CHARITABLE PLANNING: A FORK IN THE ROAD
You may decide to do charitable planning for several reasons. Some people do it because they want to give back to the community. Some just want a tax deduction. Others don’t have any heirs, and they want a low risk method to ensure they have enough money until they die. Whatever the reason, charitable planning can be broken up into three main categories.
- Charitable Deductions
- Split Interest Gifts
- Retention of Assets (doing nothing)
CHARITABLE DEDUCTIONS
Charitable deductions may reduce the taxes you pay. They do this by allowing you to deduct contributions to qualified charitable organizations from your income for tax purposes. You can get a charitable deduction when you make a donation to a qualified tax exempt organization.
Charities, if set up right, are tax exempt entities under 501(c)(3) of the tax code. However, different rules apply to each specific type of tax exempt entity. A nonprofit organization does not have to be a 501(c)(3). Non-Profit is not the same thing as “tax exempt”. 501(c)3 means tax exempt. Contributions to a tax exempt entity are deductible. Contributions to a non-profit will not be deductible unless it is also “tax exempt”.
Nonprofits may have a stated purpose to do something other than make a profit (even though they can technically still make a profit). Donors to nonprofits that do not have 501(c)(3) status do not get a tax deduction. Income generated by nonprofits is still taxable. Whereas, a nonprofit with 501(c)(3) status provides taxable deductions to donors, and its income is not taxable.
There are several types of tax exempt organizations: 1) Public charities 2) Private foundations 3) Donor Advised Funds, and 4) certain Charitable Trusts.
Public Charity
A public charity is a 501(c)(3) organization. This means it qualifies as a nonprofit organization under Section 501(c)(3) of the tax code. All 501(c)3 organizations are NOT public charities. There are a number of tests to determine if a charity is “public”. It may be public if it gets at least 1/3 of its donations from the community to support charitable causes. If not, it may still qualify as a public charity under the 10% facts and circumstances test. Charities such as a homeless shelter or a soup kitchen may or may not be “public” depending on whether or not they meet the test. Most churches, hospitals and schools that are properly structured will qualify as a public charity. One example of a public charity is Legacy Global Foundation.
Independent board members help make sure the public charity is not formed or used to benefit private interests. Board members will likely change from time to time. Public charities are not subject to the same mandatory distribution requirements as private foundations. They also have no excise tax on portfolio earnings and donors are eligible for higher tax deductions for contributions.
Individual donors who donate to public charities may deduct a portion of their contribution from their taxable income. For example, a person in the community who donates cash may deduct up to 60% of their taxable income. One who donates appreciated assets may deduct up to 30% of their taxable income; whereas, a corporation may deduct up to 25% of its taxable income.
Private Foundation
A private foundation is also a 501(c)(3) organization. They are “private” because they do not meet the public support tests. Typically, families or individuals will control a private foundation. One example is the Bill & Melinda Gates Foundation. Family members primarily fund the foundation. Private Foundations must give away 5% of their assets every year. Private foundations pay excise taxes on their portfolio earnings.
All tax exempt entities, whether public or private, must file applicable tax returns, do their accounting, and comply with IRS rules.
Grant-making Charity or Operating Charity
These can be public or private – its just a matter of what they do. Grant-making charities make grants to other charities. An operating charity, such as a pet rescue, only needs sufficient funds to pay for its costs. With an operating charity, you are better off doing a public charity instead of a private foundation. The benefits of no excise tax and the support of the public in a public charity outweigh the benefits of a private foundation.
In general, with a few exceptions, it is best to fund a private foundation with at least $10M to make it economically feasible. This is one of the reasons why Donor Advised Funds have grown in popularity.
Donor Advised Fund
Simple Set up
Unlike a public charity or private foundation, a DAF is quick and easy to set up. The cost of administration starts at about 1% and goes down from there.
Most DAFs Only Allow Cash or Cash Equivalents
A donor advised fund (DAF) is like a charitable bank account. Most people who use DAFs put cash or cash equivalents into this type of account, and they get an immediate income tax deduction. Most DAF’s will only accept cash or cash equivalents, and will only invest funds in portfolio assets. Many DAF’s, especially those offered by financial institutions, limit investments to certain portfolio assets or specific funds. However, there is an alternative. Some independent DAF’s like Legacy Global Foundation will accept alternative assets and investments. These include non-cash items such as business interests, real estate, retirement plans and so forth. This allows those of you with charitable intent and various assets to maximize your charitable contributions and, if you want, give to charities globally.
