Charitable tax planning for clients may peak in the later months of the year, but it is really a year-round activity, and the first quarter is not too soon to start thinking about it. Texas Tech University recently approved a new online Graduate Certificate in Charitable Financial Planning. I asked the program director, Russell James, a CFP and lawyer, about including charitable planning in our talks with clients.
BROACHING THE TOPIC
I think a great approach is to use a slice of pie. Here's what I mean: When talking about estate planning, explain to clients that, at death, they can leave assets to three groups: people, charity and government. Ask them to draw their own ideal pie chart on what percentage they want to leave to each group. If charity gets zero, then you don't need to bring up the issue again.
But, if charity gets some share, then you can use a whole range of charitable planning techniques to get immediate tax advantages for your clients. The great thing about this technique is that it is very powerful even if your clients don't have charitable interests. Most likely the percentage the clients want to leave to government is lower than what they would currently lose in estate taxes. This opens the door for suggesting estate planning techniques to reduce this gap.
EASY WAYS TO HELP CHARITABLE CLIENTS
A lot of the techniques covered in our graduate program are quite complex. But there are also some very simple - and powerful - steps that any planner can use.
First, if your client regularly makes charitable gifts with cash, see if you can replace these cash gifts with gifts of appreciated securities. A gift of appreciated securities held for more than a year creates a tax deduction based on its current fair market value. But there are no capital gains taxes on the gift. Essentially, the client avoids paying capital gains tax on any gifts made with appreciated securities instead of cash.
Most people don't realize that this can happen even without changing the portfolio. If clients like a stock that they just gave away, they can simply purchase more of it with the cash that they were originally going to give to the charity. They don't even have to wait for 30 days, because wash-sale rules only apply to losses, and the clients are giving appreciated stocks. For clients who were donating anyway, you have increased their tax basis in their portfolio for free.
Another simple strategy is to set up a donor-advised fund for clients for end-of-year transfers. If clients have sufficient liquidity, they can shift all of the money they expect to give in the following year into their donor-advised fund.
Clients can take the deduction at the time of shifting the money into the donor-advised fund (usually in December), and then gradually pay out to charitable organizations over the course of the following years. This allows clients to take the deduction earlier, but still be able to respond to charitable requests throughout the following years.
This is also a nice stepping stone that can lead to client interest in establishing larger donor-advised funds or private foundations. Any assets in the donor-advised fund can still generate fees for assets under management until they are paid out to charities. There are no minimum payout requirements for donor-advised funds. This means clients can take their time in deciding which charities to benefit, even though the deduction may have been taken years earlier.
IMMEDIATE TAX BENEFITS
There are a variety of sometimes complex techniques that can create immediate tax benefits in exchange for an irrevocable pledge to leave something to a charity at death. The commitment to leave a gift at death has to be irrevocable in order to get the tax deduction. (Otherwise, you could take the deduction and change your mind later.)
Let's start with a simple case. If a client records a remainder interest deed that gives a charity the right to receive part or all of a home or farmland at death, the client can take an immediate tax deduction for the discounted value of that real estate. The tax deduction is based upon the current value of the property discounted by the client's life expectancy and the IRS interest rate. With current interest rates being so low these days, these tax deductions are huge.
For example, last month the IRS interest rate fell to a historic low of 1.4%, according to IRS code 7520. At this rate, if a 54-year-old client gave a remainder interest deed in $100,000 of farmland to a charity, the immediate tax deduction would be $70,000. The client gets this 70% deduction, even though he or she keeps the land for the rest of his or her life.
This powerful technique gets even more powerful when combining it with other planning strategies. For example, the client can use the value of the tax deduction to pay for life insurance for his or her heirs. If the life insurance is held by an irrevocable life insurance trust, the heirs can receive the death benefit with no estate taxes. Or consider a client who wants to make a large conversion of a traditional IRA to a Roth IRA, but doesn't have the liquidity to pay all of the taxes. The charitable tax deduction from the remainder interest can help to offset the taxes generated by the Roth IRA without using any current cash. Of course, these are subject to various limitations and rules, but the basic concept is quite powerful.
For larger transactions involving appreciated securities, there are a variety of other techniques such as charitable remainder trusts, charitable lead trusts and so forth. The basic concept of getting an immediate tax benefit in return for a future transfer to charity is similar.
Readers can review for free all of the content of our graduate course, Introduction to Charitable Planning, at EncourageGenerosity.com. This is a sample of our new online Graduate Certificate in Charitable Financial Planning.
Each lecture is also approved for CFP continuing education credit, and includes a quiz that generates documentation of success in understanding the topic. If you have employees at your firm who you want to train, you can use the documentation as proof that they have completed the training and understand the concepts.
In our Advanced Charitable Planning course, we discuss sophisticated strategies that often involve stacking multiple techniques. Let's say we have charitably inclined clients wanting to sell a large business and to create a multigenerational family and charitable dynasty.
We can transfer the business to a charitable remainder trust that allows the business to be sold without generating any immediate capital gains taxes. The clients can take income (a percentage of the trust assets) each year from the full value of the asset, unreduced by capital gains taxes. The clients also get an immediate income tax deduction for the present value of the future charitable transfer. We can use the value of that deduction to purchase tax-protected life insurance for the heirs. The clients can receive income for the rest of their lives and then, at death, the trust can pay out to the client's own private family foundation.
This foundation can be managed exclusively by the heirs, including payments for reasonable costs of administering the foundation, attending meetings and such. The foundation need only pay out 5%, less administrative costs, allowing the corpus to stay largely intact forever.
Deena Katz, CFP, is a Financial Planning columnist and an associate professor of personal financial planning at Texas Tech University. She is also chairwoman of Evensky & Katz, an advisory firm in Coral Gables, Fla.