Tax-Effective Charitable Giving

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Hey, good afternoon, everyone. It's time for another edition of We're Talking Money Live. We have a show filled with some great ways to cut your taxes. Today we're going to be talking about tax-effective charitable giving. It's a very popular subject right now. We're getting close to tax season; actually, we're in it. April 15th is not far away. But whether you can use these strategies for 2020, you'll need to check with your tax professional on that, but these are things that you need to be aware of as we work through 2021.

To set the stage a little bit, let me talk about current landscape of philanthropy, where it is. As a wealth advisor, I see this on a regular basis. We talk about philanthropy, how it fits in, and everybody should know at least a little bit about how you can use charitable giving effectively to reduce your taxes.

So current landscape of philanthropy: there is 450 billion dollars per year being given to 501(c)(3)s, or not-for-profit organizations. That number continues to increase. We've seen it go up literally... my charts go all the way back to the late 70s, and since then we've seen a pretty consistent rise. Back around 98, 97, 98, we saw a pretty precipitous increase in philanthropy, and so then it leveled again around the 2000s. 2005 it started bumping again, came down a little bit, and then from 2009 until present we have seen this thing increase pretty significantly.

So here's what's interesting, and this is why I think the show is so important: 69 of that 450 billion dollars, that is given by individuals. So if you wondered whether charitable planning or charitable giving could be a part of your tax plan, rest assured you're going to learn something today that will make a difference. Whether you choose to implement it, that's up to you, but I'm going to give you some good things to think about, and we're going to cover about six, I believe, techniques today that should give you some meaningful ways to help avoid or reduce your taxes.

Before we go there, let's talk about new legislation. It's all over the news. Everyone's wondering, what's it going to be? What are we going to get? What will the final version of all of this look like? Well, who knows. What I can tell you is what's proposed, and I can juxtapose that with current, and we can talk through the differences a little bit, and I think that'll help you better understand why each of these strategies can make such a difference.

So let's talk about the current law. For charitable giving, in general, you can deduct charitable giving to save on your marginal tax rate. It's pretty normal; everybody knows that. Well, potential changes in the Biden proposals: so under new administration, they want to have a limit on the amount that's deductible, and that limit would be 28 percent.

Long-term capital gains rates. Boy, this one has been talked about probably as much as any part of the new laws, or the proposed laws. 20 today is what everyone enjoys on capital gain rates, and that's a heck of a good rate. People love to generate income through capital gains because of the favorable tax treatment. Under the new Biden administration's proposal, 39.6 is the proposed capital gain rates for folks earning over a million dollars.

Now, a lot of you might be saying, well, I don't earn a million dollars. Lots of people out there do, through a combination of sources, and so you have to be aware of that, because all of a sudden, if you have a lot of capital gains and you're going to go from a 20 to a 40 percent rate, or 39.6, that is going to take a huge amount of your income. It's going to be gone, vanished, quickly. So we don't know if that's going to be... we don't know if that'll be the final version here or the final result, but it certainly is... we know that's what's going to be proposed.

Stepped up death, stepped-up basis at death. Another very controversial subject. Currently, we get a stepped-up basis on all appreciated properties. So if you will something to your children or heirs, they get a stepped-up basis. So let's say you paid a hundred thousand dollars for something and today it's worth a million. When you leave it to someone via your will, they get a stepped-up basis, meaning their basis becomes the current value, and they would escape the capital gains that you would have paid had you sold that asset for the fair market value. That goes away. In other words, there would be no stepped-up basis under the new administration's plan, or at best there would be a modified stepped-up basis.

And then finally, the estate tax exemption. Boy, this one has gotten everyone's attention. Right now it's 11.7 million dollars as far as the estate exemption goes. So if you have an estate that's 12 million dollars, you can essentially pass it tax-free. If you're married, both of you, you and your spouse get the 11.7 million dollar exemption, so that means 23.4 million dollars can be passed, zero estate tax. That's a tremendous benefit, and anything over that is taxed at 40 percent.