DAF Sponsors Want to Manage the Money
Depending on the DAF sponsor, the money in your DAF may be managed by you or your own financial advisor. Legacy Global Foundation allows you to manage the assets in your DAF or bring your financial advisor on board to manage the funds. This is something that most other DAF sponsors do not do. The financial institutions that provide DAFs want to manage your money and typically do not provide you with other options.
Advise, Not Control
You can make grants from your DAF to the charity of your choice. You can “advise” – you don’t get control. The DAF sponsor is required by law to make sure the recipient of any grants is a qualified charitable organization, and as a result the DAF sponsor has the power to decline to give to a charity you may want. You define the charitable mission and the charitable causes you want to support, and independent public charities like Legacy Global Foundation will work with you to carry out your charitable intent. But the DAF sponsor legally has the final say as to where the money goes. That being said, they will typically send the money where you want it to go as long as it’s legal.
DAF Succession Plan
It should be a smooth transition of the DAF from you to the next generation. There’s usually a built in succession plan. The challenge is what is the plan? Some DAF’s only go one or maybe two generations before they are turned over to the institution managing them. Very few go longer than that. In other words, your family members have no say how that money is used after one or two generations. Legacy Global Foundation is one of the few places that will work with your family over multiple generations, which makes it ideal for “Dynasty” planning. The Legacy Global Foundation DAF continues your charitable mission.
This does not depend on whether you have a friend or a child who shares your passion and charitable vision. If you wish, a DAF may also keep you anonymous. This acts as a gatekeeping mechanism to prevent unwanted visits or phone calls from fundraisers.
SPLIT INTEREST GIFTS
Split interest gifts involve gifting a portion of money to charity but retaining an interest in the gift. Two types of split interest gifts include: 1) Charitable Remainder Trusts and 2) Charitable Gift Annuities. While we focus here on Charitable Remainder Trusts and Charitable Remainder Gift Annuities, there are several different types of split interest gifts that are not included in this article.
Charitable Remainder Trusts (CRT)
A CRT includes setting up an Irrevocable Trust. You gift the assets you want to the Trust. The Trust sells the assets and invests the proceeds of the sale. You can control the investments or have your financial advisor do so. The most common CRT is a Charitable Remainder Unitrust (CRUT). (For examples of other CRTs, click HERE.) In a CRUT, you set the percentage of the interest you retain upfront and it does not change. The percentage varies from 5% to 50% based on your age. You base the money you get on an annual calculation of a fixed percentage of the assets held by the CRUT. A minimum of 10% of the initially contributed value must be set aside for the charitable beneficiary of the CRUT.
How do you get paid? If the market does well, then you should get a payment increase each year. For example, let’s say you gift assets in the amount of $1M to the CRUT. You have a 5% payout percentage. The first year your CRUT generates 8% interest. Instead of getting 5% of $1M, you get 5% of $1,080,000. However, this can work in the opposite direction. If the market has a bad year and your CRUT performs poorly, then your payout may be less. Those who are relatively younger and less risk averse tend to be those who opt to create a CRT.
Charitable Remainder Gift Annuities (CGA)
A Charitable Gift Annuity is not a Trust. It is an annuity. This means you enter into a contract for a specified income stream for a term of years. You do not have risk because the payment you receive does not depend on market performance. You receive the same amount of money each month or year for the specified time period. However, the payout rates for CGA’s usually fall below market rates. Typically, older more risk averse people tend to do CGAs.
RETENTION OF ASSETS
When you retain your assets, you have decided not to undergo charitable planning. You just want to keep your money. This is often the case for those who 1) Are not inclined to make charitable donations or 2) Do not want or need deductions from taxable income or exemption from federal estate tax. However, be sure you do not want or need deductions from income or an exemption from federal estate tax. Some of you are in a financial position where the choice is as follows: You can either pay money to the government or donate it to charity. What would you rather do?
For example, the 2022 federal estate tax exemption amount is $12.06M per person. It is $24.12M for married couples. You need charitable planning if you are married and your taxable estate (your assets and property subject to estate tax after you die) amounts to more than $24.12M and you do not want to pay federal estate tax.
Note: In 2026, the exemption amount sunsets and automatically decreases to about $6M per person or $12M for married couples. If your taxable estate is at or near these numbers and you don’t want to pay federal estate tax (roughly 45% tax), you need charitable planning.
If you would rather donate money to charity instead of paying extra money in taxes, we can help. Please call our firm, and we will work with you to customize a plan that makes sense for you.