Family Business, Private Wealth

To give is to receive: Your guide to tax-smart charitable donations

For some time now, Warren Buffett and Bill and Melinda Gates have been goading fellow billionaires to follow their lead and pledge to give away at least half of their fortunes to charity.

More than 120 have agreed, which has in turn inspired many of America's millionaires-next-door to make a deeper commitment to philanthropy. It doesn't hurt that the wealthy are feeling wealthier these days, thanks to the years-long run-up in the stock and real estate markets and the lofty prices many businesses are fetching due to a robust acquisitions market.

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"People tend to give more when they feel wealthier," said Peter Mallouk, a lawyer, certified financial planner and president of Creative Planning, ranked No. 1 in CNBC's inaugural list of the top 100 fee-only wealth management firms. "With stock and real estate prices at all-time highs, the wealth effect is clearly in full force right now."

The wealthy may be feeling flusher, but they also face a higher tax burden than they did a couple years ago. That has many of them taking a greater interest in charitable-giving vehicles that offer tax relief.

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"There seems to be a lot more interest in planning for current charitable deductions, which isn't the same as planning for leaving an estate to charity," said Grant Rawdin, a certified financial planner and CEO of Wescott Financial Advisory Group. "Investors are looking for methods that provide current income-tax deductions and relief from higher ordinary-income and capital-gains taxes." Rawdin's firm is ranked third on CNBC's list of top fee-only firms.

Surprisingly, making a big gift to charity can be a complex endeavor. Among other things, donors need to decide whether to give cash or an appreciated asset to charity. The latter can include property, stock or a stake in a privately-held business.

Cash not always king

Most people simply donate cash to charities, which, while well-intentioned, can be a misguided strategy when it comes to maximizing the tax benefits tied to charitable giving. Those who give appreciated assets to charity get an income-tax deduction—as do those who give cash—and they avoid having to pay capital-gains taxes on profits from the sale of those assets, according to Mallouk. Tax-exempt charitable organizations can sell donations of appreciated assets without having to pay capital-gains taxes on the profits.

For some people, "the worst thing to use for charitable giving is cash," Mallouk said. "If you own real estate or stock that has appreciated in value, you can donate it, get the income-tax deduction, and the charity can then sell it without having to pay capital-gains taxes," he added. "You have transferred away your capital-gains tax liability."

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There are a wide array of charitable-giving vehicles, each with its own pros and cons. In recent years, donor-advised funds have become a popular choice among high-net-worth investors because they are relatively easy to establish, have lower expenses than do private foundations and are administered by the public charities that sponsor them.

Donor-advised funds allow philanthropists to make irrevocable contributions of cash or assets, get an income-tax deduction and take their time deciding which charities to support. Fund sponsors typically handle due diligence on potential grant recipients, make grants and oversee other tasks that private foundations must do on their own.

While private foundations must give away 5 percent of their assets a year, donor-advised funds aren't subject to the same requirement, although they can make grants only to IRS-qualified tax-exempt charities, known as 501(c)(3) organizations. Some fund sponsors allow donors to have complete say over how to invest assets in their accounts, while others offer only a menu of investment options, which is a drawback, according to some advisors.

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"Donor-advised funds offer a lot of flexibility on the timing of gifts to charity," said Elizabeth C. Hickman, a senior investment advisor at South Texas Money Management, one of CNBC's top 100 fee-only wealth management firms. "They can be a good option for someone who has had a big liquidity event and needs a bigger charitable deduction for a given year, she said, adding, "The funds allow donors to be more-intentional on the back end about which charities they support."

There are now more than 200,000 donor-advised funds in the U.S., with total assets exceeding $45 billion, according to the National Philanthropic Trust, a charity that specializes in donor-advised funds. Despite rapid growth in the number of donor-advised funds in recent years, many wealthy Americans still go the private foundation route.

Keeping it private

A private foundation is usually established by a wealthy family or individual through a big initial gift. Foundations decide how to invest their assets, usually with the help of an advisor, and have more flexibility than donor-advised funds in terms of grant making. They can, for instance, provide college scholarships or aid to families in need as a result of a natural disaster, as long as they follow IRS guidelines.

Given the high start-up and administrative costs associated with private foundations, they make sense only for philanthropists who are "well entrenched in the top 1 percent," said Mallouk at Creative Planning. "The millionaire next door," he explained, "typically goes the donor-advised fund route."

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For some philanthropists, one of the biggest drawbacks to private foundations is that they aren't exactly private. Information about their activities is readily available online, and some people would rather make grants anonymously, said Mallouk. Others are put off by the fact that private foundations must give away at least 5 percent of their assets annually, regardless of their investment returns in a given year or whether they have decided which causes to support.

"A lot of people don't like the private foundation, because it is, ironically, not that private," explained Mallouk. "If, for instance, you give a million dollars to the Boys & Girls Clubs of America through a private foundation, don't be surprised if the Girl Scouts are then calling you to ask for a donation."

People need to be clear about their philanthropic desires.
Grant Rawdin
CEO of Wescott Financial Advisory Group

For donors who can't entirely afford to part with the earnings on assets they'd like to give way, charitable remainder trusts are a popular option. Donors fund a charitable remainder trust with an irrevocable gift and get an income-tax deduction. They also get a lifelong investment-income stream from the trust. When a donor dies, what's left in a charitable remainder trust goes to a designated charity.

"A charitable remainder trust makes sense for people who want to diversify a concentrated position, are charitably inclined and still need to rely on income from that investment," said Mallouk.

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Indeed, there are many ways to go about supporting good causes. Potential donors need to consider what is going on in their lives tax-wise, whether they are truly charitably inclined, simply concerned about taxes or planning to leave a legacy.

"People need to be clear about their philanthropic desires," said Wescott's Rawdin. "They should figure out what they want to accomplish charitably and within their families and sit down with a tax expert and financial advisor to map out the smartest way to do this so that it is efficient and beneficial for tax purposes."

—By Anna Robaton, special to