The Growing Role of Philanthropy in Wealth Planning
People today are more interested than ever in finding ways to align their long-term financial goals and their personal values. According to a report from the consultancy Altrata, charitable contributions from ultra-high net worth individuals increased by almost 25% between 2018 and 2022, illustrating a growing trend of philanthropic engagement.
Positioning Philanthropy as a Cornerstone of Legacy
There are many reasons for giving during your lifetime, including supporting causes you care about, making a positive impact on the world, and accessing certain tax advantages. But in addition to what it can accomplish in the duration of your life, philanthropy can help you establish a long-lasting legacy that reflects your values.
Values are among the most important things parents can pass on to their children. Philanthropy can set an example for your heirs and, when properly established, provide a structure for giving that can carry on for generations to come. Private foundations, for example, are a popular vehicle for long-term family philanthropy. And their number has more than doubled since the 1990s.
With all the advantages, it’s also important to realize that effective charitable giving involves more than simply writing a check. You need to understand the complex regulations that can impact your contributions and the charities you support.
Understanding Regulations on Charitable Donations
IRS Regulations for Charitable Giving
Generally, contributions of money or property you make to, or for the use of, a qualified organization can be tax-deductible. If you give property to a qualified organization, you can generally deduct the fair market value of the property at the time of the contribution.
There are overall limits on charitable donation tax deductions, however. You can generally deduct charitable contributions up to 60% of your adjusted gross income, but in some cases, 20%, 30%, or 50% limits may apply.
The Internal Revenue Service’s rules about charitable donations focus on three main areas: classifying the charities to whom you can give deductible contributions, substantiating donations, and disclosing goods and services you may receive in exchange for your donation.
- Qualified Organizations: You can deduct your donations only if you make them to a qualified organization (not an individual). According to the IRS, qualified organizations include nonprofit groups that are religious, charitable, educational, scientific, or literary in purpose or that work to prevent cruelty to children or animals. Most qualified organizations must be organized or created in the United States, but income tax treaties with Canada, Mexico, and Israel also make donations to certain organizations within these countries deductible.
- Substantiation: For any charitable deduction of $250 or more, you must have the charity’s written acknowledgment. A canceled check is not enough. The acknowledgment must include the amount of the donation, a description of any property donated, and a statement as to whether the charity provided services or goods (tickets or a meal, for example) in exchange for your donation, with an estimate of the value of those provided services or goods.
- Disclosures: If you receive any goods or services in return for your donation, you can only deduct the amount of your donation that exceeds the fair market value of what you received. You will need to disclose all received items with a value equal to or in excess of $72 or 2% of your donation. Noncash contributions can require additional disclosures if their worth exceeds $500. You’ll need to complete IRS Form 8283. If your total noncash donations for the year to all parties exceed $5,000, or $10,000 for certain non-publicly traded securities, you’ll need to also have a qualified appraisal signed by a professional.
Please note that this is a broad overview of IRS regulations. IRS Publication 526 provides more detailed information. The code is complex and contains many specific regulations, including those governing deductible out-of-pocket expenses, contributions to donor-advised funds, special rules for donations of certain property types, partial interests, future interests, property that has decreased or increased in value, bargain sales of property to qualified organizations, etc. It’s important to consult with an advisor.
Charitable Giving Structures
Several legal structures can help you optimize the benefits of your philanthropic program, when set up properly.
- Donor-Advised Funds: Donor-advised funds (DAFs) are the fastest-growing charitable giving vehicles in the United States because they are one of the easiest and most tax-advantageous ways to give to charity. They are essentially dedicated accounts into which you, and other donors as well, can place cash, stocks, or non-publicly traded assets that are eligible for an immediate tax deduction. You can take your time, however, deciding how you want to distribute the donations, which meanwhile can potentially grow tax-free within the account. Although this format is relatively simple, note that IRS regulations on DAFs must be followed to avoid triggering excise taxes.