Under the Biden administration, their proposal would call for three and a half million dollar exemption, times two if you're married, seven million dollar exemption, and an estate tax rate of 45 percent if you go over the 7 million. Well, guess what? People that were banking on this 23.4 million, a lot of those folks had nothing to worry about, and all of a sudden, at seven million, I think a lot of families, a lot of folks are gonna get pulled into this estate tax problem. So things to be aware of. So that's a little bit of a summary of potential tax law changes.

Now let's talk about these strategies and figure out how we can save some tax. So the first one... we're going to go through six of these, but the first one is bunching. That's right, bunching, or accelerating deductions. What does that mean exactly? I have a lot of folks that ask, is that legal? How does it work? Ramping up your tax savings through bunching your itemized deductions can be a very powerful way to save some taxes. So keep in mind that we all have a standard deduction now, so we're talking about itemizing here versus using the standard deduction.

But just some examples to think about: if you made a charitable donation, if your plans were to make a charitable donation every year of ten thousand dollars, and we did that in, say, 2021, 2022 and 2023, you can see on your screen that that charitable donation over three years would equal thirty thousand dollars. That's simple math. Mortgage interest, let's say, was six thousand dollars in each of those years, and then your SALT deduction, so your state and local tax deduction, a maximum of 10 000 per year. All of that combined creates about a 315 dollar tax savings, and this assumes someone who is in a pretty high tax bracket, in the top tax bracket.

So let's think about that for a minute. Over those three years you ended up with 945 dollars of total tax savings. Now let's compare that to lumping or bunching those charitable donations. So if we took all of them and gave 30 000 in one year, how would that affect you? Well, the bottom line is you'd save 7 315.

instead of saving 945 dollars. So same set of circumstances here, same mortgage deduction, same SALT deduction, all things being equal. The only thing that we did different was we bunched the itemized deduction. So if you were going to give anyway, go ahead and do two or three years at one time. You can see by what I'm showing you that the savings is well worth giving in advance.

So keep that in mind. That is a tremendous opportunity that a lot of people miss. If you're going to give anyway, might as well go ahead and do it.

So, accelerating deductions. Let's just talk through one more example so that you get an even greater effect here. If you're in an income tax rate, you'll notice that we have 37 percent down to 28 here, and you're doing a ten thousand dollar gift per year. We do that over ten years, well, it's a total of a hundred thousand dollars of gifting. So you've done a hundred thousand dollars across ten years. The net effect there is about a 28 or 29 000 tax savings. That's good, no question about it.

On the other hand, if we accelerated those things, if you had the ability to accelerate those ten thousand dollar gifts and you did them all at one time in year one, your tax savings all of a sudden becomes thirty seven thousand dollars. That's an extra eighty one hundred dollars or a twenty eight percent improvement in tax savings. That's well worth considering. If you can afford to do it, why not? Might as well save some tax if you can, and that's a very simple, easy way to do it.

Let's talk strategy number two: asset selection for charitable giving. What does that mean? Well, here's what it means, is not all gifts offer the same tax savings. That's important to keep in mind, because a lot of us, when we're making our donations for the year or we're thinking about our charitable planning, we sometimes get too simple-minded and we'll think, well, I've got this, I want to give, or I'm going to do this, or I'm just going to write a check. Well, herein lies the problem.

So when we're talking about, in this example, a ten thousand dollar gift, let's look at the difference that a little bit of planning can make. So if you simply gave cash, the benefit of embedded taxes being avoided, well, there's none. The benefit of the deduction is thirty seven hundred dollars. That assumes a thirty seven percent tax rate. The effective cost of the donation was sixty three hundred dollars. For you to give ten thousand cost you six thousand three hundred dollars. The charity got ten thousand, it cost you sixty three hundred, and you had a deduction of thirty seven hundred dollars, or the benefit of the deduction. Now that's great, nothing wrong with that, but let's see if we can improve it.

Let's say that we had long-term capital gains at play here and we had 50 cost basis on some stock. So we have some stock that's appreciated. Let's look at that example. So in this case, the first thing that we notice is we avoided some embedded capital gain taxes, and in this example they were worth eleven hundred and ninety dollars. Three thousand seven hundred dollars you still benefited, just like you did in the cash example, but now we've avoided the eleven hundred ninety dollars in tax, capital gains that is, and we've received a thirty seven hundred dollar benefit because of the ten thousand dollar tax deduction. Our real cost here is only fifty one 100 10. So we have improved our position. We've saved a little more in the way of the capital gains tax. The charity got the same amount; it simply cost us less money.

