A Guide to Differentiating Your Value

A recent study by U.S. Trust, in partnership with The Philanthropic Initiative, found that more than half of high-net-worth investors believe their advisor should play an important role in their charitable giving efforts. But 61 percent of those investors also say they initiate the conversation, not their advisor. How can you change the dynamic and ensure that you’re actively helping your clients meet philanthropic goals? By expanding your knowledge of the more technical aspects of charitable giving solutions.

Charitable deductions are generally equal to the fair market value of the asset when the charity takes ownership, unless the asset has short-term appreciation. For a short-term appreciated asset, the deduction is equal to the basis.

The IRS has limited the amount of the charitable deduction a taxpayer can claim. The limit is based on the type of charity the assets are contributed to, as well as the type of asset contributed. The charitable deductions for gifts made to public charities are limited in each tax year to 60 percent of adjusted gross income (AGI) for gifts of cash and 30 percent of AGI for long-term appreciated assets. For clients looking to contribute to a private foundation, deductions are generally limited to 30 percent of AGI for cash gifts and 20 percent of AGI for long-term appreciated assets.

The good news is if your client is not able to use his or her charitable deduction fully in a given tax year because of the AGI caps, he or she can carry forward any excess, unused deduction for up to five years.

Bunching gifts. Under the Tax Cuts and Jobs Act, the standard deduction has been increased significantly to $12,200 for a single person and $24,400 for a married couple. With the deduction that high, many advisors are concerned that charitable giving will no longer make a difference in clients’ bottom lines, as clients would need total itemized deductions in excess of the standard deduction in order to “feel the effect” of their charitable giving.

As such, many practitioners recommend that clients bunch their annual gifts to take advantage of the deduction. For example, let’s say you have a single client who gives $5,000 to charitable organizations annually and has the necessary cash flow. She could bunch three years’ worth of $5,000 gifts into one gift that would qualify her to itemize her charitable deduction this year, take the standard deduction for the next two years, make additional bunched gifts in the following year, and so on.

When looking into charitable giving vehicles, there are two broad categories of gifts to consider: (1) irrevocable gifts, where the donor cannot retain any benefit from the dollars donated, and (2) split-interest gifts, where the donor or another party retains some benefit.

Irrevocable gifts. The two vehicles that are discussed most often in the irrevocable gift category are private foundations and donor-advised funds (DAFs).

1. Private foundations: Because of their complex rules and restrictions, as well as the limited deduction available, these vehicles are generally appropriate only for clients able to fund them with more than $1 million and willing to do the primary research or action in their field of interest (e.g., hiring scientists to research a cure for a particular disease, traveling to Africa to install irrigation systems).
2. DAFs: A DAF is an account established through a sponsoring charity and can accomplish the same objective as a private foundation at a fraction of the cost and effort. The client makes an irrevocable gift to the DAF and can recommend charitable disbursements from it. Because the DAF sponsoring organization is a charity, the client can take an immediate up-front charitable deduction.

Split-interest gifts. Three gift types included in the split-interest gift category are charitable remainder trusts (CRTs), charitable lead trusts (CLTs), and charitable gift annuities (CGAs).

1. CRTs: A CRT provides an income stream to the donor or another individual for life or a term of years, with the remainder going to charity. The donor can take an up-front deduction equal to the present value of the remainder interest passing to the charity. But don’t assume that your client will eliminate capital gains on the asset. Although the trust is a tax-exempt entity, the trust builds up four “buckets” of taxable income: ordinary income, long-term capital gain, tax-free income, and return of principal. When the income beneficiary receives his or her income distribution, the trust will pull that distribution from those respective buckets in order. As a result, there will be some capital gains tax involved, but your client can spread it over multiple years, which often results in a lower overall rate.
2. CLTs: The opposite of a CRT, a CLT provides an income stream to a charity for a term of years, with the remainder reverting to the donor or other individual(s). One of the most valuable uses of a CLT is as an estate tax freeze. In a nonreversionary CLT—where the remainder interest passes to someone other than the grantor (e.g., his or her children)—the gift’s value is determined on the date it is made to the trust and is equal to the present value of the remainder interest. So, if the grantor has an asset that he or she believes will continue to appreciate, he or she can contribute it to the CLT and freeze the value of the asset for gift and estate tax purposes. In this case, the donor wouldn’t be eligible for a charitable income tax deduction. Instead, a charitable gift tax deduction might be available, and the trust would be able to deduct the income payment made each year to the charitable beneficiary.
3. CGAs: A CGA is established with a charity—the donor gives the organization an asset or sum of cash in return for the charity paying the donor an annuity for life. The donor can then take a charitable deduction equal to the difference between the annuity stream’s present value and the contribution’s value. Generally, these contracts must be established directly with an active charity, which usually means advisors aren’t able to participate in the transaction.

Wealth replacement trusts. For clients who balk at giving away a large part of the wealth they could pass along to their heirs, a wealth replacement trust may be their best option of these charitable giving solutions. The client purchases a life insurance policy with a value equal to the asset transferred to a charitable vehicle. That insurance policy is purchased within an irrevocable trust that benefits the client’s family—similar to an irrevocable life insurance trust. Often, when used in conjunction with a CRT or CGA, the premiums for the insurance policy within the trust can be paid using the income generated from the CRT or CGA.

Beyond cash and securities, clients may hold valuable specialty assets that they would like to gift to a charity. Some of the most common specialty asset gifts include shares in a closely held business and real estate (e.g., a vacation home). Art, wine, livestock or farm crops, and even collectibles like stamps or baseball cards also have potential as charitable gifts.

Gifts of specialty assets come with their own rules and restrictions. The most important thing to consider, however, is that clients can unlock value in some of these assets by contributing them to a charitable vehicle. If you have clients thinking about donating these types of assets, be sure to consult with a charitable giving expert who can help you analyze the opportunity.

In an investment management space that has become much more crowded and competitive, having regular philanthropic discussions with your clients can help you demonstrate your value as a financial planner. By understanding the technical aspects of charitable giving solutions, you can provide your clients with effective methods to meet their tax, estate, and legacy planning needs.

Commonwealth Financial Network^® does not provide legal or tax advice.

Do you think the Tax Cuts and Jobs Act will have a noticeable impact on your clients’ charitable giving? How are you helping your clients maximize their charitable deductions? Please share below!