Making Charitable Contributions a Part of Your Tax Strategy

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For individuals and families that have accumulated a significant amount of wealth, giving back to the community through charitable donations offers a unique opportunity to make meaningful, lasting changes. When your family gathers and converses about all you have to be grateful for, it’s a perfect time to discuss how you can use charitable contributions to support the causes that align with your family’s goals and beliefs.

If you have had a significant liquidity event and want to lessen the tax burden, or you have a desire to make a significant contribution to charity, you should discuss with your advisors the tax-saving options available to you.

"If you want to create a legacy of giving, have philanthropic conversations when the family gathers," says Fawn Angel, senior wealth strategist for Fifth Third Private Bank. "If you have money you want to give to charity, allow even young children or grandchildren to do some research on a charity or cause and present their findings to the family. In this way, you not only pass on your wealth but also help pass on your values."

Donor-advised fund

A donor-advised fund (DAF) allows you to make a larger charitable contribution, take the tax benefits immediately, and distribute the assets to charity over time. With a DAF, you make an irrevocable donation to a fund administered on your behalf by a manager, to whom you recommend which charities the money goes to and when. You can also continue to add to the fund for additional tax deductions in future years.

A DAF is one of the least expensive and easiest ways to make a large gift. "You’re going to complete some paperwork to establish your fund. Overall, it should be pretty simple to move the assets," says Angel. An added benefit: DAF managers typically have staff available to research charities and advise on contributions.

Angel noted that the manager of a DAF can often provide advice on how to maximize the impact of the donor’s gifts. "I had a client who wanted to benefit young teenage mothers, and while she knew of one charity, the client really wanted to boost the impact of her giving," she says. "While establishing the donor-advised fund, the financial institution was able to assist her in looking into charities that had a similar mission statement, get her introduced and make that connection."

Private foundation

Setting up a private foundation to disburse funds in the future is an excellent option if you intend to donate a significant amount of money. It affords flexibility in your giving and is a good way to involve your family, who, in addition to advising on gifts, can also serve as board members or even employees.

However, a private foundation has greater legal and administrative costs than other vehicles for giving. If you have a passion for a certain cause and want to endow a foundation to address it, consider whether there’s already an organization active in that space that has the expertise, administrative capacity and credibility to carry out the mission.

Charitable lead annuity trust

A charitable lead annuity trust makes a fixed annuity payment to designated charities for a set term. At the end of the term, the remainder goes to family members or other non-charitable beneficiaries. This option is ideal if you want to make a large one-time gift, already know which charities you want to benefit and want to transfer assets to family members with minimal gift or estate tax.

A charitable lead annuity trust brings the greatest financial benefit when interest rates are low, and the assets have higher growth or income potential. If the trust’s annual return outperforms a benchmark rate set by the IRS (the so-called 7520 rate), your beneficiaries may receive a greater amount than projected at the end of the term.

Donation of stock

If you have a significant stock position or a stock position with substantial gains, consider donating the shares. Donating stock enables you to deduct the fair market value of the shares from your income and allows the charity to immediately sell the shares and turn them into liquidity without paying taxes on the capital gains. This is especially useful if you are considering selling part of your concentrated stock as part of a Rule 10b5-1 plan used by executives to diversify their holdings. By donating the stock directly, there are no capital gains taxes.

"If you hold on to the stock, you will pay capital gains upon the sale of the shares, and you will only have a portion of what they are worth to give to charity," says Angel. "When you give a charity the shares directly, you get the fair market value as a deduction, and the charity can sell those shares for the full value without paying any taxes."

Qualified charitable distribution

A qualified charitable distribution (QCD) can be a powerful planning tool for someone with charitable intent who is at least 70 1/2 years old with IRA assets. A QCD is a direct transfer of funds from your IRA custodian payable to a qualified charity. It allows the donor to exclude the amount donated from their taxable income and—if at least 73 years old—may count toward their required minimum distribution for the year.

"For retirees, a qualified charitable distribution can be a really effective way to do their charitable giving that doesn’t impact them due to the tax status of the funds," says Angel.

The IRS does limit the amount you can donate directly from a retirement account tax-free, so it is important to consult with your advisors. Also, the donation must be distributed directly by the IRA’s trustee to the charity—a regular distribution to the IRA owner that’s then given to charity doesn’t count.

Direct giving

Direct contributions of after-tax funds to a charity are the easiest way to give and can have an immediate, visible impact, but may not offer all the benefits and tax savings available with other strategies.

With a direct gift, you are constrained by the tax calendar and have less flexibility to plan your giving into the future. Also, if you choose the direct route, check that the recipient charity has the capacity to receive a large gift.

"If the charity lacks the infrastructure and ability to manage the donation, the gift could be detrimental to their future," says Angel. "For example, if the charity uses a substantial one-time donation to purchase a building but doesn’t have the annual gifts to sustain the property and pay the bills, what you find is years down the road they’re in financial trouble, so that large gift didn’t necessarily benefit them."

Dealing with tax uncertainty

If you are concerned about how your charitable contributions might affect your taxes in the future, it’s important to raise those questions with your tax advisors. However, don’t allow tax uncertainty to get in the way of your charitable giving now.

"We know what a deduction looks like today and how it could benefit your current situation," says Angel. "We don’t know what that deduction will look like in the future, so I would encourage individuals to explore making a charitable gift now to begin the journey."

For more information, contact your Fifth Third Private Bank advisor.