Formulating a Charitable Giving Strategy with Tax Efficiency in Mind (Part 2)

by Stephanie Anderson, Manager, Financial Planning and Wealth Management

This is Part 2 of a two-part series. Click here to read Part 1. 

The most effective charitable giving strategies have a clear set of goals and objectives and follow a framework that seeks to maximize the impact of designated gifts. In Part 1 of this 2-part series, we focused on the goals for giving and several of the key elements of a charitable giving plan (namely, designating specific organizations for support and setting a budget for charitable donations). In this second part of the series, we explore the other key elements of a charitable giving plan—the optimal vehicle/structure for donations and determining which assets to give to charity (with a focus on timing and tax efficiency). Finally, we look at key metrics to evaluate the impact of charitable donations.

Determining the Optimal Structure for Donations

Once you have determined the purpose for your charitable gifts and the amount, it is important to determine the most efficient way to give. The vehicle you choose for giving should be aligned with your reasons for giving, your budget, and the planned timeline for giving. It is important to keep in mind that multiple vehicles may be employed simultaneously and your preferred vehicle(s) may change over time.

Let’s consider five different ways to give—direct gifts, donor advised funds, charitable gift annuities, charitable trusts and private foundations. The tax deductions associated with these strategies assume that donors itemize deductions instead of claiming the standard deduction.

Direct Gifts

If you know which charities you want to support, you can make direct donations to each organization during your life or through bequests via your will/trust at your death. This simple, direct approach allows you to take a tax deduction in the year of the gift at the fair market value of the cash or assets donated (subject to AGI limits as discussed in part 1 of this series).   

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Donor Advised Funds

When you have decided on the amount to contribute but have not yet finalized the list of charities to make distributions to, you may want to consider a donor advised fund (DAF). DAFs are charitable giving accounts (sponsored by major investment firms as well as community foundations) that allow you to make a donation to the DAF, take a tax deduction in the year the contribution is made to the DAF, and make distributions to a variety of charities over time. Any growth in the value of the DAF will generally be tax-free, thereby increasing the amount available for distribution to charities.  A DAF is appropriate for small and large gifts. DAF accounts are a great way to involve other family members (e.g., children and grandchildren) in the process and establish a family legacy of giving.  

Charitable Gift Annuities

If you want to make a charitable gift and receive an annual income stream, you may want to consider a charitable gift annuity (CGA). A charitable gift annuity is a contract between the donor and a registered 501(c)(3) organization in which the charity agrees to pay the donor an annual sum of money (for life or a period of years) in exchange for a donation of cash or other assets. Importantly, each charitable gift annuity can only benefit one charity at a time, namely the organization specified in the contract. Many not-for-profits such as universities, hospitals, religious groups, community foundations and cultural/arts groups offer charitable gift annuities. The amount of the annuity will depend on the gift annuity rate being used by the charity, the age of the person receiving the annuity, and the size of the gift. Since the annuity payment becomes a fixed obligation of the charity, the donor will want to complete a financial assessment of the charity before entering into the gift annuity contract. Generally, the amount of the payments is based on a 50/50 anticipated split of funds between the donor and the charity.  

The amount of the tax deduction is generally the difference between the fair market value of the gift and the value of the annuity contract. A portion of the income received from the CGA will be treated as a tax-fee return of principal until the cost of the annuity is fully recovered upon reaching the life expectancy (or life expectancies for a married couple) indicated in the contract. The remaining portion of the payments will be treated as ordinary income subject to federal and state taxes. Different tax considerations apply for CGAs funded from appreciated securities held for longer than one year.  

Charitable gift annuities are in the spotlight at present due to a provision in SECURE Act 2.0 that allows individuals aged 70-1/2 and older to make a once-in-a-lifetime distribution directly from their IRA account to one or more CGAs.  For 2024, a max of $53,000 may be transferred from an IRA account to a CGA. These distributions to the CGA will be treated as a qualified charitable distribution (QCD) which will be excluded from taxable income and may be used to satisfy all or part of your required minimum distributions (RMDs) for the year. All income payments from CGAs funded by contributions from an IRA are taxed at ordinary income tax rates. Please consult a tax professional to analyze your particular situation prior to implementing a CGA strategy.

Charitable Remainder Trusts and Charitable Lead Trusts

Donors who wish to make a gift and receive an income stream may also want to consider charitable remainder trusts (CRT). A CRT is an irrevocable, tax-exempt trust established by the donor. (In contrast, a CGA is a contract between the donor and the charity.)  With a CRT, donors contribute assets to the trust, receive an income stream for life (or specified term), and then any remaining assets pass to the charity. CRTs provide donors with more flexibility than a CGA.  For example, the donor can establish a trust that distributes either a fixed dollar amount or a fixed percentage of the trust’s assets.  The donor can specify one or more charities to receive the remainder assets, including public charities and private foundations. The donor can also serve as a trustee (subject to the terms of the trust) thereby allowing some influence over the way in which trust assets are invested, as well as the timing of the sale of any assets contributed to the trust. Assets sold by the trust are exempt from taxation. (With a CGA, in contrast, the charity controls the investment of assets and the timing of asset sales.)  

The donor is eligible for an income tax deduction in the year of the gift, even though no assets will be going to the charity at that time. The deduction is based on the term of the trust, the projected income payments and IRS interest rates related to the assumed growth rate of trust assets. Please consult your tax professional for further details pertaining to your tax situation.