- Private Foundations: Private foundations are separate legal entities that are generally set up to support long-term philanthropic goals. They tend to be more expensive and complicated to set up than DAFs, so it’s best to involve professionals to ensure you achieve your goals. You may want to talk to your lawyer and financial advisor before and during the setup process. You may also want to consider hiring a professional administrator, although those tasks can also be handled by a willing family member. You can fund a private foundation with a broad variety of asset types, and as a donor, you have control over the investment and granting decisions. These entities have more freedom in granting than other charitable giving vehicles and can distribute donations to individuals, not just to qualified charitable organizations. But they must distribute at least 5% of the assets each year. A foundation can be passed down from generation to generation and can involve any number of family members.
- Charitable Trusts: There are two common types of irrevocable charitable trusts. Both can be effective ways to plan major donations, defer income taxes on the sale of assets transferred to the trust, and help provide for yourself or your family. A Charitable Remainder Trust (CRT) is a popular type of trust into which donors can transfer cash, property, or other assets. Because it is irrevocable, assets that go in can’t be taken back. The trust then pays you or your beneficiaries a specified income for a designated term, no more than 20 years, or for the life of one or more noncharitable beneficiaries, after which the remaining funds are distributed to designated charities. The remainder donated to charity must be at least 10% of the initial net fair market value of the property placed in the trust. A Charitable Lead Trust (CLT) is a less common form of charitable trust that distributes regular donations to your chosen charitable organizations for a fixed number of years (with no limit), the lifespan of one or more individuals, or a combination of the two. There is no required minimum or maximum payment to the charitable beneficiaries, as long as payments are made annually. At the end of the period, the remaining assets are distributed to your family or other beneficiaries, free of estate and gift taxes.
Compliance Challenges and Common Philanthropic Pitfalls
We’ve said, but it bears repeating, that philanthropic planning can be complex, especially when the amounts involved are substantial. Mistakes can cost you money and the ability to reach your financial and/or philanthropic goals, so make sure you are aware of all the regulations. Here are some common issues that can be avoided.
Failure to Meet Reporting Requirements
You will need to keep proper records of your philanthropic activities, just as with any other financial activity that impacts taxation. Because you can deduct up to 30% to 60% of your adjusted gross income through charitable donations, it’s worthwhile to maintain accurate records, have your assets properly appraised, and make sure any charity you support sends you complete and accurate substantiation. The IRS recommends keeping any tax documentation for at least three years after your filing date.
Unqualified Charities
The IRS will only allow you to take tax deductions for donations to qualified charities. If you donate to an unqualified organization or individual, you will not be able to take the deduction. You can ask any organization whether it is a qualified organization, and most will be able to tell you. You can also check an organization’s eligibility with the search tool at IRS.gov/TEOS.
Organizations that may not be qualified include:
- Civic leagues, social and sports clubs, labor unions, and chambers of commerce
- Foreign organizations (except certain Canadian, Israeli, and Mexican charities)
- Groups that are run for personal profit
- Groups whose purpose is to lobby for law changes
- Homeowners’ associations
- Individuals
- Political groups or candidates for public office
Conflicts of Interest
The IRS is strict in its definition of qualified charities and in the regulations that must be followed for an organization to maintain its qualified and tax-exempt statuses. Charities are prohibited by law from being organized and operated for personal gain. Although the responsibility for avoiding conflicts of interest resides with the organization, you need to be aware of the existence, or even potential for, these red-flag issues.
To research potential warning signs of conflicts of interest, you can check an organization’s annual IRS Form 990. Each year, each charity must disclose if it maintains a specific conflict of interest policy, requires annual disclosure of potential conflicts, or regularly and consistently monitors and enforces conflict of interest policies. Form 990 also requires reporting of family and business relationships among any board members, officers, or key employees and any financial transactions between the organization and interested persons.
Working with an Advisor to Stay Compliant
Today, philanthropy is an important part of private wealth management for many individuals and families. As your desire and ability to support the causes you care about grows, so may the need for professional support in navigating the complexities of charitable activities.
In addition to knowing charitable contribution limits, it’s important that you understand all the regulations and tax consequences and consult with your tax and financial advisors before you finalize your giving plan.
Take advantage of our advisor matching program today to be custom-matched with a financial advisor you can trust to support your goals with customized planning.
This article is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.
The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional before implementing such strategies.
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