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Use Charitable Giving to Lower Taxes & Advance a Cause (Part II)

7 minute read

Donating cash directly to a nonprofit organization can yield you a tax deduction, but there are even better ways to give to charity. There are a handful of tax strategies that can amplify your donation. These strategies allow you to give even more without compromising your deduction or leaving you with a tax bill. Let’s explore three of the most popular strategies.

Donor-Advised Funds

Donor-advised funds (DAFs) are investment accounts that you fund for the sole purpose of donating to charity. When you transfer cash, securities or other assets into your donor-advised fund, you can take a current-year tax deduction. As those funds sit in your account, they will grow tax free. At any point in the future, you can direct those funds to charities of your choice without paying income tax on the earnings that have accumulated.

The charitable contribution deductions you can take are generally the same as if you had donated the assets directly to a charity — meaning, the donated assets are valued in the same fashion, and your deduction is subject to the same AGI limitations — but with DAFs, your donations can grow tax free before you grant them to the charity. This tax-free growth amplifies your donation and saves you taxes all in one go.

DAFs are especially beneficial when you invest long-term appreciated assets like stocks. You can take a charitable deduction for the fair market value of the stock and erase any capital gains you would have otherwise been required to report.

As the charitable donor, you hold advisory privileges on your DAF and can direct both how funds are invested and when they are distributed to charities. However, all compliance and management requirements will typically be taken care of by the organization who is holding the funds for distributions – another benefit of DAFs!

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Private Foundations

Private foundations are investment vehicles established to support charitable causes and continue charitable work for years at a time, sometimes even beyond the donor’s lifetime. They are independent legal entities — typically organized as 501(c)(3)s — but instead of deriving financial support from the general public, private foundations are funded solely by an individual or family.

Once you establish a private foundation, you can deduct contributions you make to your foundation, limited to 30% of your AGI when funded with cash gifts. Your donation remains within the private foundation to grow as an investment until your foundation grants those funds to a charitable organization. Because private foundations are their own entity, they must file a nonprofit tax return, which means that most of their earnings are tax exempt.

Establishing a private foundation as a charity vehicle has some barriers to entry, like requiring a substantial initial investment and the cost of ongoing operations, but taxpayers often gravitate to private foundations because:

  • Contributions are tax deductible
  • If the donor contributes long-term appreciated assets, they can avoid the capital gains tax
  • Growth is typically tax-free or minimally taxed
  • Assets within the private foundation are not included in the donor’s taxable estate
  • They help the donor advance their legacy

Charitable Trusts

A charitable trust is another tax-advantaged method for contributing cash, securities, real estate, art and other assets to charity. But charitable trusts are built to support you (or your chosen beneficiaries) simultaneously.

Charitable trusts “split” the trust interest between the designated charitable organizations and your beneficiaries (which can be you, your spouse or another individual). There are two types of charitable trusts: charitable lead trusts (CLT) and charitable remainder trusts (CRTs).

What are charitable lead trusts? Charitable Lead Trusts (CLTs) make income payments to a charitable organization during the trust term and pay the remainder interest to your beneficiaries (in other words, CLTs lead with charity). 

What are charitable remainder trusts? Charitable Remainder Trusts (CRTs) are the opposite; they pay income to the beneficiaries first, and any remainder interest is gifted to the named charity when the trust term ends. CRTs may also be structured to take advantage of an estate tax deduction.

Generally, you (or your trust, depending on how you form the entity) can take an income tax deduction for the present value of future payments made to the charity. These deductions are subject to the same AGI limitations as other donations. But income earned within the trust is not always tax free; you may owe income taxes on trust earnings. This is dependent on how the trust is set up and will be determined by the trust terms. 

Below are a few frequently asked questions about CLTs and CRTs that can help you determine if a charitable trust will fit into your charitable giving plan. In low interest environments, a CLT tends to be a better option, while the opposite is true for CRTs.

Charitable Lead TrustCharitable Remainder Trust
Who receives the yearly income payments during the trust term?A charitable organizationYour designated beneficiaries
Who receives the remainder interest?Your designated beneficiariesA charitable organization
How is the value of the charitable deduction calculated?Estimated present value of the income paymentsEstimated present value of the remainder interest
Are deductions limited?Deductions for donations made to CLTs and CRTs follow the same AGI limitations as other charitable donations
(i.e., the deduction is limited to 60% of AGI for cash contributions* and 30% of AGI for donations of most other assets)
Deductions for donations made to CLTs and CRTs follow the same AGI limitations as other charitable donations
(i.e., the deduction is limited to 60% of AGI for cash contributions* and 30% of AGI for donations of most other assets)
*Cash donations are temporarily deductible at 100% of AGI in 2020 and 2021.

Establish Your Charitable Giving Plan

Each of these strategies can play an important role in your charitable giving tax plan. By stretching your donation dollars, you can help even more organizations. Staying connected with Corvee when making charitable contributions helps ensure your donations are recognized by the IRS and that your contributions yield the highest deduction.

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