Wealthy clients are likely feeling charitably inclined this time of year, but advisers take note: Not all
charitable giving vehicles are created equal.
This year's harsh tax environment is playing a role in donors' decisions to sell appreciated securities and cut down gross income. Thanks to the American Taxpayer Relief Act of 2012, the highest earners — those with taxable income over $400,000 if filing independently or $450,000 if married and filing jointly — will face a top marginal income tax rate of 39.6% and a top marginal tax rate on long-term capital gains of 20%, as well as the additional surtax of 3.8% on net investment income and a 0.9% additional Medicare tax on wages.
Individuals earning more than $200,000 (or married joint-filers who earn $250,000) will also face that additional 3.8% tax on net investment income and 0.9% on wages.
“The game has been to get the biggest charitable deduction possible,” said Christopher R. Hoyt, a law professor at the University of Missouri-Kansas City. He spoke at the National Association of Estate Planners & Councils annual conference in Las Vegas last week. “This year, we might look at ways to reduce gross income.”
One possible way for a client to reduce adjusted gross income, if he or she is over 70.5 years of age and has income that's flirting with that $200,000 threshold, is to make a qualified charitable distribution out of his or her IRA, Mr. Hoyt suggested. The distribution meets minimum distribution requirements, but keeps the money out of the client's adjusted gross income. That provision is supposed to sunset this year, so get on it.
“If you can save with the charitable IRA rollover, don't wait for the law to be extended,” said Mr. Hoyt.
Another way to save on taxes: Give appreciated stock in order to obtain a double tax advantage. “You avoid long-term
capital gains tax, and you get the charitable income tax deduction from donating appreciated property,” Mr. Hoyt said. “You are shifting your investment income to the charity.”
For the biggest donors, where and how to donate are essential parts of the planning process. Whether they utilize private foundations, a donor-advised fund or a supporting organization depends largely on the donor's objectives and the way he or she likes to give.
“Where we get involved as professional advisers is how we structure these vehicles,” said Mr. Hoyt, noting that there are tax and administrative situations to consider.
"With windfall income, you'll need a large deduction, so build your private foundation. If a donor has 270 shares of stock and wants to donate to 10 charities, it's easier to use a donor-advised fund.”
Private foundations are for donors who value having control over the board of directors, the grants that are made and the investments chosen, Mr. Hoyt explained. The downside? There's a smaller income tax deduction for real estate or closely held stock, as well as high administrative costs. Further, there's no anonymity when the foundation makes grants.
Donor-advised funds, meanwhile, feature low administrative costs and allow anonymous grants. The fund itself does the legwork to ensure the receiving charities still have their tax status granted to them by the IRS. But the cons of using a donor-advised fund is that the donor loses legal control over the investments. The fund itself also could be subject to excise taxes on excess business holdings.
There is a lengthy list of donor advised fund “don'ts,” according to Mr. Hoyt. For instance, don't donate to people outright. Don't use the money for a non-charitable purpose. Don't make grants to an organization other than a public charity. Individuals who benefit from a prohibited distribution are on the hook for a 125% penalty — say a situation in which a donor receives a benefit from an organization that received a grant from the donor-advised fund. For example, a sponsoring organization makes a grant to a school and the money pays the tuition of the donor's child.
Finally, supporting organizations, which are known as “friends of” groups, have pros and cons similar to those of donor-advised funds, but give the donor a greater sense of independence because they now have a connection to a separate corporation or a
trust rather than just an account, according to Mr. Hoyt.
