Gimme A Break

When your clients complain to you about paying their taxes this April 15, don't roll your eyes when they claim, It's not about the money. Because their irritation really may stem less from the idea of their hard-earned dollars going to the state capitol or Washington, D.C., and more from how the politicians choose to spend that money. Ironically, your clients have plenty of opportunity to both reduce

When your clients complain to you about paying their taxes this April 15, don't roll your eyes when they claim, “It's not about the money.” Because their irritation really may stem less from the idea of their hard-earned dollars going to the state capitol or Washington, D.C., and more from how the politicians choose to spend that money.

Ironically, your clients have plenty of opportunity to both reduce the amount of cash that goes from their pockets to the politicians, and ensure that more funds go to projects and causes the clients philosophically and politically agree with.

The solution is to make use of the tax breaks provided by giving to qualified charitable organizations. Here's how — and how much — your clients' philanthropic gestures may also cut their tax bill.

The Basics

Unless your client is itemizing on her tax form, she can't claim any deductions for charitable contributions (though legislation may be re-enacted that would allow non-itemizers over 70½ to donate IRA assets without paying taxes on the distributions).

If your clients make any cash donations over $250, they should be sure to get written acknowledgement of the charity's receipt of the money, along with a description of any benefit the clients may have received in return. Non-cash donations should have the same documentation, and may require an appraisal of the donated item, as well.

Savvy clients will rightfully wonder if any advantages provided by tax-deductible charitable donations will be wiped out by the alternative minimum tax. You can tell them to relax — charitable deductions are one of the few breaks allowed under the AMT.

Checking Out The Charity

The first factor that determines how much tax savings your client will receive is the status of the organization that will benefit from his or her generosity. The group must be a qualified non-profit, and almost always has to be listed in IRS Publication 78 (available at www.irs.gov) for your client's donation to be tax-deductible.

The next variable to consider is whether the charity is a 50-percent, 30-percent or 20- percent organization. These numbers refer to the deductibility of donations, expressed as a percentage of the donor's adjusted gross income.

For instance, if a client has $100,000 in adjusted gross income (AGI), and is donating to a 50-percent charity, the most she can deduct in that year is $50,000. (Before you read the previous two sentences again, just call the charity in question for verification of its status.)

Fret not if your client's gift exceeds the amount she can deduct in a particular year. Most unused amounts can be carried forward (and deducted) for up to five years, or when the carry-over amount is exhausted, whichever comes first.

Giving Cash, Or Trash — I Mean, Antiques

Once your client has settled on the non-profit of her choice, it's the type of gift that will decide just how much tax reduction she will get from the donation. Straight cash is easy to calculate. Assuming the gift doesn't exceed the AGI limits mentioned above, the donation amount is deducted from the donor's taxable income.

Say a client is in the 35-percent federal tax bracket, and writes a $50,000 check to her favorite qualified charity. The donation will reduce the amount of money she sends to Uncle Sam by $17,500 ($50,000 × .35).

Donating appreciated assets (like stock) to a qualified charity can provide an even bigger overall tax reduction. Your client will not only get a deduction based on the market value of the asset, but since the charity will be the one selling the asset, capital gains taxes will be avoided, too.

Keep in mind that your clients should only consider donating assets that have long-term capital gains. Short-term capital gain property can only be deducted to the extent of the cost basis, and any asset with a paper loss should be sold outright, instead of donated.

Calculating the tax break on other more esoteric assets or property (like real estate) is a bit more complicated, and it can be further muddled by the charity's “50/30/20” status. Your client can peruse IRS Publication 526 (“Charitable Contributions”) for more information, or just direct her CPA and representatives of the charity to get together and hash out the details.

Cutting Future Taxes

Charitably-inclined clients may also be interested in taking steps today that could cut the income, capital gains, and estate taxes that they (or their heirs) may pay in the future. One shrewd and relatively friction-free strategy is to make qualified charitable organizations the beneficiaries of IRAs, and leave assets held outside of sheltered accounts to family members.

Say you have a couple with $5 million in liquid assets: $2 million in IRAs, and $3 million in common stock with a very low-cost basis. They want a portion of their estate to go to a favorite organization, and the rest to go to their children.

For little cost and less paperwork, they can designate that the charity should inherit the IRAs, which could then eliminate the accounts from being subject to the estate tax, and also avoid income tax that their heirs would otherwise have to pay on withdrawals from the IRAs.

If the couple designates that their children will get the $3 million in stock, then upon the death of the couple, the children can get a stepped-up cost basis, and sell the stock with only a tiny amount of tax liability. (However, the stock may still be subject to estate taxes, depending on the exemption amount at the time of the couple's death.)

To Give Is To Receive

The final part of the equation that will determine what kinds of tax advantages your client wins for his generosity is what type of vehicle he uses to maximize financial benefit from the donation.

Typical methods include lead or remainder versions of unitrusts or annuity trusts, and other vehicles that will be discussed in this space during the coming months. In the meantime, you and your client can find out the potential tax deductions of various hypothetical scenarios using the calculators at http://giftlaw.com/glaw_calculator.jsp.

Writer's BIO: Kevin McKinley
CFP© is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book Make Your Kid a Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. You can reach him at [email protected]

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