Main Street Philanthropy: How the Small Guy Can Give Smart

Americans like to give. According to the Giving USA 2018 report, Americans gave over $410 billion dollars to charities in 2017, and 70% of that was from individuals. You read that right: it was people like you and me, not big corporations, who provided the lion’s share of charitable funds! This was an all-time high, in nominal terms. Numbers like these underscore how important the average person can be to funding worthy causes.

Not only do Americans like to give, but they like to give intelligently. Whenever you send a check or give your credit card number to a qualified organization, and even when you take some old appliance to the Goodwill store, you are offered a receipt so you can put a deduction on your 1040 Schedule A at tax time. If you are able to itemize under the new tax rules and are in a high tax bracket, you may be able to realize a significant tax savings from such gifts each year!

The TCJA has reduced your ability to itemize

Under the most recent tax law reform, the Tax Cuts and Jobs Act of 2018 (TCJA), for the 2019 tax year there is now a “standard deduction” of $12,200 for a single filers or $24,400 for joint filers (other deductions not given here). This has made it possible for many, if not most, filers to skip itemized deductions and opt for a simpler filing experience. It remains to be seen if the loss of itemized deductions will affect charitable giving by individuals. But some filers will still itemize because of their large contributions and other deductions.

Taking advantage of Schedule A

Consider the case of a generous retired couple, known to us, who sold their long-term home to move into more modest accommodations. They realized an enormous gain on their home, far beyond what their exclusion amounts would cover, and now they face a large tax bill. To add insult to injury, their income in all future years will put them in the lowest federal bracket. Is there a way for them to realize a large deduction now to reduce the tax on this one-time gain and still keep control over their charitable gifts for an extended period?

Well, even if they do not meet the level of donations to qualify for itemizing deductions on Schedule A, there are a few ways ways for them and the average person, with planning, to take a large charitable deduction in a single year. Below we discuss private foundations, charitable remainder trusts, and donor-advised funds as ways to create a large one-time deduction but to retain some control over the payouts for years to come.

What is a Private Foundation?

A private foundation is a legal entity you can form to fund any number of charitable causes. You would generally move a large amount of money or assets into the foundation’s account at its establishment. Because the foundation is its own entity and not part of your estate, the entire donation may become deductible in the year of the gift. (Keep in mind there may be limits on deductibility when a donation is large relative to your income, so consult with a tax advisor before funding the account).

As a nonprofit company, your foundation will have its own tax identification number, board of directors, and required meetings and record-keeping responsibilities. It’s important to realize that, should you remain in control of the foundation, you become a fiduciary to it and must ensure that the foundation follows its purpose explicitly. There are also rules surrounding required annual payouts (generally 5% of the assets each year) to avoid a hefty excise tax. Foundations’ gains and income are taxed at a very low rate (recently updated to flat 1.39% of income) as long as you follow the payout rules. For someone who wants to stay involved and who enjoys running an organization, a foundation could be a wise choice. It can even be a way to get family members involved in philanthropy under your guidance.

There are also third-party companies that take away some of the burden of running a foundation. For example, a company like Foundation Source will charge a modest fee and assist you with the stickier parts of complying with foundation rules. They can also assist you with the initial setup, and you can hire an advisor to manage the assets within the account once funded. If professional management of your foundation assets is of interest, please let us know.

Charitable Remainder Trusts

Unlike a foundation, a charitable remainder trust (CRT) is not an organization that requires staff and meetings. Instead, it’s a simple irrevocable trust whose assets are slated to go to a charity upon the death of the trust beneficiaries. The grantor (the person funding the trust) works with an attorney to draft the trust terms and designates both the charity and the income beneficiaries up front, and these cannot be changed.

A CRT might look something like this: A wealthy donor places $1,000,000 into a CRT with instructions that trust income be distributed to himself/herself or children, etc., until the death of the recipient. At that that time, the entire trust balance is donated to the charity. The deduction for the original donation can be taken in the year of the gift based on the original amount, even if the trust assets decline due to poor investment performance.

