IRS Rewards Generosity: Explore Tax-Smart Giving Strategies

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By: The American Academy of Estate Planning Attorneys

Giving generously to charity has many advantages, some obvious, and some not so obvious. First and foremost, your donation helps to support your favorite cause. Giving also makes you feel great, and if you itemize deductions on your tax return, gifts to qualified charities may result in an income tax deduction.

But what if you want to do a little more, and make a large contribution to your alma mater, your favorite nonprofit, or another charitable cause? In that case, you should consider including philanthropy in your estate plan. Larger gifts to charity often mean greater tax benefits, and there are many methods available for making a contribution.

Here are three common options:

1. Charitable Lead Trust. When you establish a Charitable Lead Trust, you can minimize your estate or gift tax bill. Here’s how: the trust is established for a predetermined period of time, and you transfer assets to it. During the designated period, the trust pays an income stream to your chosen charity. After the period expires, the trust assets are distributed to your designated “remainder beneficiaries” – generally your children or other family members. Because the remainder beneficiaries have to wait for their portion of the trust property, the IRS assigns a reduced value to their share. The result is a lower gift or estate tax bill for you.

2. Charitable Remainder Trust. If you plan to give a portion of your property to charity during your life or after your death, a Charitable Remainder Trust might be a good option. This arrangement is similar to a Charitable Lead Trust, only it’s reversed. You transfer property to the trust, and you or a family member receives an income stream for a designated period of time. When this time period expires, the remaining trust assets are distributed to the charity of your choice.

In addition to benefiting your favorite nonprofit or other charitable institution, a Charitable Remainder Trust gives you an income tax deduction for the actuarial value of the trust property that will ultimately be distributed to the charity.

3. Donation of Appreciated Property. What if you want to make a direct donation of valuable property? If the property has increased in value since its purchase, such a donation can result in significant tax savings for you. When you donate appreciated property, the IRS usually allows you to claim a deduction for the full, current value of the asset. Since you are donating, rather than selling, the property, you escape paying tax on any gain in the property’s value.

For example:

John bought stock for $2,000. It has increased in value and is currently worth $10,000. If he sells the stock, he’ll pay capital gains tax on $8,000 (the difference between his purchase price and the sales price). Assuming a 20% capital gains tax rate, the sale means a $1,600 tax bill for John.

If, on the other hand, John decides to donate the stock to charity, he’ll pay no capital gains tax – a $1,600 savings.

These are just a handful of the available options for reducing your tax bill while giving generously to charity.

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