Articles for Financial Advisors

Tax Deduction

Tax Deduction

Over time, your client will be able to deduct the full value of the gift to the charity from his/her income taxes. The fact that a charitable remainder trust makes payments to him/her or some other beneficiary for years does not change this rule. The value of the gift to charity is not the property’s value when it is placed inside the charitable trust. 

With a charitable remainder trust, the IRS takes the FMV and then deducts the estimated present value of the payments the income beneficiary has a right to receive. Things are reversed in a charitable lead trust. The income tax deduction is the estimated value of the income the charity will receive.
Once the IRS determines the present value worth of a gift to a charitable trust, your client is entitled to deduct 100% of this amount. But this deduction cannot be taken in a single year. Rather, your client can deduct a certain percentage in the year the gift is made and deduct the rest over the next five years.
The amount of the first year’s deduction depends on how the IRS classifies the charity and on your client’s annual income. The most he/she can possibly deduct is 50% of his/her AGI for the first year. For a gift to a charity to be eligible for the 50% deduction, that charity must be classified by the IRS as a public charity and the gift must be a cash gift. Most widely known charities, such as schools, churches, the Salvation Army, the American Cancer Society and many environmental organizations, meet this requirement.
Many private foundations do not meet this public charity requirement. If a gift is made to one of these charities or if your client donates appreciated assets (e.g., a home or piece of art), his/her income tax deduction for the first year can not be greater than 30% of adjusted gross income; the remaining deduction must then be spread out over the next five years. To determine whether a charity makes your client eligible for the 50% or 30% deduction, contact the IRS.

Determining  Value

If you make an outright gift to charity, the income tax deduction permitted by the IRS is the gift’s value at the time you make it. For example, if you write a $100,000 check to the Audubon Society, you’re entitled to a $100,000 income tax deduction. 
By contrast, if you make a gift to a charitable remainder trust while you are alive, determining the amount of your tax deduction is more complicated. The IRS determines the value of the charitable trust gift from tables that estimate the income beneficiary’s life expectancy, current interest rates and what the charity is expected to receive—that is, how much principal will be left—when the income beneficiary’s interest ends. The more the charity is expected to get, the bigger the tax deduction; the larger the expected return to the income beneficiary, the lower the deduction.
For example, Ted (age 78) sets up a charitable remainder trust. He gives $100,000 in trust to The Salvation Army and retains the right to receive income equal to 7% of the trust principal annually for her life. After his death, the charity will receive all remaining trust property outright. Victor (age 37) does exactly the same thing. Victor’s tax write-off will be substantially lower because Victor has a much higher life expectancy.
As mentioned, IRS calculations are influenced by prevailing interest rates; value depends on when the gift is made to the charitable trust. Large charities have staff members who can figure out your client’s actual deduction (again, based on the dollar amount, current interest rates and the client’s age). 

Appreciated  Property

One of the most useful features of a charitable trust is it provides a way to turn highly appreciated assets into cash without paying any capital gains tax up front. If you donate a non-income-producing asset to a charitable trust, the charity can convert it into an income-producing asset. If the charity sells the donated asset, your client will not be accessed any capital gain. The charity retains all the money received, without any subtraction for capital gains tax. The grantor (your client) benefits in two ways: [1] tax deduction based on the selling price of the asset and [2] a higher income stream (since no taxes are deducted from the selling price).
If an appreciated property is sold by the charity, part of your client’s payments from the charity will be considered a return of capital and part will be taxed as capital gains. Any tax owed (the capital gains portion) will be spread out over a number of years. Large charities send a year-end statement breaking down what, if anything, is taxable and how.

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