Increasing tax changes for the wealthy are coming, and motivation to find ways to protect the wealth is getting increased attention, according to a recent article from CNBC entitled “Here’s how to reduce exposure to tax increases with charitable contributions.” Beck & Lenox Estate Planning & Elder Law, LLC have advised clients who are already charitably inclined with a couple estate planning tools, Charitable remainder trusts (CRTs) and Donor Advised Funds (DAFs). Explaining how being charitable may reduce estate taxes is a goal of the law firm for particular clients. The decision as to what to do always lies with the client.
The CRT is complicated, requiring estate planning attorneys to create them and accountants to maintain them. The DAF is simpler, less expensive and is growing in popularity. Both enable income tax deductions, in the current year or carried forward for five years, on cash contributions of up to 60% of the donors’ AGI and up to 30% of AGI on contributed assets. These contributions also reduce the size of taxable estates.
CRTs funnel asset income into a tax-advantaged cash stream that goes to the donor or another designated non-charitable beneficiary. The income stream flows for a set term or, if desired, for the lifetime of the non-charitable beneficiary. The trusts must be designed, so that at the end of the term, at least 10% of the funds remain to be donated to a charity, which must be designated at the outset.
No tax is due on proceeds from the sale of trust assets, until the cash makes its way to the non-charitable beneficiary. When assets are held by individuals, their sale creates capital gains tax in the year they are sold.
CRT donors can fund the trusts with highly appreciated assets, then manage them for optimal returns while minimizing tax exposure by adjusting the income stream to spread the tax burden over an extended period of time. If capital gains tax rates are raised by Congress, this would be even better for high earners.
DAFs do not allow dispersals to non-charitable beneficiaries. All gains must ultimately be donated to charity. However, the DAF provides advantages. They are easy to create and can be set up with most large financial service companies. Their cost is lower than CRTs, which have recurring fees for handling required IRS filings and trust management. Charges from financial institutions typically range from 0.1% to 1% annually, depending upon the size, and a custodial fee for holding the account.
DAFs can be created and funded by individuals or a family and receive a deduction that very same year. There is no hurry to name the charitable beneficiaries or direct donations. With a CRT, donors must name a charitable beneficiary when the trust is created. These elections are difficult to change in the future, since the CRT is an irrevocable trust. The DAF allows ongoing review of giving goals.
Funding a DAF can be done with as little as $5,000. The DAF contribution can include shares of privately owned businesses, collectibles, even cryptocurrency, as long as the valuation methods used for the assets meet IRS rules. Donors can get tax deductions without having to use cash, since a wide range of assets may be used.
The DAF is a good way for less wealthy individuals and families to qualify for itemizing tax deductions, rather than taking the standard deduction. DAF donations are deductible the year they are made, so filers may consolidate what may be normally two years’ worth of donations into a single year for tax purposes. This is a way of meeting the IRS threshold to qualify for itemizing deductions.
As you can see, being charitable may reduce your estate taxes! Which of these two works best depends upon your individual situation. Whether with Beck & Lenox or your estate planning attorney, you’ll want to determine how much of your wealth would benefit from this type of protection and how it would work with your overall estate plan.
Reference: CNBC (April 20, 201) “Here’s how to reduce exposure to tax increases with charitable contributions.”