And then the third example: what if we had stock that we've held on to for a long time? Maybe it was something that we bought early in the game and it had very, very low cost, and so we'll call that a zero percent stock basis, or cost basis. And so long-term capital gains at play again. So let's look at the difference when that is the case. You now have a 20, almost 2 400 that we save on capital gains tax. We still save thirty seven hundred dollars by making this tax deductible contribution, and so our net cost now is, to make a ten thousand dollar gift, right, a ten thousand dollar gift only cost three thousand nine hundred twenty dollars. That's tremendous leverage, and all it took was a little planning.

So instead of cashing out of those stocks in this example and writing a check to the charity, let's think about giving the stocks. You get the same benefit as a tax, in terms of tax deduction, but you also avoid the capital gain just by simply planning a little bit. And if you're not sure how to plan for these types of gifts, call us. We'll walk you through it. We have the ability to run these calculations for you in pretty short order, and we can help you make better decisions.

Let's talk about strategy number three. Now this is important, pay attention here: offsetting a Roth conversion through giving. Everybody listening has heard about a Roth conversion, I feel sure, but not everybody can do a Roth conversion, because it can be a little bit prohibited based on taxes. The tax cost of converting to a Roth, it can get up there pretty quickly. So if you're rolling, or converting, a large IRA to a Roth IRA, everything that you convert is exposed to taxes. And so let's say that you had 250 000 in a Roth and you roll that, or excuse me, in a traditional IRA, and you roll that to a Roth, every dollar is taxed as ordinary income.

And so sometimes a Roth can look very appealing, or a Roth conversion, but if you don't have the ability to pay the tax, then you have to step back and ask yourself, is this really makes sense? But if there was a way that you could do it and reduce or eliminate that tax, would it make sense? And probably it would. So first let's talk about reducing tax cost of a Roth conversion, and then let's talk about who would be best suited for such a conversion.

So the charitable deduction from a donation, we can actually apply those against the increase in taxable income. Well, that right out of the gate sort of gives you a little bit of my thunder. That tells you if we can use charitable planning, we can probably make a Roth conversion much more attractive.

So it's ideal for people that expect taxes to be higher in the future. Maybe you expect your income to be higher, therefore taxes would affect you differently, or you simply expect taxes are going to go up. Maybe you're thinking about the landscape in the U.S. today and you're thinking, wow, we got a lot of debt, we have a lot of things working against us as a nation with lower taxes, and you might be thinking that's probably not sustainable, so we might need to raise taxes. And if you believe that is part of the long-term strategy for our country, Roth conversion might be a great possible technique for you.

It's also great for those who have a longer investment time horizon or time frame. So if you're beyond, in other words, if you have time to leave this money alone once we make the conversion, if you have five years or more, it might be a good strategy. And then if you can pay the tax cost of the conversion with non-retirement dollars, or if we can offset a lot of it with charitable planning, then you might be a suitable candidate here.

Reducing tax cost of a Roth conversion is not something that you should take lightly here. It could be a big, it could be a consequential decision that you make, and it's hard to undo it. Once you make that decision, you're going to have a tax bite. So we want to be very careful. You want to be circumspect as you walk through this kind of conversion or consider it. This is where you really need the help of a professional to walk you through what these calculations are going to look like. So it could be a wealth advisory firm like OmniStar, could be your CPA, it could be a combination.

But let's look at how this would work. So if you're paying for a conversion with no charitable deduction, if you have a 500 000 traditional IRA and we roll that to a Roth, or we convert it to a Roth, you are going to at a minimum pay 185 000 to the IRS for that rollover, or that conversion. And that again assumes we're using a 37 tax rate for all of our examples today, so keep that in mind. So if you're in that tax rate of 37 percent, this is going to line up just about perfect for you, and if you're lower, then obviously the tax by to the IRS would be slightly less than what I'm illustrating. But 185 000 to the IRS.