The same provisions of SECURE Act 2.0 that allow for a one-time distribution from an IRA to a charitable gift annuity also allow a one-time distribution to a CRT.  From a practical standpoint, most charitable remainder trusts are typically funded with at least $100,000. So, using a distribution from an IRA to fund a CRT may only be viable in the case of a married couple if each party were to contribute the $53,000 lifetime maximum to a CRT in 2024.

Charitable Lead Trusts (CLT) are the reverse of a CRT—the charity receives an income stream for a period of time (e.g., donor’s lifetime) and then the remaining assets in the trust pass to the non-charitable beneficiaries (often family members) designated by the donor. The donor does not receive a tax deduction in the year that assets are transferred to the CLT.  Instead, the donor is entitled to an estate or gift tax deduction for the value of the charitable income stream.  It is important to note that a CLT is not tax-exempt.  A CLT may be a desirable structure for donors who want to pass property to heirs while also reducing estate and gift taxes.  

Private Foundations

High-net-worth donors who wish to make an impact on particular charitable causes may want to consider setting up a private foundation. The foundation structure gives the donor full control over mission, distribution decisions, investment choices and board structure.  Given the expenses associated with setup and ongoing administration, recommended initial funding amounts are typically well north of $1 million. (A donor advised fund may be an appropriate alternative for smaller contributions.)  A significant liquidity event, such as the sale of a business or receipt of an inheritance, would be an ideal opportunity to establish a private foundation. While private foundations are tax-exempt organizations, they must pay a nominal excise tax of 1.39% on their net investment income.  Additionally, foundations are required to make minimum distributions during their taxable year with minimums depending on whether they are operating or non-operating foundations.  

Donors are able to take a tax deduction in the year in which a contribution is made (up to 30% of the donor's AGI for cash and 20% of AGI for long-term appreciated publicly-traded securities). Additionally, the donor can avoid paying capital gains taxes on securities or property donated to fund the foundation, although the foundation will pay an excise tax on the net capital gains when the assets are sold. Lastly, assets donated to the foundation are excluded from the donor’s estate and will not be subject to federal or state estate taxes. With a majority of foundations set up to exist in perpetuity, and a structure that allows family members to serve on the board or be employed by the foundation, a private foundation is a great way to establish a charitable family legacy for generations to come.  

Deciding What Assets Will Be Donated

While writing checks to charity is one way to accomplish charitable goals, sophisticated donors may want to consider giving other assets to maximize the net impact of their gifts.   

Cash

Cash is certainly a convenient way to complete charitable gifts, allowing donations of up to 60% of the donor’s AGI for contributions to public charities and donor advised funds. From a timing perspective, donors may also want to be strategic in making cash contributions to increase itemized deductions in years in which AGI is higher due to bonuses or Roth conversions, for example. Additionally, donors may decide to “bunch” contributions by giving two year’s worth of contributions in a given year in order to exceed the standard deduction and thus itemize deductions. In years in which a bunching strategy is not utilized, the standard deduction would be claimed.  

Appreciated Securities in a Taxable Account

Donors may find it advantageous to fund their donation with publicly-traded securities (e.g., stocks, exchange-traded funds, and mutual funds) that have been held in a taxable account for more than one year. By transferring the securities directly to the charity and having the tax-exempt entity sell the securities, the donor can generate a greater net benefit to the charity than if the donor sold the stock themselves, paid the capital gains tax, and then transferred the after-tax proceeds to the charity.  

Retirement Assets

For donor’s aged 70-1/2 or older, it is possible to make charitable donations using IRA assets in a qualified charitable distribution (QCD). For 2024, the maximum amount that may be transferred to a charity as a QCD is $105,000 (inflation adjusted). The QCD can also be used to satisfy the donor’s required minimum distribution for the year.  With a QCD, assets are transferred from the donor’s IRA account directly to the charity. Because the QCD is a direct transfer, the amount is not recognized as taxable income for the year and no itemized deduction is taken.

As discussed above, a provision in SECURE Act 2.0 allows for a once-in-a-lifetime contribution (a max of $53,000 in 2024) of a QCD to a charitable gift annuity or a charitable remainder trust.  

Other Assets

Other types of assets that may be donated to a charity include real estate, privately-held business interests, private equity and hedge fund investments, art and collectibles and cryptocurrency. Donors will need to consult with their chosen charitable organization or donor advised fund to determine if these types of donations make sense as a charitable donation.    

Tracking the Impact of Charitable Gifts

After you have defined your purpose for giving, your budget, your ideal vehicle(s) and selected assets to donate, it is important to have a framework in place to evaluate the impact of your charitable gifts. There are many ways to track impact. A series of simple questions can serve as an effective outline to guide your evaluation.    

• What problem(s) are you trying to solve with your donations?
• What organizations are working to address the problem(s)?
• How long will it take to see change?  
• How much will it cost to effect change?
• What are the markers of a successful outcome?  

As you continue to do research on the causes about which you are passionate and stay abreast of the news on the organizations to which you are making donations, you may decide to make changes in the amount and frequency of your donations or in the roster of organizations you support. The discipline of asking and answering a few simple questions…and reflecting on the answers will help you to refine your charitable giving strategy over time.  

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We hope you have found this information helpful in designing your charitable giving strategy. Because tax laws often change, we recommend that you consult with financial planning, tax or estate planning professionals prior to implementing a strategy.  If you would find it beneficial to work with an experienced tax professional or a financial advisor to determine the best possible choices for your specific financial and tax situation, please contact us.

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