Issues AND INSIGHTS February 2015 Tax-Powered Philanthropy: Doing well by doing good IN THIS ARTICLE Higher tax rates offer greater potential savings from charitable giving Strategies such as outright gifts of appreciated properties, donations of IRAs, and charitable trusts can help mitigate taxes The strategy that s right for you depends on your giving and personal financial goals, level of complexity, and the assets you wish to give Carol G. Kroch, Esq Managing Director Wealth and Philanthropic Planning Wilmington Trust Company The increased tax rates and stock market growth of the past few years makes 2015 another good year for affluent, charitably inclined individuals and families to give to favorite causes. Strong market performance including double digit gains in major stock market averages has provided financial comfort to many affluent families, at least some of whom experienced significant investment losses during the financial crisis. At the same time, still low interest rates are making certain wealth transfer planning strategies particularly advantageous. And the higher income tax rates in effect since 2013 can actually increase the tax savings from your charitable gift. After over a decade of uncertainty, The American Taxpayer Relief Act of 2012 (ATRA), which was effective starting January, 2013, ushered in welcome certainty on the income tax, the alternative minimum tax (AMT), and the three wealth transfer taxes (estate, gift, and generation-skipping transfer or GST). However, for higher-income taxpayers, ATRA increased income tax rates on ordinary income, capital gains, and dividends, and reinstated limitations on itemized deductions 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 1 of 8
figure 1 The important numbers for 2015 2015 Income Tax Highest Rate 39.6% Applies to taxable income over: $464,850 (married) $413,200 (single) Capital Gains (Long term) and Dividends Highest Rate 20.0% Applies to taxable income over: $464,850 (married) $413,200 (single) 3.8% Medicare Surtax on Net Investment Income Applies to Adjusted Gross Income (AGI) over: $250,000 (married) $200,000 (single) Trusts with income over $12,300 Phase-out of Itemized Deductions and Personal Exemptions Estate, Gift, and Generation-Skipping Transfer (GST) Tax Highest Rate Estate, Gift, and GST Tax Exemption (as indexed for inflation) Annual Exclusion Gift (as indexed for inflation) Applies to AGI over: $309,900 (married) $258,250 (single) 40% $5,430,000 $14,000 and personal exemptions. Particularly when coupled with the 3.8% surtax on net investment income, many higher-income families now face higher tax rates and a greater tax burden than they did before 2013. (See Figure 1) ATRA s IMPACT ON WEALTH TRANSFER TAXES In a positive move for wealthy families, ATRA made permanent the $5 million per person exemption for federal wealth transfer taxes, which comprise estate, gift, and generation-skipping transfer taxes. Indexed for inflation, this exemption is $5.43 million for 2015. Although the highest wealth transfer tax rate increased from 35% to 40%, the rate was made permanent, again bringing welcome certainty to wealth transfer planning. Of course permanence is a relative term when it comes to taxes and Congress, particularly in light of the new Congress and a Presidential election season emerging on the horizon. However, ATRA does not provide relief from state estate or inheritance taxes, some of which have an exemption of $1 million or less. As a result, planning is also important for those at wealth levels below the federal wealth transfer tax exemption who live in states that have state estate or inheritance taxes. GIVING STRATEGICALLY CAN SAVE TAXES AND BENEFIT YOUR FAMILY TOO Philanthropic planning can help you mitigate these higher tax rates while supporting your favorite charities. And some philanthropic strategies can also benefit you 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 2 of 8
or your family. The strategy that is right for you will depend on your giving and personal financial goals, the assets you wish to give, and the level of complexity with which you are comfortable. For example, an outright gift of cash to charity is simple to make, will likely provide you with an income tax deduction, and will remove assets from your estate, but will not offer as many tax planning opportunities as other, more complex, strategies such as IRA charitable distributions at death, outright gifts of appreciated securities, charitable remainder and lead trusts, and private foundations and donor advised funds. There are of course many other forms of charitable gifts, but we highlight these as being particularly suitable for high-net-worth families. (See Figure 2) A note on charitable gift planning Although every charitable gift is potentially deductible, the amount of the charitable contribution deduction for federal income tax purposes depends on a variety of factors: the kind of asset given, the nature of the charitable recipient, and the donor s AGI, as outlined in Figure 3. figure 2 What to consider when organizing your philanthropic portfolio Gifts of property (stock, real estate, art, conservation easements) Gifts of cash Family foundations, donor advised funds, and supporting organizations Charitable Remainder and Lead Trusts Giving should be entered into in just the same way as investing. Giving is investing. john d. rockefeller Gifts of IRA assets figure 3 Permitted deductible charitable contributions for federal income tax purposes Charitable Gift Categories Adjusted Gross Income 1 3 4 Gifts of Cash to Public Charities and Certain Foundations Colleges, universities, museums, hospitals, United Way-type organizations Donor Advised Funds Supporting Organizations Conduit Foundations Operating Foundations Gifts of Long-Term Capital Gain Property (including appreciated stock) to Public Charities and Certain Foundations Gifts of Cash to Private Foundations Gifts of Long-Term Capital Gain Property to Private Foundations Additional Limitations: Full fair market value deduction permitted only for gifts of qualified appreciated stock, which is stock traded on an established securities market. 