16TH ANNUAL PROFESSIONAL ADVISORS SEMINAR
Advisor News
Tips for Charitable Donors Who Can’t Use Deductions
Only about one-third of U.S. taxpayers itemize federal income tax deductions, meaning that the other two-thirds, when they make charitable contributions, generally receive no tax benefits. Nonitemizers also include individuals with relatively high incomes. IRS statistics for the most recent tax year available showed that nearly 2 million taxpayers with adjusted gross income of $100,000 to $200,000 used the standard deduction. Roughly 200,000 returns filed by taxpayers with AGI of $200,000 to $1 million also did not itemize.
IRS studies indicate that older taxpayers, in particular, use the standard deduction, which for 2012 is $7,400 for individuals who have reached age 65 and $14,200 for joint returns where both spouses are 65 or older. Seniors often no longer have mortgage interest to deduct and also incur lower miscellaneous expenses and state sales or income taxes.
A few donors have the opposite problem: They are unable to deduct all their charitable contributions due to the deduction ceilings (50% of adjusted gross income for cash gifts and 30% for gifts of long-term capital gain property), even with the five-year carryover for excess deductions. But tax savings may yet be available to these donors, apart from the charitable deduction, and it may be possible to restore deduction benefits to nonitemizers.
Tax and financial planners generally recommend a four-part strategy for reducing clients’ income taxes: Deduct as much as possible (or strive to qualify for tax credits); divert investment income to persons in a lower income tax bracket; defer tax liabilities to a future date through qualified retirement plans, savings bonds, growth stocks, deferred annuities, etc; and convert from ordinary income investments to arrangements with better tax results, such as qualified dividends, long-term capital gain investments and bonds that produce tax-exempt interest. All of these strategies have counterparts in charitable gift planning that can produce tax savings for clients who can’t use charitable deductions.
Copyright © by R&R Newkirk. All rights reserved.
Donors Should Get Their Deductions in a Bunch
“Doubling up” (or tripling up) on charitable deductions by pre-paying future years’ annual contributions to one’s house of worship, college, hospital or other charities is a traditional strategy. A 70-year-old widow who distributes $5,000 annually to various organizations could instead give these charities $15,000 every three years, preferably in appreciated securities. (Note that even nonitemizers save by giving appreciated securities.) Another plan would be to make several years’ worth of annual contributions to the donor advised fund of a community foundation or a “commercial” donor advised fund (operated by companies such as Vanguard and Fidelity). The deductions could be sufficient to let donors itemize, and they can “advise” charitable grants over the next several years.
Copyright © by R&R Newkirk. All rights reserved.
Diverting Income to Charities May Reduce Multiple Taxes
For the last six years, qualified donors have been able to divert minimum required distributions from IRAs to charitable organizations (qualified charitable distributions). No charitable deductions were available, but donors weren’t taxable on their RMDs, which reduced not only taxable income but also adjusted gross income – the measuring stick for a variety of tax penalties. In some cases, QCDs also reduced state income taxes, possibly in states that had no contribution deductions. Charities and donors are hoping Congress will restore QCDs for 2012.
Clients also have the ability to divert interest income to charities via interest-free loans (maximum of $250,000 per charity), although that benefit may be marginal in times of low interest rates (Temporary Reg. §1.7872-5T). High-wealth donors who are hamstrung by contribution deduction ceilings may also have transfer tax exposure that would be alleviated by inter vivos charitable lead annuity trusts that transfer assets to heirs at reduced gift taxes. Nongrantor lead trusts also reduce donors’ income taxes indirectly by diverting investment income to charitable organizations during the trust term.
Copyright © by R&R Newkirk. All rights reserved.
Deferring Income through Unitrusts and Gift Annuities
A “flip unitrust” can work well for clients who: (1) want to make a gift today, obtain a tax deduction and receive lifetime income, but postpone most or all of the income until some future date (the year they retire, for example), and (2) want to make a gift and at the same time arrange for young grandchildren (or children) to receive payments when they start college – five, ten or 15 years in the future. Income deferral enables the trust to grow considerably, tax free, before payments are needed.
The flip unitrust is a special form of charitable remainder trust that initially pays little or no income, depending on how the trust is funded or invested. The trust assets may appreciate greatly in value for several years. Later, after a specified date or “triggering event,” the trust “flips” to become a standard unitrust that pays beneficiaries a fixed percentage of, say, 5% or 6% of an expanded trust principal. Most donors who set up unitrusts want their income to start right away. But the “flip trust” is ideal for people who want to reduce taxes, save more for retirement, establish a college fund, or achieve other goals – while helping a worthwhile cause, as well.
Deferred payment charitable gift annuities offer a different plan: The donor transfers cash or securities in exchange for a charity’s promise to pay a fixed annuity to one or two individuals for life with the first payment occurring at least one year after the date of the gift. Most charities offer deferred payout rates based on recommendations of the American Council on Gift Annuities. Payout rates are higher for deferred annuities than for immediate payment gift annuities: the longer the deferral period, the higher the payout rate. The amount transferred to a charity, less the present value of the lifetime annuity retained for one or two persons, is deductible. Charitable deductions are higher for deferred payment annuities than those available for immediate payment gift annuities. In recent years, many donors have established “flexible” deferred gift annuities that allow them to extend the first payout beyond the date originally selected, and receive large annual payments. Payments can start earlier, as well, at reduced amounts.
Copyright © by R&R Newkirk. All rights reserved.
Converting Assets to Income with Good Tax Results
Clients can convert from investments taxed as ordinary income to payments that are tax free or taxed at lower rates (qualified dividends or long-term capital gains, for example) through charitable gift annuities and charitable remainder trusts. Gift annuity payments currently can be as much as 75% to 85% tax-free return of principal during a recipient’s life expectancy. Charitable remainder trusts offer the opportunity for payments to be taxed as long-term gain or qualified dividends, under the four-tier system of CRT taxation. Tax-free payments are possible, as well, from tax-free interest or distribution of corpus (which come after ordinary income and capital gain payments).
Both of the foregoing gift arrangements also offer the opportunity to liquidate highly appreciated assets with reduction or avoidance of capital gains taxes. Real estate investors, or owners of collectibles, may decide to transfer assets laden with capital gains to charitable remainder unitrusts – not so much for the charitable deductions available as for the ability to sell the assets within a tax-exempt trust that will provide a lifetime stream of income to beneficiaries.
Copyright © by R&R Newkirk. All rights reserved.
Applicable Federal Rates
December 2011: 1.6%
January 2012: 1.4%
February 2012: 1.4%
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