How to Leverage Your Charitable Giving With Smart Tax and Investment Strategies

“To whom much is given, much is expected” is a famous quote that has been used by presidents and preachers as a reminder that the most successful in our society also have a duty to give back to the benefit of others.

Fortunately, this edict is second nature to the wealthiest Americans.  A 2019 study found that the United States is still the most generous country in the world for the last decade.  Even within the United States, the wealthiest Americans give the most both in total charitable dollars and even as a percentage of their incomes.

According to the Philanthropy Roundtable, the top 1% of income earners (approximately $400,000) income or higher per year provide about a third of all charitable dollars in the United States.  And those earning $2 million or more per year donated approximately 14% of their incomes to charities whereas households earning between $200,000 and $2 million per year were still donating a very generous 8.5% of their income on average.

Done correctly, charitable giving can be integrated with your investment and tax planning to create and maximize benefits to both the donor and the recipient charities.

Of course, there are many rules that govern the tax and investment implications of the various ways that you can give. With this article, we review some of the most common opportunities and strategies associated with charitable giving.

Charitable Gifts and Their Tax Deductibility

The simplest and perhaps most common situation involves donations of cash or property to a qualified charity.  In order to take a tax deduction for the donation, the following criteria must be met:

  • The charity must be qualified. An IRS qualified charity is one that has a 501(c)(3) tax-exempt status or is a church or religious organization.
  • You must meet several documentation requirements. You must keep good records, including cancelled checks and acknowledgement letters to back up your deductions if the IRS asks.
  • You must donate cash or property. You actually have to make an actual donation of money or property in the year for which you are claiming a tax deduction. A pledge or promise to donate is not sufficient.
  • You need to file using Form 1040 and itemize your deductions. You can claim a tax deduction for charitable giving on Schedule A, Form 1040, if you qualify to itemize. If you claim a standard deduction, which is larger than it was a few years ago, you cannot deduct your donations as a line item.
Charitable Giving Through Wills and Trusts

Wills and trusts are legal documents that direct the dispersal of assets at the time of a person’s passing. A will is typically written to name one or more beneficiaries, who are individuals or entities to which the decedent wishes to leave property, cash or other assets upon death.

It is very important that due consideration be given to a person’s will and/or trust while they are living and of sound mind. There are a lot of details to consider, including selection of the beneficiaries. In most cases, a professional - typically an attorney who practices trusts and estates law - is consulted to assist in the creation of wills and trusts. If done improperly, or if the deceased has no will, a court will likely get involved which can cost much more and result in substantial delays. In such cases, the actual wishes of the deceased may or may not be carried out at all. 

Because of the tricky nature of wills and trusts, and due to the fact that probate law can be involved, most people like to talk with a financial professional, even before they get a will or trust drawn up. This is especially true for high net-worth individuals. An experienced investment and financial advisor, like Ridgewood Investments can advise you throughout this process.

Charitable Trusts: Charitable Lead vs. Charitable Remainder Trusts

A charitable trust is an entity set up to hold a set of valuable assets, usually liquid assets such as stocks and bonds but sometimes also private assets such as real estate or collectibles, which a donor signs over or uses to create a pool of value to benefit one or more causes of interest.  One or more persons are usually named as trustees to oversee the operations of the trust. Charitable trusts can be excellent vehicles through which to transfer your wealth for charitable purposes to support one or more causes that particularly resonate with you. They come in more complex flavors: Remainder trusts and Lead trusts.

Remainder Trusts. In a remainder trust, the assets are signed over to a trust for a specified length of time. When the time is up, the assets (and any profits that have been accumulating) become the property of the organization.  Remainder trusts can often provide for some or all of the income from the trust before it ends to be given back to the donor or someone the donor designates.

Lead Trusts. Conversely, in a lead trust, the donor does not give up control of the assets. Instead, any gains or interest the assets produce, or a specific portion thereof, are given to the charitable organization. However, when the lead trust expires, the assets revert back to the owner or his or her beneficiaries.

