Year End Charitable Donation Strategies

The right strategy for giving can stop the IRS from taking!

By Alan G. Orlowsky, J.D., C.P.A.

This article has been updated several times. Additionally, Sally Foley, CPA, contributed to this article.

"Charity begins at home" is an appropriate maxim for most people who are struggling to raise their children, support their families and save for their retirement. But for those who are fortunate enough to have the necessities of life and the resources to provide for a rainy day, philanthropy is an affordable and gratifying option.

Give During Your Lifetime

When discussing the tax consequences of charitable giving with a client, I usually advise, if possible and affordable, that they should make donations during their lifetime, rather than at death. The purpose of this advice is two-fold:

If you donate during your lifetime, you can enjoy the blessings of giving and the gratitude of those to whom you give. Secondly, not only are you removing these funds from your taxable estate, they also qualify for a deduction on your personal income tax return. If such gifts are made subsequent to your death, there is only an estate tax savings, and hence the government's share of the gift giving burden is far less.

For example, if you are an 80-year-old individual with a $5 million dollar estate, you fall into the 45% estate tax bracket. If you make a $100,000 gift to charity this year, your income tax savings is $36,000 (assuming a 36% income tax bracket).

If you then die in 2008, at that time there is $64,000 ($100,000-$36,000) less in your estate because of the gift in 2007, and therefore an estate tax savings of $28,800. The aggregate tax savings is $64,800 ($36,000 plus $28,800).

If you had waited until your death to make the gift, the tax savings would only be $45,000 (45% of $100,000).

Thus, by making donations while you're still alive, you realize an additional $19,200that you can give to your family.

By giving now you can have your cake and eat it too.

Charitable Remainder Trust

If you are not ready to make an outright gift during your lifetime, you may consider establishing a charitable remainder trust (CRT). With the CRT you can make a charitable contribution to the trust at any time. The assets in the trust will go to the charities of your choice after your death, but during the remainder of your lifetime you will retain income from the donated asset! Still, you are permitted to take an income-tax deduction for the year in which you make the donation.

Better yet, a CRT lets you sell highly appreciated assets, such as a low-yielding stock, free of capital gains tax, and turn it into a lifetime income stream.

Here's how it works:

To establish a CRT, you either visit your attorney who will help you draft the trust document, or contact the selected charity -- some charities will set up the trust for you and cover the cost of doing so, as long as they are the designated beneficiary.

The trustee then sells the donated assets at fair market value (incurring no capital gains tax liability), and reinvests the proceeds in income-producing assets such as corporate bonds, say at 7 percent interest. For the rest of your life, and that of your spouse if you so desire, the trust pays you the interest income. When you die, the remaining trust assets pass to the charity or charities you have selected.

In this way, the CRT allows you to reduce your income taxes now, avoid capital gains taxes, and reduce estate taxes upon your death. More importantly, it allows you to give more to a charity or charities that have special meaning to you, all at the expense of the IRS!

The Charitable Foundation

Another vehicle for making charitable gifts, either during your life or subsequent to your death, is the charitable foundation. Individuals and corporations establish charitable foundations for a number of reasons:

Foundations can make a major difference in the lives of others.

They can make a powerful statement about you and your values.

Substantial tax benefits are available to foundations.

The foundation can live well beyond the life of its founder.

You can use it as a vehicle to encourage charitable giving by other relatives

Although the benefits of foundations are significant, there are considerable administrative and regulatory requirements. Large foundations are subject to yearly audits. All foundations must file IRS Form 990 each year, which includes both financial and administrative information. Furthermore, there are restrictions on self-dealing, conflicts of interest, political activities, etc.

For smaller estates and smaller gifts to existing charities, a foundation is not the recommended vehicle of choice. Unless your gift is greater than $500,000, I do not advise creation of a foundation because, unless the funds are substantial, the burdens of administration outweigh the benefits of creation.

Donor-advised Funds

There is a way to enjoy many of the benefits of a charitable foundation while avoiding the administrative hassles. Donor-advised funds (DAFs) are charitable accounts that you establish in your name (like naming your own foundation), but the funds are held by an organization such as a community foundation, university, religious federation, public charity, hospital, or trust company. More recently, brokerage firms have established DAFs for their clients. A popular community foundation in the Midwest, for example, is the Chicago Community Trust (312-372-3356).

