By Tony Martignetti, Esq.
Tony Martignetti is managing director of Martignetti Planned Giving Advisors, LLC, a planned giving consultancy that works with a wide range of educational, cultural, social service, religious and healthcare institutions to create donor opportunities for middle-income investors. Contact Mr. Martignetti at firstname.lastname@example.org.
Media attention on President Obama's proposal to lower the value of tax deductions for charitable donations for wealthy individuals has focused attention on high net worth giving, but it ignores the fact that the majority of charitable giving in the U.S. really comes from non-wealthy donors. Will Obama's proposal change that fact? Not at all.
There is considerable consternation in the non-profit community around President Obama's proposed cap on charitable deductions. His budget proposal would limit income tax charitable deductions to 28 percent for taxpayers at the highest marginal income tax rate, currently 35 percent. These are taxpayers whose annual income exceeds $250,000.
Under the proposal, a $1,000 gift to charity from a donor whose income is high enough to put them in the 35 percent bracket would earn a $280 charitable deduction (28 percent of $1,000) rather than a $350 deduction (35 percent of $1,000).
This isn't great for non-profits, but it won't have the devastating effect on charitable giving that many critics predict.
Consider these points:
First, let us recognize at the outset that it is merely a budget proposal. It may not become law.
Second, even if it does, it won't take effect until 2011. That gives charities time to educate donors and retune their messages. Plus, it gives wealthy, high income donors two years to continue making gifts that are deductible up to their highest marginal income tax rate. I see here an opportunity to encourage donors to accelerate pledge payments so they earn maximum deductions.
Finally, if the proposal becomes tax law, I am less concerned than most because high income donors contribute a small percentage of all charitable gifts and tax advantages aren't the reason they give.
Nearly two-thirds of all the charitable gifts in 2004 came from donors whose income was under the $250,000 threshold, according to Giving USA 20071. (Their bracket was capped at $200,000.) This is the most recent year for which I can find this statistic, but giving patterns generally don't shift much over five years.
We all know that enormous gifts from the wealthiest donors make headlines, while gifts from those at middle and low incomes comprise most of the giving to our nation's non-profits.
We also know that tax considerations are not the primary motivation for giving-including for the wealthy. In the 2007, U.S. Trust Survey of Affluent Americans, only 33 percent cited tax advantages as their first thought when deciding whether to donate. You may know this from your own practice.
Our nation's donors give to non-profits because they value the missions they're supporting; they believe in a spiritual leader, a scholarship program or a promising modern dance company; they want to set an example for others, including their children; they want to repay the society they regard as having supported their success; and they want to help those who have less. Taxes? They figure in, but they're not top of mind.
I recognize that a planner's time with clients is more focused on strategy and quantitative analysis than the other motivations for giving. Hopefully, not exclusively. I hope you enjoy the softer side in your practice as well.
For those strategic sessions, what does the charitable sector have to offer you?
Charitable Remainder Unitrust
If you have bullish clients who are charitably inclined, look to the Charitable Remainder Unitrust-for a term of years.
You know this staple of planned or deferred giving programs, and you may have had clients approach you about it after a non-profit proposed it to them. It pays income for life to one or two "income beneficiaries" and that income is a fixed percentage of the trust value.
The trust's market value is calculated anew every year and that revaluation feature makes the Charitable Remainder Unitrust a terrific charitable vehicle for a bullish client who believes we're at or near the market bottom. They will enjoy the run up in the trust's portfolio because their annual income from the trust is tied to the portfolio's market value.
The savvy planner will recommend funding a trust with appreciated stock, so your client's capital gain tax liability is avoided at sale. There's still a lot of appreciation around. Clients who have held equities for decades have very low basis positions. Their portfolio isn't worth what it was last summer, but many long-term investors do have stocks worth more than they paid for them.
Put those stocks in the trust for two reasons. When the trustee sells them for diversification, the tax on the gain is avoided; these are tax-free trusts when properly created. Also, your client will enjoy increasing income as the new portfolio rises in value. This gift strategy appeals to bullish donors, remember.
