planning along with how to leave your estate to your dependents and loved ones.
Many tools are available to accomplish these goals at the same time. You can reduce income taxes, generate income, provide for charity, reduce estate and gift taxes, and provide for loved ones.
You don’t have to wait to use these strategies in your will. In fact, it often is a good idea to implement some of the strategies now. First, you can see the benefits of your gifts and change your mind about future gifts if the money isn’t used as you intended.
Current giving also provides income tax benefits. With so many estates currently exempt from estate taxes, the income tax benefits today are more valuable to many people than the estate tax benefits later.
Most importantly, a properly-structured gift can provide you or loved ones with income or wealth while helping charity. The strategies we discuss in this visit are for those who already are charitably inclined. You can select the strategies that will maximize the wealth available to you, your family, and charity.
Of course, you always can make a simple cash gift to a charity. You’ll receive an income tax deduction, and the charity will benefit from the gift. But there are ways to give that deliver more benefits.
A more effective strategy might be to give appreciated investment property. You receive a charitable contribution deduction of the property’s current fair market value. The charity can sell the property and spend the proceeds. No one pays taxes on the appreciation that accrued while you owned the property. Giving appreciated property can put more after-tax cash in your hands than if you sold the property and used the after-tax proceeds or other after-tax cash for giving or spending. The gift of appreciated property can be especially useful with difficult-to-sell property.
Or consider a charitable gift annuity. It will fulfill multiple goals. You transfer cash or property to a charity. In return, the charity promises to pay you a fixed income for life or a period of years. The annuity payments will be less than you’d receive from a commercial annuity. The difference is a charitable gift to the non-profit organization, and you receive a tax deduction for it.
Most charities agree to pay the same amount on their annuities, so you aren’t likely to gain anything by shopping among charities for the best payout. But there are exceptions. Stanford University, for example, has a reputation for generally paying less than most, while Pomona College says its annuity pays more and can be more attractive than a commercial annuity.
IRS regulations are used to determine the amount of your tax deduction, and it’s based on your age and current interest rates. Your estate planner and tax specialists with the charity will be able to determine your deduction.
Most major charities offer gift annuities. Keep in mind that all you receive is a promise from the charity to pay you income for life. Ensure a charity is well-managed and financially strong before making a gift annuity transaction.
Many community foundations offer gift annuities and to some extent let you direct which orginizations benefit from your charitable gift.
The charitable gift annuity provides three benefits: guaranteed income for life, a current income tax deduction, and a gift to charity.
A Charitable Remainder Trust also provides multiple benefits. In a CRT, you give appreciated property to a trust you created. The trust sells the property and reinvests it. Since the trust is a charitable one, it isn’t taxed on the sale. All the sale proceeds can be reinvested. You also aren’t taxed on the appreciation that accrued while you owned the property, because you’re giving it to a charitable entity.
The CRT begins paying you, or a beneficiary you named, annual income. The income can be a fixed annual amount, known as a charitable remainder annuity trust (CRAT). Or it can be a percentage of the trust value, known as a charitable remainder unitrust (CRUT). The advantage of the CRUT is that the income can increase if the trust’s investments do well. Of course, payments can decrease if the investments do poorly.
You can add some variations to the distribution formula. You can say the trust makes distributions only to the extent it has income and realized capital gains, so it doesn’t have to sell property to make a distribution. You also can say that a missed distribution is made up in a later year when there is enough income.
The tax code puts some restrictions on CRTs. Among them are that the annual annuity must be least 5% of the trust assets but can’t be more than 50%. The term can’t be longer than 20 years, unless it is based on the life of one or more noncharitable beneficiaries.
Once the income term ends, the charity receives whatever property is remaining in the trust.
You receive an income tax deduction for transferring property to the CRT. IRS regulations are used to determine the amount of the deduction, which equals the present value of the amount the charity is expected to receive in the future. As with a gift annuity, the amount of the deduction varies with your age (or the age of whoever receives the income) and current interest rates.
The property you give to the CRT is out of your estate, so for people with taxable estates it reduces the tax while providing current income and income tax benefits.
The CRT is very handy when you own property that isn’t paying much income but is highly appreciated.
The charitable lead trust is considered the mirror image of the CRT, because the charity receives income first for a period of years under the CLT. Then, after the income term expires, the remaining trust property can revert to you or can be transferred to your loved ones, such as adult children. When the trust is created you take a charitable deduction for the present value of the charity’s stream of income payments, using the IRS regs that consider the years of payments and current interest rates. When your loved ones are the final beneficiaries, you’re making a charitable gift to them of the present value of that gift. The present value is computed using the same IRS regs, and it’s likely to be a discounted value from what they’ll actually receive.
One major difference is the CLT is not a tax-exempt trust. All of its income and gains are taxed to someone. You can set it up as a grantor trust. In that case, you pay all the taxes on the trust income and gains. You might want to do this because paying the taxes is a way of reducing your estate and giving maximum benefits to the charity and your loved ones. It is especially beneficial when the charitable gift deduction and other tax breaks you might have reduce your income taxes.
The CLT can reduce current taxes when set up as a grantor trust. It also is a good way to remove an asset and its future appreciation from your estate while retaining some control of it by acting as trustee. The CLT is especially good for an asset that has a low value today but you expect to appreciate.
Today’s low interest rates also make a CLT attractive to people with taxable estates if the assets in the trust will appreciate faster than the interest rate the IRS uses to compute the present value of the charitable gift to your loved ones. Because today’s interest rates will be used to compute the value of your charitable gift, your loved ones will receive far more in value than the amount on which you paid gift taxes.
Of course, if you’re wealthy enough you can create a private foundation to receive your contributions. You and your family can serve as the officers and board and decide over time which charities receive the money. Private foundations have a lot of rules and regulations. That’s why you need to be fairly wealthy for one to make sense. You’ll need experienced tax counsel guiding all your actions if you want to avoid problems with the IRS, which has been more aggressive in this area in recent years.
Always keep in mind that there are limits on charitable contribution deductions. In most cases, the annual limit is 50% of adjusted gross income. Contributions you can’t deduct can be carried forward to future years. But sometimes the limit is 30% or even 20% of adjusted gross income. There also are specific, detailed requirements for each of these strategies. Because of these two factors, you want to work with one or more experienced advisors when considering these strategies.
When giving to charity is part of your long-term plan, you might not want to wait to give through your estate. You, your family, and the charity all might benefit more if you give today, especially when you use one of these strategies. You could receive a tax deduction and income today while reducing your estate and benefiting the charity.
RW August 2015.