2 50% 30% 30% 20% 1 Adjusted gross income does not include income exempt from federal income tax. 2 Qualified appreciated stock is limited to 10% of the outstanding stock of a corporation, including all prior gifts made by donor and family members to any private foundations. 3 Does not address phase-out of deductions for higher income taxpayers. 4 Does not address alternative minimum tax. 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 3 of 8
In general, the income tax law favors gifts of cash over gifts of property and gifts to public charities over private foundations, but cash gifts do not offer as many tax planning opportunities. When a gift is not fully deductible in the year made, a carryforward rule permits it to be deducted over the next five years, subject to the same AGI limitations in those years. A charitable gift generally will be fully deductible from the estate, gift, and GST taxes, regardless of whether it is made during life or at death. Beware limitations on itemized deductions and personal exemptions For taxpayers subject to higher tax rates, the good news is that generally the value of a deduction increases when rates are higher. However, under a phase-out rule reinstated in 2013, deductions by taxpayers with adjusted gross income (AGI) above a threshold limit, set for 2015 at $258,250 (single), or $309,900 (married filing jointly), are reduced by 3% of the income over the threshold, up to 80% of the total deductions. This rule applies to the deductions for home mortgage interest, charitable contributions, and state and local income and property taxes, among others. Caveat on calculating the deduction: Your actual tax savings from a charitable gift is dependent on the interplay of very complex rules: whether you are subject to the AMT; what kind of property you donated; whether the charity is a public charity or a private foundation; and the total amount of your gifts relative to your adjusted gross income. It s always important to run the numbers to see what the actual deduction will be. Donating some or all of your IRA IRA assets are particularly attractive to give to charity, rather than to leave for your heirs, as your heirs will pay income tax on the entire IRA distribution. Particularly if your estate is subject to estate tax, the combined wealth and income tax burden on IRA assets can be extremely high. There are no restrictions on how much of your IRA assets can be left to charity at death, and the transfer will not be subject to income, estate, or gift tax. A lifetime donation of IRA assets, when permitted, can also also be very tax-efficient. The IRA charitable rollover provision, which expired on December 31, 2014, permitted individuals aged 70½ or older to transfer up to $100,000 directly from an IRA to qualified charities without recognizing income or taking a charitable contribution deduction. The rollover contribution rule was helpful for taxpayers who did not itemize deductions, had already maximized their permitted charitable contribution deductions, lived in a state that does not provide for charitable contribution deductions from state income tax, or who could benefit from a lower amount of AGI. Until 2013, for many donors there was no tax difference between taking an IRA distribution into income, followed by a deductible charitable gift, and making a transfer directly from the IRA to charity. However, with the 3.8% surtax on net investment income now in effect, donors who are close to the AGI threshold could keep their AGI down by distributing directly to charity from the IRA if lifetime charitable distributions are again permitted. For example, when this rollover was in effect, an unmarried individual with $175,000 of other adjusted gross income, and a $50,000 required minimum distribution (RMD), could keep below the $200,000 threshold by distributing $30,000 of the RMD to charity. None of the donor s investment income would then be subject to the new surtax. The IRA charitable rollover provision has consistently been reinstated by Congress since it first expired in 2007. As of this writing, the House of Representatives has passed a bill making the IRA charitable rollover provision permanent, but the Senate has not yet acted. Past extensions have been only for a year or two. All donors can do now is watch and wait. 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 4 of 8