Now if we took that same conversion and we said, hey, I'm gonna make some donations to charity, that's already part of my plan, or it's something I've been considering and I think I'm gonna put that in practice, I'm gonna implement that charitable contribution. If you simply did, say, a hundred thousand dollars to your charity, if that was something you were going to do, then it would reduce your IRS tax payment to 148 thousand dollars. So by making that contribution, it would save you almost forty thousand dollars on your Roth conversion. That's a tremendous savings, and that's just one example. We could build this thing to save more or less, but the point here is not to save more or less. The point is for you to know that Roth conversions shouldn't be automatically counted out when it comes to your planning. It might be something that's quite appropriate, and it might be less costly than you realize. And again, if you have a longer horizon, why wouldn't you do it?

Here's a few other reasons that would make this a very, very beneficial move. So can we reduce it? Number one, do you have five years or more? So can we reduce the tax, and then do you have five years or more to let the money remain invested? And do you have the ability to either make charitable contributions or pay with after tax dollars whatever taxes would be due? If you say yes to those things, and those are doable, then okay, this might fit you.

Here are the other reasons why you'd consider it. Once you have money in a Roth, you are not, there's no mandate that stipulates a distribution like a traditional IRA. So it's 72 years old, you're not mandated to create these required minimum distributions, and if you're somewhere around retirement age, you've heard of those, but those go away. You don't have to do that.

The other huge benefit of a Roth is everything that comes out is tax free for forever, and if you leave those dollars to your family, to heirs, your children, never to be taxed. So a traditional IRA, when you leave that to your children, not only is it taxed today, but we've also lost the stretch provision of a traditional IRA. So those things are gone. That makes charitable planning, and it makes this type of planning even more important. It's even more effective now.

So let's go on to another strategy, and this is called QCD, or qualified charitable distribution. So QCD, this one's not new, but I don't think it's been talked about enough. It came into play over the last 24 months, and here's what it says. Basically it says up to a hundred thousand dollars, up to a hundred thousand dollars from your IRA can be distributed directly to a public charity.

Now why is that important? First, the QCD eligibility begins at 70 and a half years old. Your required minimum distributions, if you're not already taking them, that's been moved to age 72, but this QCD, for planning purposes, you can start using this as early as 70 and a half. So that's something important to keep in mind. Up to a hundred thousand dollars.

Why is that important? Well, here's why. It offers you the advantage of reducing your adjusted gross income by using, instead of using below the line deductions, which don't give you the same tax treatment that's saying an above the line deduction or simply not going on the tax return at all. You don't get the same benefit. So below the line deductions, you want to avoid those if possible. Don't avoid them if it's the only thing you have, it's better than nothing, but if you can get above the line, or simply avoid it going on your tax return, you're going to get a much better result. And so this QCD, or charitable distribution, it allows for this contribution, or this distribution to a charity, to never go on the tax return. So it also reduces your required minimum distributions.

Here's what this thing would look like. If you move a hundred thousand dollars from your IRA to a qualified charity, as long as we move that money using what's called an institution to institution transfer, you can move a hundred thousand dollars in any year with no chance of it hitting your tax return. Tremendous opportunity there, a great way to plan. Keep in mind, you cannot, the one thing that you can't use here is, are two things: private foundations and DAFs, or donor advised funds. Those are not eligible recipients, but everything else fair game.

So you utilize the QCD when you have situations that include these things. So when the donor cannot itemize, if you can't itemize, all you get, your standard deduction, which is far better than it used to be, QCD might make sense. The majority of your assets are held in an IRA, obviously the QCD makes a lot of sense. Your required minimum distributions, they can push you into a higher tax bracket. If that's about to happen and you're going to make some charitable

contributions anyway, QCD would be a potential solution. And then for any immediate donation, just things that you want to do and you want to use the least friendly tax dollars in your portfolio, use the IRA dollars to make these immediate donations.

Now, giving appreciated securities, well, that might be an even better option. So when the donor can itemize their deductions, use that method, appreciated securities. If you own highly appreciated assets in taxable accounts, we're not talking IRAs now, taxable or non-qualified accounts, if you have highly appreciated assets, want to use those. And then the required minimum distribution, if you don't expect it to push you into a higher tax bracket, using the appreciated securities, that might be a better option.

