Strategies for more-effective year-end giving | Capital Group

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Strategies for More-Effective Year-End Giving

By Aaron Petersen
Senior Wealth Specialist

The end of the year is a time when many families make decisions about charitable giving. Donating to favored causes benefits more than the philanthropies themselves. Research shows that giving to charity can make you happier and is even good for your health. Plus, it can result in a sizable tax deduction, especially if you structure your contribution appropriately.

But before you open your checkbook, it’s important to make sure you are achieving your goals in the most efficient way. In short, you want to give strategically. Beyond deciding which organizations to support and how much to give, you need to choose what to give. This means deciding whether to give cash, stock or other types of assets. You also need to consider how to give, such as donating directly to a public charity or setting up a private family foundation. These choices depend in part on your personal values and philanthropic goals. Understanding the various options helps to ensure that both you and your favored causes will derive the maximum benefit. Such decisions must be made before December 31 of this year to apply to your 2014 taxes.

Making the right tax moves is especially important given last year’s increase in tax rates for high earners. The top marginal rate rose to 39.6% from 35% on income exceeding $400,000 for singles and $450,000 for married couples filing jointly. The capital gains rate also rose for people in upper brackets, to 20% from 15%. In addition, upper-income earners are now subject to the 3.8% Medicare surtax on investment income that was implemented as part of the Affordable Care Act. It applies to the lesser of either net investment income (including interest, dividends, annuity income, rents, royalties, capital gains and passive income activity) or modified adjusted gross income (MAGI) that tops $200,000 for single taxpayers or $250,000 for married couples filing jointly. For the surtax to apply, taxpayers must have 1) net investment income and 2) MAGI that exceeds the threshold amount.

It’s crucial to decide whether to give cash, securities or other assets.

The first steps in philanthropy, of course, are choosing to whom and how much to give, and whether it will be a one-time gift or ongoing assistance. After that, you need to determine what to give. The most straightforward gift is cash — simply writing a check to one or more charities. All else being equal, a $1,000 donation for someone in the 39.6% bracket will reduce federal taxes by $396.

Another option is to donate publicly traded stock or other securities. Given the strong advance in the equity market in the past five years, many taxpayers hold shares with significant long-term gains. Qualifying taxpayers who donate stock to public charities (private 501(c)(3) organizations) can deduct the fair market value of the appreciated securities rather than the cost basis for which they were purchased. In other words, some investors can avoid taxes on long-term capital gains while still receiving write-offs for the full value of their shares. Other types of assets that can be donated include art and automobiles.

Clients often ask whether they should support public charities or carry out their philanthropy through specialized vehicles. There are three basic options: donate directly to a public charity, set up a private foundation, or use a donor-advised fund. Each has benefits and limitations, as outlined in the chart on the opposite page. The choice largely rests on the tax implications, how involved donors want to be and how much time they can devote to the process.

Foundations give donors more control but carry higher costs.

A family foundation is a tax-advantaged entity created to distribute money to other charitable organizations. A key benefit of a foundation is that it allows the benefactor to maintain hands-on control, including oversight of investments and selection of recipients. Creating a foundation is also a good way to foster family involvement, now and in subsequent generations, and to establish a personal legacy of philanthropic commitment.

Unlike giving to a public charity, however, setting up a foundation can involve significant up-front and ongoing legal and administrative costs. Thus, foundations generally require larger financial commitments, typically of several million dollars. In addition, they are subject to strict regulatory oversight by the Internal Revenue Service. In general, foundations must pay annual excise taxes of 1% to 2% of net investment income. They are also required to distribute at least 5% of net investment assets each year.

Donor-advised funds are another potential option.

Donor-advised funds are a cross between public charities and private foundations. They are easy to set up and relatively inexpensive to maintain. However, donors have less control over how the entities are managed and the funds are doled out. Benefactors can recommend charities, but they cannot order that their money go to specific organizations.

Qualifying taxpayers can make up-front donations to the fund and receive an immediate tax deduction even if they will not make recommendations on how to distribute the contribution for years to come. That can be beneficial in a year in which a donor has especially high income and wants to maximize tax savings, while making distributions to charity over time.

For years in which donations exceed adjusted growth income limits, qualifying taxpayers may be able to carry forward the excess contributions for up to five years, thus potentially lowering their future tax burdens. This applies to charities, donor-advised funds and private foundations.

Donating to public charities brings greater tax benefits than giving to foundations.

Given that charities and foundations are both engaged in benevolent causes, it would seem logical that the federal tax rules applying to them would be similar. But there are significant differences in tax treatment for charities and foundations. (The rules for donor-advised funds are similar to those for charities.)

The rationale is that people who allocate money to public charities give up their decision-making ability, whereas those who set up private foundations are able to retain full control over their funds. And though there are stringent IRS regulations to prevent this, there is the potential for abuse by foundations.

In general, gifts to public charities (and donor-advised funds) carry larger tax benefits than those made to foundations. Cash contributions to charities can be deducted up to a maximum of 50% of adjusted gross income. For a foundation, the limit is 30%. Thus, a donor with an AGI of $500,000 could deduct as much as $250,000 for cash allocated to qualifying organizations, compared with $150,000 for money allocated to a foundation.

For publicly traded stock or real assets given to a charity, the maximum deduction is 30% of AGI. For a foundation, it’s 20%. Therefore, a benefactor with AGI of $500,000 who gives to a charity could write off up to $150,000. Gifting the same assets to a foundation would bring a maximum deduction of $100,000.

Perhaps even more interesting is the difference in valuation treatment of property other than publicly traded equities, such as real estate or stock in a closely held company. Assume that a property purchased for $50,000 has doubled in value, to $100,000. If the property were donated to a public charity, the taxpayer would get a deduction based on the full fair market value of $100,000. But if the property were transferred to a foundation, the deduction would be limited to the original cost basis of $50,000.

All else being equal, someone in this situation would likely be better off selling the investment and donating the cash proceeds to the charity because the deduction for the cash donation would more than offset the tax due on the sale. Assuming the donor is in the highest tax bracket, he or she would pay a long-term capital gains tax of $10,000 ($50,000 in appreciated value multiplied by a 20% tax rate) while qualifying for a deduction of $100,000, netting $29,600 in federal tax savings.

Tax rules are often complex and have diverse applications for different individuals. That is why it is extremely important to consult your tax or legal advisor before implementing any of the strategies outlined above. We would be happy to evaluate your situation through a customized planning analysis with our Wealth Advisory Group. Just contact an Investment Counselor for further information.

Aaron Petersen is a Senior Wealth Specialist for Capital Group Private Client Services. Aaron works on various wealth and investment planning issues, with a particular expertise in retirement planning matters. He joined Capital Group in 2000.

The views expressed herein are those of the author and do not necessarily reflect the views of everyone at Capital Group Private Client Services. The thoughts expressed herein are current as of the publication date, are based upon sources believed to be reliable, are subject to change at any time and should not be construed as advice. There is no guarantee that any projection, forecast or opinion will be realized. Past results are no guarantee of future results. This material is provided for informational purposes only and does not take into account your particular investment objectives, financial situation or needs. You should discuss your individual circumstances with an Investment Counselor.