Their trust income can be taxed below ordinary income rates. Income from these trusts is characterized by how it is distributed by the trust. To the extent the trust realizes and distributes capital gain income, which is typical in the first year due to sale of the funding assets, your client will be taxed at capital gain rates. If the trust distributes tax-free income, earned from a tax-free portfolio, it is paid as such to your client. Not surprisingly, the trust must distribute all its ordinary income before capital gain and all its capital gain income before tax free.
Beyond the income, income tax and capital gain tax advantages, your client earns an income tax charitable deduction in the year of trust creation. Their deduction-the present value of the estimated remainder to charity-is discounted using the prevailing applicable federal rate (2.4 percent in May2) and also relies on trust term and anticipated earnings.
Using appreciated stock, the deduction is limited to 30 percent of adjusted gross income. The 5 year carry forward provision applies to give your client up to 6 years to make full use of their deduction.
These trusts typically run for the lives of the income beneficiaries. That's the way non-profits usually think of them. Look at them, instead, for a term of years. The number of years your client thinks will get them through the recession. A 3 or 5 year trust (the duration must be determined up front) will pay its income for that term in annual, or more frequent, installments and pay its remainder to the non-profit(s) your client wants to support. Recognize that one Charitable Remainder Unitrust can benefit multiple organizations.
A trust of this type can help your client's loved ones through the recession. The creator of the trust need not receive its income. Your client can designate a sibling or her parents as the income beneficiaries. Any one or two natural people can benefit. Because it runs for a fixed term of years, you won't run afoul of a non-profit's minimum age requirement for income beneficiaries, which logically should apply only to a trust for life.
Important to you, there's no need for this vehicle to reduce the assets you have under management. You can be the trustee. If your institution has the infrastructure to manage the accounting and tax filing, work with your client to recommend you to the non-profit.
Charitable Remainder Annuity Trust
What if you have a client who is not bullish but risk averse-and is charitably motivated? She doesn't know when the bottom will come and won't bet income on her best guess.
The risk averse will prefer the Charitable Remainder Annuity Trust. It, too, pays fixed percentage income, but there is no annual revaluation. The rate of income is applied to the trust's opening value to determine the dollar amount paid each year. This trust pays fixed income.
Your client (or whoever she selects to receive income) knows from the outset-and to the penny-how much will be received in each year of the trust's life. Perfect for the market wary.
Here, the risk is borne by the non-profit as remainder beneficiary. If the annuity trust's earned income doesn't cover the payout to income beneficiaries, then corpus gets invaded to make up the difference. An annuity trust agreement explicitly grants invasion authority to the trustee. Exercising that authority means less on the back end for charity. In exchange for shifting risk away, your client sacrifices the upside potential of a rise in the trust's portfolio.
Set this one up for the same term as suggested for the Charitable Remainder Unitrust: the number of years your client thinks it will take to get out of the recession.
Let's look at the income rates. The charitable trusts must pay between 5 and 50 percent. To prevent gouging and protect charitable interests, the remainder value must be at least 10 percent of the funding asset's market value when contributed to the trust. For the annuity trust, where corpus depletion is more likely, the possibility trust assets will be entirely consumed and the remainder dwindles to zero, must be less than 5 percent. Widely available commercial software alerts the user when a trust risks not passing these tests.
For either of these trusts to make financial sense, your client has to want to help one or more non-profits. Otherwise, they'll look to commercial annuities and comparable products, which always pay a higher rate. Of course, they come sans the capital gain savings and charitable deduction.
The annuity trust shares these features with its counterpart:
- Your client or their loved ones can receive trust income
- Capital gain tax liability is avoided upon the sale of appreciated assets within the trust
- Income tax charitable deduction is earned in the year the trust is created
- Deduction is the present value of the estimated remainder to charity
- Deduction is limited to 30 percent of adjusted gross income when appreciated assets fund the trust
- Five year carry forward is available
- Income can be taxed at less than ordinary rates
- You can be the trustee
- Multiple non-profits can benefit from one trust
Think about these staple vehicles in a new way-with a life of just a few years-to get your charitably inclined clients through the recession. With you as trustee, and one or more charities at the end, several people will enjoy a brighter few years.
1 Giving USA 2007, page 63
2 IRS Revenue Ruling 2009-12