And lastly, for long-term strategic planning, giving these types of assets, so highly appreciated things, to a donor-advised fund, you get the benefit of the tax deduction. Now, where using the QCD you can't, you can't give and receive the benefit if it's going to a donor-advised fund, but with appreciated securities you absolutely can. So keep those things in mind. Qualified charitable distribution, or a QCD, big, big benefit.

Now, number five, we're gonna get a little more complicated. Stay with me. It's not that complex, but it has a few more moving parts. I think you'll like this one, particularly if you're a person with, or a family with, highly appreciated assets, or maybe more appropriate to say if you have a need for income, or if your children or grandchildren maybe have a need for income and you want to take care of them. This could be a tremendous benefit or strategy that can eliminate an enormous amount of tax. In some cases it can eliminate all of the tax when it comes to something like an IRA.

So an irrevocable trust, let's talk about this. What is the charitable remainder trust? It's an irrevocable trust that generates the potential for income streams for you or your beneficiaries. Now, the remainder of that trust has to go to a charitable institution or organization to qualify for this tax treatment that we're about to talk about. And there's two types here. There's a charitable remainder unitrust and there's a charitable remainder annuity trust.

Now, what's the difference? Well, the unitrust is my favorite, because payments are a fixed percentage of the trust value each year. That means if the trust value goes up, so as your market value increases, you get a raise each year. The downside of that is if we have a bad market year, maybe things are down a little bit, you might get a little, a reduction in your distribution. But over time we generally see value of securities and portfolios go up, so the unitrust tends to be my favorite. The annuity trust, on the other hand, same mechanism, but it's a fixed set of payments. They never change, regardless of the value in your trust.

Now, how does this thing work? It's pretty, it's actually pretty simple. Let me walk you through an example, and I think you can see this on the screen. You make a contribution to your charitable remainder trust. A partial tax deduction is generated when you do that. The charitable remainder trust holds the assets, and then it pays you an income stream for a predetermined time. At the end of that time, whatever that period is, and whether it's making payments to you or your family members, at the end the remaining amount in the charitable remainder trust goes to the charity or charities of your choice.

Quick side note here: you've got to keep in mind that a certain amount has to be left in that trust. It's something referred to as the 10 remainder rule. I won't get into that right now, because that's a much deeper subject and we don't have time for it, but we can certainly educate you on that if you find this to be something that you want to explore.

So who is a good candidate for this charitable remainder unitrust, or what we call a CRT? Clients who want to make immediate charitable deductions, but they also have a need for income or income stream, either for yourself or another person in your family. Perhaps also a good option for clients who want to provide for heirs, maybe the next generation. And if you want to benefit a charity, that's also key. If you're not charitably inclined, this is probably not a good tool for you.

So let's talk about it. Let's talk about the charitable remainder trust with a little spin on it here. This is very important for people with IRAs. IRAs, as we all know, probably the least efficient method of transferring wealth that we can talk about, or that we know of. And here's why: IRAs are included in your estate for estate tax purposes, and the monies inside of the IRA are income taxable. So a double whammy, if you will, and that's a big one to consider.

So if you have IRA assets, this could be a great solution. But let me give you a warning: this is only a good strategy if you have some charitable intent, or if you think that charitable giving is something that you want to make part of your plan. Now, if you're already a philanthropist or you're already charitably inclined, then we're talking about something that probably will interest you.

So here's how it works. You're the donor, you own the IRA. Instead of you leaving that IRA outright to your children or your grandchildren, whoever it is. Today we don't have that stretch provision that a lot of you are probably aware of, but when we lost that, all of a sudden we don't have this leverage any longer that allowed us to leave that IRA in a tax-deferred instrument over the beneficiary's lifetime. We lost that. And so now what's the next best option? Well, you can leave it in that IRA when your family or your heirs inherited for no more than 10 years, and then it all has to come out, and that means they're going to pay a lot of tax.