Your DAF is a component of the organization, which administers the funds and makes the grants to charities. You can recommend which charities it should distribute the funds to, but the organization is not obligated to follow your recommendations. For that reason, you should choose an organization that routinely donates to charities that you favor.

DAFs typically require a minimum initial donation of anywhere from $1,000 to
$250,000. You can make subsequent contributions -- which are irrevocable -- at any time, typically in increments of $1,000. You enjoy an immediate income tax deduction for your donation, even if the DAF does not make a grant in the same year. In addition, funds in your DAF are not included in your estate for tax purposes. And like a CRT, you may avoid paying capital gains tax on appreciated assets that you donate.

Complex regulations

If you are considering donating large sums of money to one or more charitable organizations, you should meet with your attorney or accountant to determine the best tax strategies for making such gifts. The laws in this field are complicated. Choosing the proper strategy will not only allow you to leave more money for family members, but will also allow you to pass on more to your favorite charities.

CRT Benefits in Black & White

Here's an example that illustrates the generous tax advantages of a charitable remainder trust (CRT). Fred and Irma, ages 72 and 73, are planning to retire next year but need a steady stream of income. About 15 years ago they purchased stock in Microsoft for $20,000, and now it is worth approximately $500,000. The stock pays no dividends, so they would like to sell it and then purchase corporate bonds with the proceeds. Upon their deaths they would then like the remaining funds to go to their favorite charity.

In Scenario A, Fred and Irma sell the stock without use of a CRT. A capital gains tax of $96,000 is due ($500,000 minus $20,000 equals $480,00 in capital gains, at a tax rate of 20%) , which would leave them with $404,000 after the sale. If they invest the remaining funds in bonds yielding a 7 percent return, they would have a yearly income of $28,280 (7% of $404,000).

In Scenario B, they donate the entire $500,000 worth of stock to a CRT. The CRT sells the stock and buys bonds yielding 7 percent. No capital gains tax is due. Fred and Irma would have a yearly income of $35,000 (7% of $500,000), which is $6,720 more than if they had not used a CRT. Moreover, the charity gets $96,000 more than in Scenario A ($500,000 - $404,000), and the couple enjoys a larger charitable deduction on their income tax return for each year they make a donation to the CRT. This is truly a win-win situation for all parties except the IRS.

About the Author

Alan G. Orlowsky, President of Orlowsky & Wilson, Ltd. in Lincolnshire, Illinois, has been counseling people on estate planning for 28 years. He previously worked for the IRS in its Estate and Gift Tax Division. He also worked for the Deloitte & Touche accounting firm, and he has taught taxation and accounting at Loyola University of Chicago, School of Business.

If you have questions about this post or about a particular legal situation, please contact Alan Orlowsky by calling 847-325-5559.

Five Common AND Costly Estate Planning Mistakes

I have been helping people plan their estates for over 26 years, and I have seen just about every kind of mistake that can by made by attorneys, individuals, families, beneficiaries, trustees, etc. In most cases the mistakes were made by well-intentioned people who nonetheless failed to take advantage of opportunities to accumulate wealth, shelter their assets from estate tax, and protect their estates for future generations. In some cases they were negligent or even malicious. In all cases the mistakes were costly.

I'll describe some of the most common estate-planning mistakes that I've dealt with (the names have been changed to protect confidentality), and how to avoid making them yourself. By taking action and exercising care now, you can save a fortune later.

1. Neglecting items of sentimental value
Several years ago the executor of an estate, a woman named Marie, hired me to probate the estate of her father, Neil. Marie had two siblings. She also had a step-mother, Neil's second wife, who did not get along with Neil's children.
Neil´s will left a portion of the estate to the stepmother and the balance to his children in equal shares. Unfortunately, the will was silent as to distribution of his personal property, which included a collection of firearms and numerous paintings of purely sentimental value. The stepmother felt she was entitled to most, if not all, of the paintings. Marie, on the other hand, distributed the paintings among the three children (and took the guns for herself). The stepmother hired an attorney to fight for the paintings, which were ultimately divided evenly among the four beneficiaries. But the legal fees far exceeded the value of the property, family relations were further strained, and in the end nobody was happy.

