Many individuals desire to make charitable bequests but are not certain how to do so or how they work. This is an area where a CPA can offer valuable assistance. There are many issues—some tax-related, some not—but the overriding concern is the client’s desire to do some good with what they’ve accumulated.
There are many ways clients can create legacies. Contributions can be made directly or indirectly, with or without conditions, and while they are alive or upon death. Based upon individual circumstances, what might work for one client might not be effective for another.
The easiest and least complicated type of bequest is a cash donation to the charity. The donation can be made with restrictions if it is not going into the general fund, and the bequest can include programs that would last several decades if sufficient amounts are donated. If the client does not want to make the contribution during their lifetime, she can leave instructions in her will, a trust, or even as a designation in a retirement fund. Such donations will not be disbursed until after death, and then only in accordance with the governing document. Appreciated securities can also be donated instead of cash. This allows the donor to avoid recognizing the capital gain on the stocks or reducing her cash balance by writing a check.
Some people pledge amounts that will be provided over extended periods. This provides immediate recognition, allows the charity to plan programs using those funds, and can allow the donor to accumulate or earn the amounts that will be contributed.
If contributions will be sufficiently large, some clients might want to establish a private foundation under IRC Section 501(c)(3). Such a foundation can be created during an individual’s lifetime with currently made contributions or after death with bequests. Either way involves costs in setting up the foundation, operating and managing it, and complying with IRS and state regulations and filings. Some set up foundations with nominal amounts and use them minimally during their lifetimes, intending to make substantial bequests at a (hopefully much) later time. Until then, the donor can act as trustee and conduct the affairs of the foundation on his own.
A donor-advised fund (DAF) is an alternative to a foundation. Like foundations, DAFs can be established during lifetime or at death. A contribution of cash or stocks can be made to a DAF, for which the donor will be entitled to a tax deduction for the year of contribution. The fund amounts are then segregated by the DAF, invested conservatively, and held until eventually disbursed to the charities designated by the donor. Designations can be made at any time and in any amount the donor wishes. The funds transferred to the DAF cannot be returned to the donor, nor does the donor have any rights to the funds; the donor can, however, make recommendations of distributions to a public charity. Usually the DAF will comply with these requests, but the donor should make sure of this before opening the account.
Any earnings of the DAF, excluding administrative charges, will be added to the donor’s account and available for future contributions. There is usually no time limit, so contributions could be housed in the DAF for many years. No tax forms need to be filed, and there are no required statement filings or compliance actions. When the donations are made to the recommended charity, the donor will not receive a tax deduction (since she already received one when she contributed to the DAF); however, the charity can receive a letter acknowledging that the donor was the contributor. There is no minimum annual contribution amount for the DAF to make, as there is with foundations. Contributions can be made in the donor’s name or any family member’s, and family members can be designated to make recommendations. Contributions can also be made anonymously. Restrictions and special designations can also be placed on the contributions as long as the charity agrees to the conditions.
There are numerous organizations sponsoring DAFs, including many commercial vendors and some large charitable organizations. Minimum contributions to open a DAF are $5,000–$10,000, depending upon the DAF; some DAFs require no minimum contribution at all.
Like foundations, DAFs permit an accelerated charitable tax deduction using appreciated stocks without being taxed on capital gains. This strategy is beneficial for someone with a large taxable gain for a given year, because she can accelerate what she would normally contribute over the next few or more years and receive an upfront deduction. Someone planning to retire in a few years can also do this in order to receive the deduction while still in a higher tax bracket and have the contributions continue when no longer receiving a salary.
Life insurance is a death-only bequest. A policy is purchased by a designated charity with the donor as the beneficiary, and the insured receives charitable deductions for paying the annual premiums. The insured can also make a single lump-sum premium payment, which would provide an upfront deduction. This would be appropriate for someone with large current taxable income that is not expected to reoccur.
Conditions and Restrictions
Conditions and restrictions are not uncommon for all of these plans and include the following:
- Naming rights to a program, professorship, bench, room, or building;
- Scholarships or research grants;
- Medical or scientific research projects;
- Contributions in exchange for an honorary degree;
- Annual awards (not scholarships) or grants based on exceptional performance in an area or intended activities, or to provide the ability for special work to be done during a sabbatical from a regular position; and
- Contributions to target a specific situation, such as for research, publicity, or preparing and distributing educational materials.
ADVICE FOR SETTING UP A DONOR ADVISED FUND (DAF)
- Open the fund with the minimum required amount, if applicable. Based upon where the fund is opened, this could range from $5,000 to $10,000.
- If possible, use appreciated long-term stocks, so the donor will receive a current tax deduction (subject to how their return is filed) for the full value of the shares and not be taxed on the gain.
- The money in the DAF can be invested in a bundled investment fund.
- The DAF can be used during one’s lifetime or after death by the beneficiaries.
- The DAF can be in the name of the donor or in the name of a person the donor wants to honor with the future charitable gifts.
- The donor’s will or trust agreement will provide for a charitable bequest to be made to the DAF.
- The DAF can be named as a beneficiary of the donor’s IRA or retirement plan.
- The donor can select people authorized to make the suggestions for the distribution of the funds after death. The donor should provide such persons with an instruction letter, possibly in his will or trust agreement.
- The DAF will remain open as long as there is a successor designated person to act on the DAF and there is a balance in the account.
- There is no cost to setting up the DAF.
- The DAF will charge an ongoing management fee that should be offset by some of the earnings on the fund balance.
- No tax returns, or any reporting, are required, and no annual professional fees are payable.
- DAF activity can be handled and tracked online or by postal mail.
- No provision is permitted to be made in the DAF for compensation to the donor advisor; however, the instructions may stipulate that the donor advisor can make a certain amount of contributions from the fund to her own preferred charities.
As with any area of financial planning and charitable contributions, there are many ways to accomplish the same goals. Methods not covered above include the following:
- Charity gift annuities. A lump sum is paid to the charity in exchange for a guaranteed cash flow for the rest of the donor’s life. The charity receives the residual amount, and some current tax deductions result.
- Charitable remainder annuities or unitrusts. Large current capital gains income is sheltered in the trust, resulting in a partial current deduction, and the grantor receives annual cash flow that is taxed based upon the nature of the income in the trust. The charity will receive either the residual or a stream of distributions after the death of the grantor.
- Charity lead annuities or unitrusts. These are similar to remainder trusts, except the charity receives an annual cash flow and the grantor’s beneficiaries receive the residual at the end of a period that could be as long as 30 or more years.
- IRA and pension required minimum distributions. These are not legacies, since decisions are made annually, but if individual tax circumstances warrant, the required minimum distribution, up to $100,000, can be paid directly to the charity and not count as taxable income or qualify for a contribution deduction.
- IRA and retirement account designations of beneficiary. A charity, group of charities, a family foundation, or a DAF can be named as the beneficiary of a retirement account. The payments will escape income and estate tax.
The methods of contributing described above, like all contributions, have IRS-imposed maximum annual deduction amounts, which should be factored in when advising the client.
CPAs possess many tools to assist individuals with their desire to establish a charitable legacy that will last long after their lifetime. The methods suggested here bear relatively low cost (except for the insurance premiums), are controllable during one’s lifetime, and will escape estate tax and provide a current income tax deduction if made during one’s lifetime.