What's the alternative? Well, you could leave your IRA, or you could name your charitable remainder trust as the beneficiary. And when you do that, no tax is paid when that IRA is distributed to the CRT, or the charitable remainder trust. The charitable remainder trust then pays out, based on your wishes, income to your children, and eventually the remainder goes to your favorite charity or charities. That is a win-win. If you want it to benefit your charities, you do that, and if you want to benefit your children with a much better than a 10-year window in which they can leave the money in the IRA, in this case you could set it up for 20 years. So this effectively brings back at least a version of what we all knew as the stretch provisions.

So charitable remainder trusts, they used to only be talked about for purposes of highly appreciated property, real estate mostly. And if you had real estate, you'd put it into this charitable remainder trust, sell it inside the trust, avoid the capital gains, take the income, get a tax deduction, and then leave something to your favorite charity. Well, still popular, still a great technique, but let's not forget you can make just as much progress, you can be just as effective with the charitable remainder trust when it comes to your IRA. So don't forget that one.

Now, that's five strategies. All are not just good strategies for putting charitable planning in your wealth management process, but these are charitable strategies that are going to save you a lot as it relates to tax. These things are not only going to help you reach your goals, but they're going to help you avoid tax. That is truly a win-win.

Number six, let's talk about the last one. That is testamentary gifts. Now, there's charitable tax incentives when it comes to estate planning, and I just want to remind you, today's federal tax exemption, it's 11.7 million dollars per person, so 23.4 million for a couple. Highest tax rates only 40 percent. Only, that's a lot. Unlimited deduction for charitable contributions. But that is potentially going to change, and if it does, you're going to have a much different set of rules to learn, to know, and planning.

I was talking to an attorney out in Washington State just a couple of days ago. She's working with one of our clients out in Washington, and Katie and I were talking about these presumed changes. Maybe they won't come to fruition, but we were talking about just how onerous these things are, and they can be. They are significant. If they're passed as written, these are going to make, it's going to feel draconian in a lot of ways to a number of listeners, and you got to be prepared for that.

So remember, these exemptions today at 23.4 million, we're talking about going down almost two-thirds, or maybe a little more than two-thirds, down to seven million, with an estate tax rate of 45 percent. So are these planning techniques more valuable today? Absolutely they are. Will they be talked about more? Rest assured. People like Katie out in Washington, she's already gearing up for it. She surmised that this will be her busiest planning year, and she's been practicing estate tax law for an estate tax savings techniques for I believe about 25 years, and she expects this to be a very, very busy season. I agree with her.

So let's talk about these gifts, then, from trusts and your estate, and the deduction that would come with that. Here's what you have to know. You can make gifts from your trust or your estate, and you will certainly get the deduction. That will remove assets as it relates to the estate tax calculation. However, if you have something like an IRA, or what we call an income with respect to decedent asset, it's not as simple as saying that you want that to go to a trust or to a charity. The reason is, it's a double taxed instrument. So if it has accumulated taxes, and someone's got to pay those taxes, and it could also cost them estate tax.

So what's the real answer here, or what's the right answer? The right answer is name IRD assets to a charity, so that those things escape the estate tax wrath. That's one part of the solution. The other part of the solution is early planning. Let's figure out what legal documents you need, what strategies will fit best, what are your goals and objectives, what are you trying to accomplish, and let's design strategies that fit what you and your family are trying to accomplish. What's most important to you is the way that you should plan.

So keep all these things in mind. There's a lot that we went through today. I know I filled your heads with a lot of good information, and you might forget some of it, but don't worry, we're going to have this on our website. You can come read about it, we'll have all the slides, you'll be able to learn more. And if you want to talk to us, you can reach out by email, you can check us out at omnistarfinancial.com, or you can ring us, set up a time to do a Zoom call. We'll go through all of these things with you, and we'll tell you if it makes sense for you to consider them.

So until our next show, I wish you the best. Thanks for joining us, and hey, make sure you check out these strategies. Get those taxes down. See you next time.

Thanks for joining us on We're Talking Money. Be sure to visit us at omnistarfinancial.com, where you can learn more about how we provide value to our clients. Subscribe to the show and our newsletters, and drop us a line with topic suggestions for upcoming shows. If you enjoyed the show, we would appreciate you passing it on to a friend and providing a rating on iTunes.

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