It seems the more you get involved in your clients' charitable intentions, the likelier it is that you end up giving away your two most precious commodities: your time and their money. But the fact remains that assisting benevolent activities involves two components shared by most successful financial advisors: working with rich people and being near money in motion.
Giving USA, published by the Center for Nonprofit Management, says that individuals gave about three-fourths of the $240 billion sent to nonprofits last year. And rich people bore the lion's share of that generosity; the wealthiest 1 percent of families account for about a quarter of all donated dollars. But while their efforts and deeds are noble, your expertise can help them do better. The NewTithing Group, a not-for-profit research group, estimates that in 2001 America's wealthier individuals wasted $659 million by giving inefficiently. That money could have been kept by the donors or also passed along to deserving nonprofits. Instead, it went to the government, mostly in the form of capital-gains taxes.
The following giving strategies cannot only cut your clients' capital-gains taxes, but income and estate taxes, too. The chance for you to earn your keep increases with each technique's degree of difficulty.
We Accept Cash with Photo ID
Advantages: Simplicity. Write the check, take the tote bag and it's over. Plus, a cash donation gives your client the maximum potential deduction — up to 50 percent of adjusted gross income for money given to a public charity.
Watch out: You may give even more money to the charity and fewer taxes for your client by donating appreciated assets to the nonprofit and letting the organization sell the asset tax-free (see below). And with the new Check 21 procedures, your client will need to specifically ask her bank for a substitute check to prove the donation was made.
Stocks and Bonds
Advantages: Giving highly appreciated assets cuts your client's taxable income and sends money to the charity that would otherwise have been sucked up by capital-gains taxes. This strategy is not just for positions in the black; donating securities with losses allows the client to deduct up to 50 percent of his original cost-basis from adjusted gross income each year until the cost-basis is exhausted.
Watch out: Got a client with a huge short-term gain? Donating it may not give as big of a deduction as you would think. The IRS says when giving ordinary-income items, only the donor's cost-basis of the asset — not the fair market value — can be used to offset taxable income. (For more rules on giving securities to charity, see accompanying table.)
Naming a Charity as an IRA Beneficiary
Advantages: The client doesn't have to give up access to the money and can change the beneficiary to another charity (or family member) at any time. This strategy works especially well if the client has both taxable and sheltered assets; his family members can inherit the money outside of the IRA, and the retirement account goes to the charity free from income and estate taxes.
Watch out: Make sure you separate any IRA assets intended for a charity into a separate account, rather than setting up the nonprofit as a co-beneficiary with descendants. In the latter scenario, upon the client's death the heirs have a short time to transfer the charity's share to a new IRA. If the process is slowed by any disputes or delays, the account may have to be liquidated before the heirs intended, triggering big taxes on money they didn't need just yet.
Advantages: A few thousand dollars in annual premiums could be worth hundreds of thousands for the charity when the donor passes away. Even if the client is a long way from his great reward he can still get a tax break today. If the charity is named as the irrevocable owner and beneficiary of the life insurance, the current premiums are tax-deductible. If a paid-up policy is donated, the client can deduct the cash-surrender value.
Watch out: Note the word “irrevocable” in the above paragraph. If the client ends up outliving his undonated assets, he can't get at the cash value in the policy. Also, cash-value policies have been known to occasionally underperform the initial projected rate of return.
Advantages: A private foundation for the six- and seven-figure set. Your client can drop as little as $10,000 into a pool managed by a community or mutual fund company (Fidelity's is the largest of the latter — see more at charitablegift.org). The donor gets an immediate tax deduction but can recommend the fund disperse money to any IRS-approved charity — whenever and for as little as the fund will allow.
Watch out: Not all donor-advised funds are created equal. You should evaluate the underlying investment options, expenses and giving restrictions before you recommend a particular offering. And although the client can select a charity, the organization sponsoring the donor-advised fund usually reserves the right to veto the decision.
Advantages: Kills about six birds with one stone. Your client creates the charitable trust and transfers in the designated assets. He picks charities to receive payments from the trust over a predetermined period or the life of the donor. When the period is up, what remains in the trust passes to the donor's intended beneficiaries, with little or no gift or estate taxes.
Watch out: Poor investment performance of trust assets or too-generous charitable disbursements could leave little money for the client's heirs. Plus, the trustee needs to accept the hassle of filing annual trust returns. Finally, the trust is irrevocable; the donor can't go back and alter the original terms.
Advantages: It's sort of a mirror of the charitable-lead trust — the beneficiaries get the income over the designated period, then the charity gets whatever is left over when the payment period is up. But an added benefit is that your client can get an immediate tax deduction on the actuarial benefit of the initial donation.
Watch out: Try getting a charity excited about a gift they may not receive for a few decades, and then only if there's money left over in the trust. And like the charitable-lead trust, the hassle and complexity in establishing and administering these vehicles can be a constant source of consternation to you and your client. Still, for many people, the benefits outweigh the negatives. According to the IRS, in 2001 there were about 120,000 charitable-remainder trusts and charitable-lead trusts holding assets with a combined book value of $120 billion.
Advantages: Unfamiliar with these? If you're hunting “elephant” clients, you better get up to speed. The National Committee for Responsive Philanthropy says there are about 65,000 private foundations controlling a half-trillion dollars in assets — an average of over $7 million per account. The donor gets control over where the money is invested, as well as how much and how soon it is dispersed (subject to certain IRS limitations). And since the donor runs the show, it is perfectly acceptable to bring family members into the operation.
Watch out: Earlier this year, Congress and the IRS began looking into the motivations and actions of several private foundations. They were concerned with alleged self-dealing, too much ownership of private businesses and not enough of the income distributed to legitimate charitable endeavors. Besides the government scrutiny, there is the fact that running a private foundation is no different from managing a regular charity or small business. Plenty of overhead and administrative expenses means that only those with at least a few million dollars to set aside should consider parking their money here.
Finally, giving money to a charity should happen because your client wants to help. But his altruism can also generate a decent cut in his taxable income. The convoluted ratios depend on the type of property donated and what type of organization is on the receiving end of the transaction. There is even a helpful worksheet available in IRS Publication 526. But once you get a look at the details, you'll soon realize there is going to be one more beneficiary of your client's generosity — a wise and patient tax professional.
How generous is your state?
Each year the Catalogue of Philanthropy releases its Generosity Index, measuring how much itemizing residents of a particular state give, in relation to their adjusted gross income. Here is the most recent ranking, based on 2001 tax returns:
Top states (as a percent of income)
3. South Dakota
48. New Jersey
49. Rhode Island
50. New Hampshire
See a complete list of the rankings at: http://www.catalogueforphilanthropy.org/cfp/db/generosity.php?year=2003
Transferring a stock to a charity? Here's what you need to know:
The IRS says the shares need to be in the charity's possession by Dec. 31 to get credit for the current tax year. Better get cracking early, though — the year-end holidays slow the process even more than usual.
Your client needs a letter from the charity describing the gift, including the number of shares, the date and if any consideration was received in exchange (like an oven mitt, for example).
The value of the donation is not based on what the stock closes at on the day of transfer. Instead, your client has to take the high- and low-trading price during the day and average out the two figures.