Outright gift of appreciated securities Giving an outright gift of appreciated securities may also provide particularly attractive tax benefits. You will generally be allowed a full fair market value deduction for the donated securities, up to 30% of AGI, if donated to a public charity; 20% of AGI if donated to a private foundation. Beware, however, of giving closely held stock to a private foundation, as a full fair market value deduction is not allowed for such gifts. In addition to the deduction itself, you will also save the capital gains taxes (both federal and state, if any) that would have applied if you sold the securities and donated the proceeds. Put differently, a gift of stock to a charity allows you to put more in the charity s hands without giving up more of your resources. The silver lining to today s increased capital gains tax rates is that the tax savings from avoiding tax on sale is now greater. And if you are also subject to the 3.8% surtax, you can avoid that as well. In addition, with higher income tax rates, the tax saving from the contribution deduction is also likely to be greater. Finally, donated assets will be pulled out of your estate, potentially reducing your estate tax liability. Charitable remainder and lead trusts: Helping charity and family Charitable remainder trusts (CRTs) and charitable lead trusts (CLTs) are more complex forms of charitable giving, but they provide opportunities to benefit both charities and family members, in different ways. Such trusts typically require greater funding than an outright gift to charity, as they will require the expense of longterm management of the trust s assets. But in the right circumstance, they can provide considerable benefits from both an income and estate tax perspective. Charitable remainder trust A CRT provides for annual payments from the trust to one or more individual beneficiaries (often including the donor) for a term of up to 20 years or for the lives of the beneficiaries. At the end of the term, the remaining assets are distributed to one or more charities, which may include a family foundation. There are many benefits to a CRT from both the charity s and the donor s perspective. Unlike a will, which can be changed, a CRT gives a charity the comfort of an irrevocable commitment. And of course, unlike an outright gift, the donor and/or the donor s family can still benefit from the income of the trust. A CRT is required to pay out at least 5% of its initial value as an annual annuity or 5% of its fair market value annually, known as a unitrust payment. In today s low interest rate environment, a CRT can be an attractive way to provide a fixed income stream at considerably higher rates than most fixed income investments are yielding. A CRT may be created by a will or during a lifetime. The remainder value passing to charity at the end of the trust term is not subject to estate or gift tax either way. Note that if a successor income beneficiary is not the donor s spouse, there could be a sliver of the trust that is subject to estate tax. A lifetime CRT provides the added benefit of a current income tax deduction (subject of course to the general limitations on the charitable deduction) based on the value of the remainder that will pass to charity in the future. An important feature of a CRT from a planning perspective is that when it sells appreciated assets, the capital gains tax is deferred, making a CRT particularly useful for a donor whose goal is to diversify an asset and then derive an income stream from it. As each distribution is made to the non-charitable beneficiary, it is included in the beneficiary s income under complex income ordering rules. Depending on the amount of ordinary income earned by the trust, a portion of the distribution may represent capital gains previously earned by the trust. It is sometimes said that a CRT avoids tax on capital gains, but in fact the gain is merely deferred until distributed. By the same token, a CRT does allow the entire proceeds from a sale by the CRT of an appreciated asset to be invested and grow rather than having to pay all the capital gains tax in the year of the sale. Not surprisingly, this strategy is popular among 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 5 of 8
charitably minded individuals with highly appreciated assets who wish to diversify their investments. Charitable lead trust Basically the inverse of a CRT, a CLT provides an annual payment to one or more charitable beneficiaries for a period of time, with the remainder interest going to family members or trusts for their benefit. The value of the income or lead interest, determined using the IRS valuation rate, known as the Section 7520 Rate, reduces the value and therefore the gift tax cost of the transfer of the remainder to the family. Using a CLT permits the transfer of appreciation in excess of the IRS benchmark rate to a family, free of estate and GST tax. CLTs are particularly attractive in today s low interest rate environment (See Figure 4). CLTs may be structured in different ways to take advantage of income tax deductions or to leverage the GST tax exemption. CLTs could be a particularly good choice if you give to charity every year, do not need current income from your investments, and wish to transfer to family using a reduced amount of estate, GST, or gift tax exemption. In addition, a CLT can be structured either to provide an upfront charitable contribution deduction for the donor, or a charitable contribution deduction for the trust in each year it makes distributions to the charitable beneficiaries. As with other charitable gifts, the value of the charitable lead interest reduces the donor s taxable estate. Private family foundation If you wish to contribute substantial assets to charity and are prepared to devote more time to planning and administering a charitable entity, a private family foundation could be an attractive option. Private foundations which are generally funded by a single donor or family provide numerous estate planning and income tax benefits, which may be even greater this year under the new higher tax rates. Private foundations allow charitably minded individuals and families to control their assets, create a charitable legacy, and unite family members around a common philanthropic goal. A private foundation can be more expensive and time-consuming to