This article continues a our six-part series on charitable giving. In the first installment, we explained the importance of establishing the why before focusing on the how.
Now, we’ll take our first step into the how, with a discussion on the simplest method: direct giving.
In our last article, we were introduced to Dean and Jessica Howard. The Howards’ charitable purpose, or their “why,” was focused on their son, James. At an early age, James was tragically diagnosed with a rare type of childhood cancer. Blessedly, he has been in remission for the last sixteen months, and their philanthropic mission is twofold:
- Appreciation for the non-profit hospital that cured their son, and
- Eradication of the type of childhood cancer that viciously attacked their son.
With that purpose, the Howards need to figure out the best how. In other words, how do they best use their wealth to achieve their mission?
When Direct Giving Makes Sense
When a charitable mission can be fulfilled by giving directly to a charity, a direct gift is the simplest and often the best way to achieve that mission. For example, the Howards want to both show appreciation to the hospital that saved their son and wage a war on a particular disease. A gift to the hospital that cared for James can achieve both goals. A gift thoughtfully shows appreciation to the staff, while as importantly providing critical financial resources to fight this disease for the next afflicted child who is a patient.
Lifetime Giving vs. Charitable Bequests
Once the Howards have decided that their charitable mission is best met by a gift to the hospital that cured James, the next planning question is how much will they provide to the hospital and when. In thinking about how to answer these questions, it is helpful to take a step back and think about the Howards’ wealth and their financial plan. Under their plan, their wealth is going to be used for the benefit of three groups of people:
- the Howards;
- their family members (their children, in particular);
- the hospital.
So the first step is to build a plan that provides the right assets and income to the right people at the time the Howards choose. Presuming the Howards are like most clients, their priority is to themselves. Stated another way, their number-one priority is to ensure that their own needs and wants are met before shifting focus to their children or the hospital.
It is due to that prioritization that many clients do not make charitable gifts during their lifetimes. Leaving property to the hospital at their death eliminates the needs of one of the three parties from consideration, simplifying the balancing required to two parties: the children and the charity.
However, there are tax benefits of lifetime giving that are not available for charitable bequests. Those benefits, and their economic impact, are forfeited if those transfers are delayed until death.
Further, bequests cannot provide the non-economic benefits of lifetime transfers, such as observing the impact the gift makes and receiving appropriate appreciation.
Simply put, the Howards will make more economic impact and be more fulfilled by making lifetime gifts; therefore, they should make sure they have a financial plan that gives them the peace of mind that such a gift will not in any way diminish their goals for independence and to leave a legacy.
Tax Benefits of Lifetime Giving
When it comes to direct giving, the reason people give is found in their charitable mission. People would not make charitable gifts for the tax benefits alone; there needs to be a deeper connection in wanting to make a philanthropic impact.
But for those who want to make a charitable impact, the tax code materially assists that impact:
- First, for lifetime gifts to charity, the internal revenue code allows a tax deduction for the value of the property given. While there are limits on the deduction, for most gifts and donors, those limits (60% of the donor’s adjusted gross income) are rarely met. In 2020, cash donations are deductible up to 100% of adjusted gross income rather than the standard limit of 60%.
- Second, for those who want to give stock (or another capital asset) rather than cash, the code provides the additional benefit of allowing the tax deduction for the full value of the stock up to 30% of adjusted gross income without the need to recognize any capital gain income inherent in the shares. Any excess can be carried forward. For example, if the Howards purchased Apple stock for $10,000 that is now worth $210,000, they could give that stock to the hospital and take a $210,000 tax deduction (up to 30% of adjusted gross income). If instead they sold the stock, they would incur a $40,000 tax bill due to the $200,000 appreciation in the liquidated shares.
- Finally, if the Howards have IRAs, those assets can be powerful giving tools. When the Howards take IRA distributions, they have about 60% purchasing power from those assets (the other 40% is lost to income taxes). But if they leave those distributions to charity, those assets have dollar for dollar impact to the charity and to the fulfillment of the Howards’ charitable mission.
If, on the other hand the Howards leave the same value as a charitable bequest, they do avoid the estate tax on the value of the assets left to charity. While that can be a tremendous impact to people with considerable wealth, for anyone with a net worth less than $23 million, there is no tax benefit at all to the gift.
Given the incentives of the tax code, it makes sense for the Howards to make lifetime gifts and allow the code to enhance the impact of their giving and assist them in achieving their charitable mission.
If the Howards’ charitable purpose can be met by a direct gift to a charity, that is the best and simplest way to make an impact. But what if it cannot? What if the size of the gift the Howards want to make is more than the organization can handle? What if the tax planning surrounding the gift is inconsistent with the duration of impact that the Howards want to make? What if the Howards want to “test out” one or more organizations before giving them more resources?
In the next two articles, covering donor-advised funds and private foundations, we’ll see how the Howards’ charitable giving evolves as they become less convinced that their charitable mission can be met by direct giving to the hospital.
Article By Joe Maier, JD, CPA, Senior Vice President, Director of Wealth Strategy and Bob Schneider, CFP®, RICP®, Senior Vice President, Wealth Advisor - Johnson Financial Group