Recently the “stretch IRA” provisions that permitted some IRA beneficiaries to withdraw from an IRA over the lifetime of the decedent were abolished. In general, all traditional inherited IRA funds must now be withdrawn within 10 years. However, it has been suggested that if you were to roll IRA money into a CRT, the income payments could continue to the beneficiaries for their lifetimes, and the principal would avoid current taxation. Speak with your financial planner if this strategy might be of interest, as there are some technicalities to consider.

Of course, once you fund a CRT or any irrevocable trust, you lose all control of the assets (beyond income distributions). In directing the trust, the trustee of a CRT must consider both the eventual benefit of the charity as well as the desired income distributions and faces fiduciary liability to both parties. We haven’t heard of a charity suing an individual’s trust because it was expecting a larger gift, but income beneficiaries are not always so grateful. If you are a busy person and want to use a charitable remainder trust, it can pay to hire both a professional investment advisor and an impartial trust company to help you stay in compliance with trust terms.

Donor-advised Funds to the Rescue!

What if you haven’t got the time or inclination to set up a private foundation, and the fiduciary liability of a charitable remainder trust gives you pause? For the rest of us, there is the donor-advised fund. A donor-advised fund (DAF) works much like a foundation, which can accept large charitable contributions and yet only pays out a certain amount each year in order to maximize its life.

However, a DAF doesn’t require the donor to run a foundation—often a full-time job. Instead, the DAF is run by a third-party company for a fee (usually a small percentage of assets) who lets the donor “advise” how much and to whom to distribute from the original gift. This allows the gift to be recognized in the current tax year’s deductions but distributed according to your wishes over a longer period.

Returning to the retired couple mentioned at the beginning, if their financial plan shows it is all right to turn over a large lump sum (gifts to a DAF are irrevocable), they can calculate their expected giving over the next, say, ten years and put that amount into a DAF. Provided that the total of their year’s deductions exceeds the $24,400, they can take a bite out of the tax from their large current-year capital gain.

Then, rather than giving money out-of-pocket to the same charities they would already have funded, they can simply direct the DAF manager to send money to those charities each year with minimal involvement. In future years, when deductions will not be as valuable, they can still take the new standard deduction which, in the case of our example couple, might be sufficient to wipe out most of their taxable income each year.

An added benefit of a DAF is that the money may remain invested between distributions. It need not remain static in a bank account. Most DAF providers include options for professional management. So if the investments in the DAF do well, there will be more to give in future years, though the gains will not provide additional deductions for the donor.

If you have an interest in planning for your philanthropic future, we would love to discuss your philanthropy goals with you and help advise you on a smart way to set up your giving. Click here so you can set up a free consultation with one of our fiduciary advisors.

About Arthur Doglione

Arthur is an industry veteran with more than 20 years of experience working with high-net-worth clients. He has an extensive background in wealth management with particular expertise in portfolio management. Before establishing Alpha Fiduciary, Art was a Senior Vice President with Merrill Lynch where he built his practice to be the largest of Merrill Lynch’s Arizona territory.

Art founded Alpha Fiduciary in 2006 and has completed two acquisitions since then. The firm currently serves clients across many states as a fee-only Registered Investment Advisor (RIA).

Art founded Alpha Fiduciary as a fiduciary advisory firm. This means it has a responsibility to its clients first and foremost.

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About Arthur Doglione

Arthur is an industry veteran with more than 20 years of experience working with high-net-worth clients. He has an extensive background in wealth management with particular expertise in portfolio management. Before establishing Alpha Fiduciary, Art was a Senior Vice President with Merrill Lynch where he built his practice to be the largest of Merrill Lynch’s Arizona territory. Art founded Alpha Fiduciary in 2006 and has completed two acquisitions since then. The firm currently serves clients across many states as a fee-only Registered Investment Advisor (RIA). Art founded Alpha Fiduciary as a fiduciary advisory firm. This means it has a responsibility to its clients first and foremost.