maintain than other charitable giving vehicles but, for many, the benefits are worth the effort. On the financial side, private foundations provide a valuable current income tax deduction while also creating a tax-exempt vehicle for future growth of assets. Assets donated to a private foundation are also excluded from your estate, reducing your estate tax liability, if you would be subject to it. Equally important for many families is the fact that a private foundation can create family cohesion by transmitting philanthropic values to future generations, encouraging communication across generations, and developing leadership skills in children and grandchildren. A private foundation also permits a family to build an endowment, permitting strategic use of charitable funds when needed. figure 4 Comparison of Applicable Federal Rates & Section 7520 Rates: 2001 2015 Date Short-term AFR Mid-term AFR Long-term AFR Section 7520 Rate (0-3 Years) (3-9 Years) (Over 9 years) Jan. 2015 0.41 1.75 2.67 2.2 Jan. 2009 0.81 2.06 3.57 2.4 Jan. 2004 1.71 3.52 5.01 4.2 Jan. 2001 5.90 5.61 5.78 6.8 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 6 of 8
It is important to note that private foundations are highly regulated and donors must be careful not to inadvertently run afoul of the many restrictions intended to ensure that foundations are used to further philanthropic, rather than private, objectives. Donor advised funds For some donors, a donor advised fund (DAF) may better achieve your goals, or may be more cost-effective. A donor advised fund is a fund maintained by a public charity, such as a community foundation. A donor is permitted to recommend grant distributions from a DAF, but technically the public charity sponsoring the DAF makes the final distribution decision. Some DAFs allow donors to use their own investment advisors to invest the funds. Because a DAF is sponsored by a public charity, it is not subject to the deduction limitations and operational restrictions that apply to private foundations. So donors may contribute appreciated property, such as closely held stock, to a DAF and still receive a full market value deduction. However DAFs are prohibited from holding large positions in a closely held business for the long term and are also subject to restrictions prohibiting donor benefit. Because DAFs are simpler and less expensive to establish than private foundations, they are a good option for smaller donations. THE SILVER LINING OF HIGHER TAX RATES While ATRA did bring higher taxes on income and investments, and some limits on deductions, it also brought relief to affluent families in the form of a significant wealth transfer tax exemption (although with a higher tax rate). The good news is that higher income taxes can often mean greater tax savings from charitable giving. If you are philanthropically inclined and wish to maximize your gifts to charitable causes while reducing wealth transfer, income, capital gains, or net investment income tax, there is a charitable giving strategy that will meet your financial, personal, and philanthropic goals. Wilmington Trust has been serving as a corporate trustee for more than a century, helping individuals and families translate their success into meaningful and lasting legacies. We understand that there is much more to managing wealth than simply managing money, and we are committed to helping you develop and implement the most effective wealth transfer plan for your unique situation. Please do not hesitate to contact your relationship manager, call us at 866 627.7853, or visit our website at wilmingtontrust.com if you have any questions or would like additional information. Investments: Are NOT FDIC-Insured Have NO Bank Guarantee May Lose Value 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 7 of 8 CS7266
Renowned Expertise: About our Author Carol G. Kroch, Esq. Managing Director Wealth and Philanthropic Planning Wilmington Trust Company Carol is responsible for oversight of charitable trusts and chairs Wilmington Trust s Wealth Committee, a team of attorneys and financial planners who focus on trust and estate planning, income tax and financial planning, and philanthropic planning for Wealth Advisory Services. She has extensive experience working with individuals and nonprofit organizations in estate, trust, and charitable gift planning and in advising nonprofit corporations and trusts, including private foundations and public charities. Carol holds a J.D. from Boston College Law School, where she was a member of the Law Review and the Order of the Coif, and a bachelor s degree from Wellesley College. She is a frequent author and speaker on trust, estate, and charitable planning and on nonprofit governance. This publication is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service. It is not designed or intended to provide financial, tax, legal, accounting, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought. This publication includes tax rates and other information sourced from the Internal Revenue Code and regulations. Wilmington Trust is a registered service mark. Wilmington Trust Corporation is a wholly owned subsidiary of M&T Bank Corporation. Investment management and fiduciary services are provided by Wilmington Trust Company, operating in Delaware only, and Wilmington Trust, N.A., a national bank. Loans, retail and business deposits, and other personal and business banking services and products are offered by M&T Bank, member FDIC. Investments: Are NOT FDIC-Insured Have NO Bank Guarantee May Lose Value 2015 Wilmington Trust Corporation and its affiliates. All rights reserved. page 8 of 8 CS7266