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are numerous tax benefits available to taxpayers who make charitable contributions. But
contributions should be well planned and careful records should be kept to maximize these
tax benefits. This chapter discusses record-keeping requirements, which are more stringent
than they were just a few years ago; charitable contributions of appreciated property,
which provide a tax break; and several more sophisticated techniques that are available
for making large charitable contributions. The chapter also explains how to benefit
tax-wise when you contribute property that has gone down in value.
Planning for
Charitable Contributions
- Recordkeeping Rules: With regard to cash
contributions, you cannot rely solely on your canceled check to substantiate contributions
of $250 or more. For both cash and noncash contributions of this size, you must get a
contemporaneous, written description of the contribution from the recipient. The
description must contain:
- an acknowledgment of the amount of your contribution.
- a description of any noncash property donated.
- a statement whether or not the charity provided goods or services (such as a reception
or event ticket) in return for the contribution, and
- if goods and services were provided, a description and good faith estimate of the value
of the goods or services.
Noncash contributions worth more than $500 must have cost and acquisition information.
If the claimed value of a single noncash contribution exceeds $5,000 (except contributions
of publicly traded stock), you must get an appraisal of the item's value and attach it to
your return.
- Gifts of Appreciated Property: One of the
best tax planning opportunities for taxpayers who are not in a position to set up
charitable trusts or foundations is the deduction allowed for the charitable contribution
of appreciated long-term capital gain property—both tangible personal property (such
as artwork) and intangible property (such as stocks and bonds). To get the deduction, you
must have held the property for more than one year. By making such a contribution, you get
to deduct the full fair market value of the gift, while the appreciation in value is not
taxed.
For example, suppose you are in the 39.6% bracket and plan to make a charitable gift of
appreciated securities. You must choose between gifting the securities outright or selling
the securities and gifting the cash proceeds. The comparison between a gift of securities
worth $100,000 (assume that this includes $60,000 of appreciation in value) and a gift of
$100,000 cash generated by selling the securities clearly illustrates the benefit of
gifting the appreciated securities outright (see the table below).
The gift of stock allows you to permanently avoid $16,800 of tax on the appreciation, and
the charitable organization gets the full value of the stock.
Property that has gone down in value, in contrast, should not be contributed directly to a
charity. It should be sold first to create a realized loss. The proceeds could then be
contributed to a charity and the amount of the proceeds could be deducted.
| Benefit of a Gift of Appreciated
Property |
| |
Gift of Stock |
Gift of Sales
Proceeds |
| Charitable gift |
$100,000 |
$100,000 |
| Marginal tax rate |
39.60% |
39.60% |
| Tax benefit of gift |
39,600 |
39,600 |
| Tax on appreciation |
|
|
| ($60,000 x 28% capital gains rate) |
0 |
- $16,800 |
| |
|
|
| Net benefit of gift (tax savings) |
$39,600 |
$22,800 |
Techniques for
Large Charitable Contributions
Several more sophisticated techniques are available for making large charitable
contributions. The two most common are charitable remainder trusts and charitable lead
trusts. With both techniques, a partial interest in property is given to a charity and a
partial interest is reserved for noncharitable beneficiaries, such as the donor or his or
her family.
- Charitable Remainder Trust: In the case of a
charitable remainder trust, the donor contributes money or property to a trust that
provides for specified income distributions to one or more beneficiaries, at least one of
which is noncharitable. The income distributions to the income beneficiary must be made at
least annually, either for the life of the income beneficiary or for a specified term not
to exceed twenty years. Upon termination of the noncharitable interests, the remainder of
the trust property is distributed to a charitable organization.
A significant opportunity exists with charitable remainder trusts in situations involving
highly appreciated property (provided the ultimate beneficiary is a public charity or the
equivalent of a public charity). If the property is transferred to the trust and later
sold, there is no current tax on the capital gain and, in fact, the gain may never be
taxed, depending on the terms of the trust. The donor receives a charitable deduction
equal to the present value of the remainder interest in the year the trust is created.
Example: You establish a charitable remainder trust that pays a 6% annual annuity
to you for your life (assume you are age 65), with property that has a fair market value
of $100,000. The IRS rate is 8%. You would get a charitable deduction of $51,184 in the
year the trust is established. Each year you would receive $6,000 from the trust, and at
your death, the charity would get the balance of the trust assets.
There can be multiple individual income beneficiaries and multiple charitable
remaindermen. The beneficiary is taxed under a fairly complex four-tier system according
to the character of the income received, but is never taxed on more than the amount
received each year, $6,000 in this example.
Charitable remainder trusts can help you achieve your financial goals, but they may not
always be regarded favorably by your heirs. It is possible to achieve the two goals of
providing for your family and favoring a charity by simultaneously creating a wealth
replacement trust when you create your charitable remainder trust. As indicated above,
annual income must be distributed to one or more beneficiaries. Your wealth replacement
trust can be one of these beneficiaries. The trustee of the wealth replacement trust
purchases life insurance on your life. Upon your death, the life insurance proceeds paid
to your wealth replacement trust can be distributed to the trust's designated
beneficiaries, such as members of your family, if you want.
- Charitable Lead Trust: In the case of a charitable
lead trust, a portion of the income generated by the trust passes to a charitable
organization annually for a fixed number of years, and the noncharitable beneficiary
receives the remainder upon termination of the trust. Whether you receive a charitable
deduction depends on whether you establish a grantor charitable lead trust or a nongrantor
charitable lead trust. If you establish the former, you receive a charitable deduction in
the year the trust is funded computed based on the present value of the annuity to be paid
to charity. The price for a deduction is that the grantor is taxable on the income until
the income term terminates.
- Private Foundations: Private foundations are
charitable organizations that receive their financial support from private (as opposed to
public) sources. Generally, the primary purpose of the private foundation is to contribute
funds to other charitable organizations. If a private foundation complies with a set of
complex operating rules, donations made by individuals to the private foundation may
qualify for tax deductions as charitable contributions. Prospective donors must be aware
that there are several types of private foundations. Rules governing the organization of a
particular type of foundation determine the deductibility of gifts to that foundation.
(See Section IV F. Income Tax Effects of Outright Gifts for the deductibility of gifts to
various types of charitable organizations.)
Individuals may want to set up their own private foundations to pursue certain charitable
objectives while making sure that their contributions are tax deductible.
- Gifts of Appreciated Stock to Private Foundations: Normally,
your deduction for a donation of appreciated publicly traded stock to a private foundation
is limited to your cost basis in the stock. (See Chapter 1 for a
temporary law change effective until June 1, 1997.) There are alternatives, however, that
will allow a deduction for the fair market value of appreciated stock, such as donating
the stock to public charities (including community foundations that have donor advise and
consult funds), to certain permitted private foundations, or to certain organizations that
support public charities.
- Testamentary Charitable Gifts of Retirement Plan
Assets: The testamentary transfer of retirement plan assets to a charitable
entity may have a relatively small after-tax cost because these assets are potentially
subject to income tax, estate tax, generation-skipping transfer (GST) tax, and special
excise taxes. Most retirement plan assets are composed of pretax contributions and
earnings and are subject to income tax when the assets are received by an heir after the
owner's death. The value of the retirement assets is includible in the owner's estate and
subject to estate taxes. If the owner gives these assets to grandchildren, they are
potentially subject to GST tax. If the retirement plan has excess accumulations or makes
excess distributions (as defined by the IRS), it will be subject to special excise taxes.
The combination of the above income, estate, generation-skipping, and special excise taxes
can consume more than 80% of the value of the plan and, therefore,
the real economic cost of such a charitable gift may be less than 20%
of the value of the retirement plan assets.
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