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NOV EM B E R 2 0 1 2
Tax-Efficient Philanthropic Moves to Consider Now
Beyond private foundations, donor-advised funds and other tools can help you prepare
for higher taxes and meet additional needs while maintaining your focus on philanthropy.
The basic goal of impact philanthropy is to maximize the good
work that a charitable gift can achieve. Figuring out which
causes and charities can best achieve that end and determining
how aggressively to participate in terms of both time and money
are the key steps for any donor interested in this approach to
philanthropy. But there’s another factor to consider: What is the
most appropriate vehicle for enabling a donor’s giving? Choosing
the right one can help maximize not only the social impact of
your gift but also its potential benefits for you—whether that’s
providing anonymity or heightening tax efficiencies that, in the
end, can help you give even more.
Not that tax advantages are the main reason most people
give. In the 2012 Bank of America Study of High Net Worth
Philanthropy, only 32% of wealthy donors cited tax benefits
as the chief motivation for their charitable giving. Still, when
it comes to making such gifts, being as tax-efficient as possible
is an important consideration. And perhaps that’s never been
truer than now, with tax increases looming in 2013 under
almost any scenario, regardless of whether the country goes
over a fiscal cliff.
Although private foundations, in the popular conception,
are the most prominent vehicles for charitable giving,
they’re expensive and time-consuming to set up and
maintain, requiring significant operating support. That’s
why alternatives such as donor-advised funds and charitable
lead trusts are worth considering, particularly in the current
tax environment, says David Ratcliffe, managing director,
Philanthropic Solutions Group at U.S. Trust.
Depending on the vehicle, donors can match their giving and
tax strategy to the right vehicle. For instance, if upper-income
earners are worried about taxes rising next year and beyond,
certain charitable-giving vehicles can help them offset future
taxable events with charitable deductions. Or if a coming rise
in capital gains taxes means investors want to sell a basket
of securities this year, other vehicles can help donors take
charitable deductions now.
DONOR-ADVISED FUNDS
A donor-advised fund (DAF) is an irrevocable investment
account operated by a nonprofit manager with 501(c)(3) status.
(Clients who wish to create DAFs can set them up under the
auspices of Bank of America’s Charitable Gift Fund.) Donors
to a donor-advised fund enter into an agreement entitling
them to recommend which charities receive their funds.
Recommendations are almost always honored if the recipient is
an approved charitable nonprofit organization in the U.S.
One of the prime benefits of a DAF is the tax efficiency
it offers donors, especially those contributing gifts of
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appreciated securities. Donors are able to contribute
securities and claim a deduction based on the full current
market value of the stock, as opposed to just the cost basis in
the case of a private foundation.
In addition, DAFs may have particular use for investors who
are concerned about the expiration of certain of the so-called
Bush-era tax cuts. Suppose, for example, that you’ve sold a
business or a chunk of stock this year, in expectation of an
increase in capital gains taxes in 2013. That still might leave
you with a major tax obligation for 2012. You could reduce
your exposure by putting some of the proceeds from the
sale into a DAF, or by simply gifting the appreciated asset
directly to the DAF before realizing the capital gain.
As a general rule, donors can use a DAF to deduct up to
50% of their total annual adjusted gross income if their DAF
contribution is large enough and in cash. Any amount above
50% can be carried over and deducted in the following year
or years (up to five). Foundations, by contrast, offer much
more limited deductions, allowing donors to deduct just
30% of their adjusted gross income—again, if the gift is cash.
For gifts of securities, DAFs allow donors to deduct up to
30% of their adjusted gross income, while foundations allow
for just 20%.
The advantages of DAFs go beyond their tax efficiency. They
remove all administrative responsibilities—someone else is
filing the tax returns for the entity and tracking legal and
regulatory changes potentially affecting 501(c)(3)s. DAFs
also provide a greater degree of privacy than foundations,
whose operations are subject to public reporting and
inspection; DAFs, by contrast, allow for anonymous gifts,
and their records remain private. And because DAFs
needn’t make an annual payout (as foundations are required
to do), DAF donors can take their time determining and
recommending the best charitable recipients.
CHARITABLE LEAD TRUSTS
A charitable lead trust (CLT) can help meet two objectives—
donating to charity and creating a financial legacy for your
heirs—with the same vehicle. With a CLT, you place assets in
a trust, and each year the trust is active, the charity receives
a payment. At the end of the trust term, the fully appreciated
value of the remaining trust assets goes back to you or—as is
often the case—to your designated heirs.
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VIE W PO IN T
There are two primary types of CLTs. The choice between
them usually comes down to whether you want to use the
resulting charitable deduction now (to reduce your personal
income taxes) or later (to reduce the wealth transfer taxes that
will need to be paid at the end of the trust’s term, when the
beneficiaries receive the remaining assets in the trust).
With the first type, called a grantor charitable lead trust
(GCLT), the donor is considered the owner of the trust. That
means a onetime charitable deduction on the donor’s personal
income taxes can be claimed, at the GCLT’s inception. The catch
is that over the term of the trust, the donor has to pay taxes
on the interest and capital gains that the trust accumulates.
Ascertaining the amount deductible at inception is complex—it
generally requires specialized software programs that use an
IRS formula to take into account the projected interest earnings
and anticipated charitable contributions. The U.S. Trust
Philanthropic Solutions Group can help your Financial Advisor
and tax professionals with the calculations.
“Donor-advised funds may
have particular use for clients
concerned about the expiration
of certain Bush-era tax cuts.”
A nongrantor CLT, on the other hand, is treated as a
separate tax entity. That means donors aren’t allowed a
charitable income tax deduction on their personal tax returns.
However, neither are they on the hook for the taxes on the
income or capital gains of the trust. Moreover, the charitable
contributions the nongrantor CLT makes over the years can
be used to reduce or even eliminate transfer taxes when the
trust has run its course and the remainder of the funds in the
CLT is passed to the beneficiaries.
There is some urgency to consider a nongrantor CLT before
the end of the year. To further reduce the transfer taxes
that are ultimately owed when assets are transferred to
beneficiaries, you also are entitled to designate the initial
contribution to the trust as a gift for gift tax purposes. In 2012
NOVEMBER 2012
MERRILL LYNCH WEALTH MANAGEMENT
you have up to a $5.12 million total lifetime gift tax exemption
with which to make such a gift. If the 2002-2003 tax cuts
expire without congressional action, that limit would drop to
$1 million in 2013. The current thinking among Merrill Lynch
and U.S. Trust experts is that eventually a compromise will be
reached that keeps the exemption from reverting all the way
to its 2002 level. Still, no matter the outcome, the size of the
tax-free gift you can leave with a nongrantor CLT will likely
be somewhat limited by the exemption change.
Ratcliffe stresses that giving isn’t an either-or proposition.
Even if you already have a foundation, he says, you might
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use a DAF, a CLT or some other mechanism to meet a
particular need. And not just for tax reasons, he adds. A
DAF, for example, may provide an excellent, low-risk way
to educate children or grandchildren about philanthropy.
By naming them co-advisors to a DAF, you can gauge their
interest in giving and their potential to perhaps one day
serve on the board of your foundation.
Speak with your Financial Advisor about the Bank of
America Charitable Gift Fund, DAFs, CLTs and other
giving strategies, and how they might fit into your overall
philanthropic plans.
NOVEMBER 2012
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