Solution: Some people wrongly believe that there is no place in a will for personal property that does not have significant monetary value. If you are leaving items of personal property, whether of actual or sentimental value, clearly state in your will how you would like them to be distributed.

2. Failing to secure the documents
A few years ago my client Christine informed me that her Uncle Leo, with whom she had a close relationship, had died. Leo had prepared a will but it was nowhere to be found. Christine said Leo had promised her a substantial inheritance, but because the will was missing and she was not related to him by blood, the Illinois Public Administrator's Office gave the entire estate to nieces and nephews who lived in Europe -- and who Leo had never met!

Solution: Make copies of your documents and store them in a safe place. Put the original in a bank safety deposit box; even if the key is lost and the whereabouts of the box is unknown, it can always be located by a vault box search. Give copies to your executor and attorney. And keep a copy in a safe place at home.

3. Keeping secrets
In a recent case, an elderly woman named Gwen died and left a bequest of about $40,000 to her devoted caretaker. The other beneficiaries of Gwen's seven-figure estate included four nephews and nieces, who were jealous of the caretaker's close relationship with their aunt, and who were surprised to discover, when the will was read, that Gwen had left such a sum to the caretaker -- in fact they expressed shock, anger, and bitterness. The nephews and nieces argued that the caretaker had exercised undue influence over the deceased, and therefore was not entitled to the bequest -- which to me seemed trivial relative to the size of the estate. Although the bequest was upheld in court, the challenge was costly, it caused delays, and it upset Gwen's devoted caretaker.

Solution: Make your feelings known to your executor and beneficiaries -- preferrably before you die -- about which people you wish to leave bequests to. If you think this may cause conflict, explain in a letter why you feel the way you do; send the letter to all relevant beneficiaries and attach a copy of it to your will. Ideally, you should resolve potential disagreements and quell hostilities (as much as possible) while you are still alive.

4. Naming an unqualified trustee
Rosita, a hard-working, 54-year-old, divorced mother of one child, died recently after a long battle with AIDS. Fortunately, she had revised her estate plan immediately after her divorce, removing her former husband as the beneficiary, executor and trustee. Rosita named her daughter, a junior in high school, as the sole beneficiary; and named her best friend Carly as executor and trustee.
I had advised Rosita against naming Carly as trustee because Carly had no experience managing a trust, nor was she equipped to handle the conflicts that I expected to arise with the ex-husband. I suggested an institutional trustee, but Rosita insisted on naming Carly, whom she trusted. When Rosita died, the ex-husband indeed hired a lawyer and demanded control over the estate, claiming he would do a better job than Carly in managing the trust funds for his daughter's benefit. Noting that he was insolvent, at Carly's request I spent a considerable amount of time convincing the ex-husband's lawyer that he could not possibly win this battle, before they backed off. But the ex-husband conceivably could cause more trouble down the road. This was all too much for Carly -- she resigned as trustee and gave the job to the successor trustee, a large financial institution.

Solution: If there is any chance of a conflict or dispute among family members, appoint an institutional trustee. Your best friend may feel honored to be appointed, but the work of resolving conflicts can be substantial -- not to mention the work of investing, managing, and distributing trust funds.

5. Procrastinating
Howard was in the hospital being treated for cancer when he decided to amend his will -- which he had meant to do for a number of years. His lawyer brought the documents to the hospital and Howard signed them, witnessed by two of the lawyer's assistants. Howard died quite suddenly soon thereafter. A disgruntled heir challenged the amendment in court, claiming that Howard had been incapacitated while in the hospital.

Solution: First of all, Howard should have amended his will years earlier, when there was no question about his competence. But in this situation, the lawyer should have brought along two witnesses in the health care or social services fields, who could testify authoritatively as to Howard's competence. Better yet, the lawyer could have videotaped the signing to further prove his client's competence.

About the Author

Alan G. Orlowsky, President of Orlowsky & Wilson, Ltd. in Lincolnshire, Illinois, has been counseling people on estate planning for 28 years. He previously worked for the IRS in its Estate and Gift Tax Division. He also worked for the Deloitte & Touche accounting firm, and he has taught taxation and accounting at Loyola University of Chicago, School of Business.

If you have questions about this post or about a particular legal situation, please contact Alan Orlowsky by calling 847-325-5559.