The Biggest Tax Bang For Your Charity BuckJoan Warner
You know the winter holidays are nigh when your mailbox bulges with charity appeals. Many people respond, hoping to do some yearend tax-cutting while they throw a few bucks at their favorite causes. Before generosity overcomes you, it pays to understand when the tax code rewards charity--and when it does not.
It doesn't necessarily follow that the more you give away, the more you save on taxes. Charitable donations, like other itemized deductions, are subject to limits. Some kinds of contributions are fully deductible, others only partially, and still others not at all. Similarly, how much you can give depends on the kind of charity you're funding.
PERSONAL GOALS. The Internal Revenue Service divides charitable organizations into two groups under its Section 501(c)(3). Most charities that depend mainly on the public for support, such as the World Wildlife Fund or United Way, are called 50%-type organizations because you may give them--and deduct--up to 50% of your adjusted gross income in any tax year. To charities with a smaller support base, such as private and community foundations, you can donate up to 30%.
Other rules, too, vary according to what kind of charity receives your munificence and the nature of your donation. For example, money given to individuals is never tax-deductible. Neither is the value of services rendered to the needy, even if those services are lifesaving. Most charities tell you their tax status up front. If you get
a pitch from a charity that doesn't, check with the irs or the Philanthropic Advisory Service of the Council of Better Business Bureaus (703 276-0100).
Your first instinct in trying to combine altruism with money management might be to work backward from your tax goals. But experts say that's a mistake. "I advise clients to focus on their personal goals," says Ross Nager, director of Arthur Andersen's Family Wealth Planning Practice. "It's almost impossible to make money by giving it away to charity." Nager encourages people to look at the pattern of their donations, consider other objectives such as estate planning, and then work out the most tax-advantageous strategy for carrying them out.
You can use charity to shave income taxes, capital-gains taxes, and gift or estate taxes. In the first case, planning consists mainly of timing donations to maximize their tax benefit. If you think President-elect Clinton will raise rates, for example, you may want to postpone some of your 1992 giving until after New Year's. A $1,000 donation costs you $690 aftertax if your bracket is 31%, but only $640 if that rate hits 36%. "Probably taxpayers with incomes over $200,000 should be concerned" about timing, says Jeff Keyser, tax partner at Deloitte & Touche in Cincinnati.
You should, of course, document all deductions in case of an audit. Check stubs will do for a simple cash gift, but donations that buy you a privilege or reward require some care: If you pay $200 to attend an animal-rights benefit gala, the irs will assume you had $200 worth of fun. The agency won't allow a deduction unless the organization provides a receipt showing just how much of that amount helped animals.
APPRAISALS. Noncash gifts that are difficult to value, unlike publicly traded securities, require special treatment. If you give more than $500 worth of used clothing or furniture to Goodwill Industries or your local thrift shop, you must file Form 8283, on which you explain to the irs how you valued the donation. For noncash gifts exceeding $5,000, such as artwork or private-company stock, you must supply a formal appraisal. "It's the taxpayer's responsibility to get a determination of value," says Keyser.
Many tax advisers recommend giving away appreciated property instead of cash when possible. The beauty of this approach is that you realize not only a current deduction but a capital-gains tax savings. Say you had $10,000 worth of stock for which you paid $1,000. If you sold the stock and gave your profit to charity, you could take a $10,000 current deduction and save $3,100 in taxes, but you'd owe $2,520 in capital-gains taxes (28% of $9,000), so the gift would cost you $9,420. If instead you donated the stock, you'd take the same current deduction but pay no capital-gains tax, and the gift would cost only $6,900. The strategy can apply to baseball cards, antiques, real estate--anything that's worth more than you paid for it.
Some complications ensue, however, when you give appreciated property. For one thing, the limits on how much you can donate a year are lower: 30% of agi to public charities and 20% to private ones. Second, if you are subject to the alternative minimum tax, you may deduct only the property's cost, not its market value. That doesn't make for much of a tax savings. "Since more and more people are becoming subject to amt, this could be a trap," says Nager.
Another wrinkle arises when you donate real estate. Say you give away an appreciated building on which you have taken depreciation. If you sold the building, only part of your profits would be capital gains. The rest would be recaptured depreciation, which is treated as ordinary income. So if you give the building to charity, you may deduct only the part of its market value that derives from capital gains. In fact, the irs scrutinizes any donated property that normally generates income. A clockmaker who gives clocks to an orphanage may not deduct their market value, only what they cost to make.
Whether you donate cash, old clothes, or depreciated property, they are present gifts that yield immediate benefits to the recipient and the donor alike. Another way to do well by doing good is with deferred giving, which is normally done through a trust. Under this approach, the recipient doesn't derive full benefit from the donation until some future date--usually specified by the donor. But in most cases, the donor sees immediate results.
With a charitable-remainder trust, as the name implies, an organization gets what's left over from a gift after the donor uses it during a specified period of time. When you set up the trust, you take a current deduction for the present value of that future gift. The amount is calculated according to irs actuarial tables and depends on your age and the term of the trust. During that term, you receive an annuity, which may either be fixed at the outset (at no less than 5% of trust assets) or indexed annually to the trust's income. When the term expires, the recipient gets all the remaining principal plus any accrued income.
'EVERYONE WINS.' Putting appreciated stock in a charitable-remainder trust may be the smartest move of all. The trust pays no income or capital-gains taxes. So it has more to invest than if you had sold the stock and invested the proceeds. The trust can then sell the stock tax-free, diver-
sify, and throw off maximum income. Furthermore, your taxable estate is reduced by the trust amount. "You end up doing very well for yourself, your family, and the charity," remarks Joel Isaacson, director of financial planning at Clarfeld & Co. "Everyone wins except the government." The only drawback to such a setup is that when the trust terminates, the remainder goes to charity rather than to any heirs.
Some insurers recommend charitable-remainder trusts, but they usually have an ulterior motive: selling you a life-insurance policy to replace the money you cut from your kids' inheritance. "You have to think through the ramifications," says Arthur Andersen's Nager. "You tie up the capital in trust, the charity gets it, insurance isn't free, and you don't have as much control over investments."
Whether you're considering a sophisticated device such as a trust or just wondering how much to give the Boy Scouts this year, figure out your motivations first. Charity and tax-saving don't necessarily dovetail. "If your sole goal is to reduce income tax," says Nager, "you're probably better off buying municipal bonds." But then you would miss out on that warm, fuzzy feeling the holidays are supposed to bring.