Are you a gracious giver, perhaps even a philanthropist? If you are a taxpayer, then the answer is yes. How, you ask? During your lifetime, your wealth is subject to taxes in a variety of forms. Income taxes levied on your wages, interest and dividends, and capital gains taxes extracted on the sale of your appreciated assets may tend to make April 15 one of your least favorite days each year.
Our tax system is voluntary in its form, but the civil and criminal penalties for noncompliance make the process involuntary in its substance. Thankfully, for our national defense and other essential programs of the federal government, most taxpayers voluntarily comply with the Internal Revenue Code (IRC) and pay their fair share.
Beyond the essentials of government, however, are there any programs funded by the federal government you personally consider nonessential and perhaps even wasteful? If there are, then you are an involuntary philanthropist by your financial support of the causes selected by Congress and the White House.
Perhaps there are private sector charities you deem more worthy of your tax dollars? Chances are you already support these charities. There are a variety of ways to skin the proverbial cat when it comes to charitable giving, from simple to rather complex.
In fact, your giving options can be tailored to your unique charitable objectives from dropping cash in a red kettle outside Walmart during the Christmas season to creating an endowment that will provide charitable benefits long after you are gone. What follows is a brief overview of this range of options, but this is a subject that can (and does) get complicated rather quickly.
Do you want to make your charitable gift now, in keeping with the old adage that “if you are giving while you are living, then you are knowing where it is going”? Just drop cash in the red kettle and, viola’, charitable contribution is over and done! On the other hand, if you want to make larger gifts and even maintain more control over how those charitable gifts are distributed over time, then you can make gifts that are not made directly to any charity in a lump sum. These “sustaining” gifts are instead made to an entity that itself is a charity. Examples include famous “private foundations” like the Rockefeller Family Foundation or less famous “donor-advised funds” created by the Krull family.
In fact, this is how Gretchen and I handle all of our personal charitable giving now and after we are both gone through our estate plan. Not only does our foundation through the National Christian Foundation allow us to remain anonymous (you need not remain anonymous and can give your fund any name you wish), but it provides a convenient means to keep track for the IRS and involves our three daughters as fund “advisors” now and after we are gone.
Perhaps instead of current giving, you would prefer to make you charitable gifts after you are done with the assets. If yes, you can arrange for either “outright” gifts or “split-interest” gifts. Two common assets do not require any attorney assistance (or fees) when used as charitable gifts. Simply designate the charity as a beneficiary of your life insurance or retirement funds. The latter is the perfect asset of choice when it comes to benefitting charity and disinheriting the IRS. How? If you designate a non-charity as the beneficiary, then he or she must pay income taxes on every dollar distributed. By contrast, if you designate a charity as the beneficiary, then it pays no income taxes and every penny is available to the charity.
Other forms of deferred giving include bequests to charity under your Last Will and Testament or Revocable Living Trust, as well as retaining a “life estate” with a remainder interest passing to charity. These forms do require proper legal planning and vary in complexity. For example, are you a voluntary philanthropist who has highly-appreciated assets, wants to avoid capital gains taxes and are looking to increase your current cash flow? If yes, then you really should know about IRC § 664 and how you may turn your involuntary philanthropy into tax-savvy voluntary philanthropy.
Charitable tax deductions have been part of the IRC since its inception. Why? The government’s own research determined that private sector charities deliver social services more cost-effectively than the government itself. The government, in turn, sought to encourage increased charitable giving to private sector charities by enacting IRC § 664 in 1969. In essence, IRC § 664 permits split-interest gifts, making it attractive for taxpayers to have their cake and eat it too!
A Charitable Remainder Trust (CRT) is a popular split-interest gifting technique. Through a CRT, you may increase your current income, enjoy current income tax deductions and leave a substantial financial legacy for your favorite charity(ies) upon your death (or upon the death of your spouse, if later).
Here is how it works. First, you create a CRT and contribute an asset to it. [Note: Appreciated assets (i.e. assets that would be subject to capital gains taxation were you to sell them yourself) are commonly contributed because they tend to be low income producers and have a low income tax basis.] Second, the CRT sells the asset without capital gains taxation and then reinvests the proceeds in an income-producing portfolio that grows income tax free inside the CRT. Third, you (and your spouse) receive an enhanced lifetime income plus valuable income tax deductions for up to six years. Fourth, upon your death (or upon the death of your spouse, if later), the CRT distributes any remaining CRT assets probate-free to your selected charities and your estate receives a charitable estate tax deduction for the value of the assets distributed.
As the saying goes, charity begins at home. Accordingly, many Americans want to maximize the wealth they ultimately transfer to their children and grandchildren. While the CRT provides a lifetime income and tax benefits to the taxpayer (and spouse), it correspondingly reduces the estate eventually available to loved ones. This is obviously one of the major drawbacks to CRT planning. However, there is a tax-savvy strategy available to replace the value of the CRT assets for the benefit of loved ones. I call it “The Charitable Trifecta.”
In the world of high-stakes wagering on horse races, winning the Trifecta is a most noteworthy achievement. To win, you must pick not only the winner of the race, but also the second and third place finishers. When it comes to gracious giving, most taxpayers would prefer to benefit their charities first, themselves second, their loved ones third…and the IRS dead last. This Charitable Planning Trifecta can be achieved through a carefully coordinated financial and legal strategy that includes both a Charitable Remainder Trust (CRT) and a Wealth Replacement Trust (WRT).
The creation of a CRT helps your charity finish first, with you (and your spouse) a close second. Before the charity inherits the assets held in the CRT upon your death (or upon the death of your spouse, if later), you (and your spouse) enjoy a lifetime income from the CRT and valuable charitable tax deductions. However, when the charity inherits the assets held in the CRT, they are forever unavailable to your loved ones. That is where the WRT comes in.
With your CRT generating income sweetened by income tax deductions, you may have a total annual income in excess of the amount necessary to maintain your lifestyle. If so, then you may want to consider acquiring Life Insurance in WRT to replace the value of the CRT assets ultimately passing to charity instead of to loved ones. To keep the value of the Life Insurance death benefit out of your estate (and that of your spouse) you must be very careful to follow the WRT dance steps to ensure proper ownership of the Life Insurance from the outset.
First, you create a WRT. While you may not be serve as a Trustee (nor should your spouse), you may select the current and successor Trustees. The beneficiaries of the WRT will be your loved ones.
Second, you (and your spouse) make gifts to the Trustee on behalf of the WRT beneficiaries in an amount roughly equal to the insurance premiums. The Trustee then provides written notice of the completed gift to each WRT beneficiary and that each beneficiary has a designated timeframe (not less than 30 days is typical) to request distribution of his or her respective share of the gift. After the designated period has lapsed, the Trustee applies for the appropriate Life Insurance and pays the initial premium. [Note: This annual gifting ritual continues until your death (or the death of your spouse, if an insured and your survivor).]
Third, assuming all of the WRT dance steps have been followed, the death benefit will be estate tax free when paid to the WRT for your loved ones. This will replace the value of the CRT assets paid to the charity. With careful planning and crisp execution, your Charitable Planning Trifecta will enrich your charity, yourself (and your spouse) and your loved ones … disinheriting only the IRS.
As you can see, there is more to charitable planning than you may have imagined beyond making on the spot contributions to a red kettle. For instance, have you heard of a Charitable Lead Trust (CLT)? It is a CRT only in reverse. The charity receives the income from your assets funding the CLT for a period of time, but your loved ones are the remainder beneficiaries. Before making significant charitable contributions, be sure to consult with experienced legal counsel who can explain your range of options.
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