Charitable trusts can provide some outstanding tax benefits to the high-net-worth donor. For example, highly appreciated stocks are especially vulnerable to enormous capital gains and estate taxes, but if transferred to and held in a charitable trust, donors can get an immediate federal tax deduction based on the value of the amount donated while simultaneously saving on the upfront capital gains taxes that would be due.

Charitable trusts can be quite complex, and many factors need to be considered before entering into one. A trusted financial advisor such as Ridgewood Investments can personally guide you through the many details involved and work closely with your other advisors such as your estate attorney and CPA to help create and implement a smart financial plan to take maximum advantage of the legal structure that can give you the most efficient and beneficial outcome.

Private Family Foundations and Similar Entities

There are several other tax-beneficial charitable entities worth considering. These are private family foundations, donor-advised funds and community foundations.

  • Private Family Foundations. This is an entity that is set up and directed by a family and funded with the family’s assets. They are created to enable the family to make charitable or philanthropic gifts. The family gets a tax deduction every year a contribution is made.  Using a private family foundation can help to avoid or minimize capital gains taxes and can reduce potential estate taxes. Setting one up generally involves a lawyer or CPA, as they can be more complex and somewhat expensive to do correctly.
  • Donor-Advised Funds. A donor-advised fund is comparable in many respects to a private family foundation without the complexity of having to set one up on your own.  A Donor-Advised fund acts almost like a pooled family foundation shared with many others families for efficiency.  One main distinction is that, after making an irrevocable contribution, the donating family can make recommendations to the sponsor, but the organization itself handles the fund’s management and all necessary record keeping.  Your irrevocable contribution is tax deductible in the year it is given. Moreover, just as with a private family foundation, there are no capital gains taxes on gifts of appreciated assets.  Another advantage of donor advised funds is that they can be quite cost effective and the gifts of assets can still be invested to grow well into the future.  Due to their many advantages, it is not surprising that Donor Advised Funds have become increasingly popular, especially among affluent families with charitable intent.
  • Community Foundations. These are tax-exempt, publicly funded charitable organizations dedicated to improving people’s lives within a local community setting. The first of these in the US, the Cleveland Foundation, was founded by Frederick Goff, whose intention was "to pool the charitable resources of Cleveland's philanthropists, living and dead, into a single, great, and permanent endowment for the betterment of the city”. Donors to community foundations may be eligible for a tax deduction, up to IRS limits. Some community foundations offer Donor-Advised Funds.  The main difference is that community foundations are public charities subject to additional requirements.

Of the above options, the Donor Advised Funds are growing the fastest, are the easiest to set up and offer substantial tax and investment advantages.  One major benefit of the donor advised fund is that it allows the timing of the donation and the timing of the gifts to be separated.  Someone with appreciated investments can transfer some of the position to the Donor Advised Fund and take a deduction immediately.  The money can then be invested within the Donor Advised Fund to grow and increase in value.  The donor can then direct gifts whenever he or she wants to support a worthy cause in the future by asking the donor advised fund to give a certain amount of the previously transferred funds and investments to a particular cause.

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Ridgewood Can Help You Sort It Out

As you can see, charitable giving not only can help out your favorite causes, but, if structured and executed properly, can help minimize your taxes as well. There are more than a few ways to give and that some of these methods can be somewhat complex.

If you are affluent and want to structure your charitable giving in a way that can maximize your impact and minimize your taxes, Ridgewood Investments would be happy to chat with you and compare notes to help match you to a solution that fits your particular situation.

About the Author

High Net Worth Financial Advisor New Jersey

Kaushal “Ken” Majmudar, CFA founded Ridgewood Investments in 2002 and serves as our Chief Investment Officer with primary focus on managing our Value Investing based strategies. Ken graduated with honors from the Harvard Law School in 1994 after being an honors graduate of Columbia University in 1991 with a bachelor’s degree in Computer Science. Prior to founding Ridgewood Investments in late 2002, Ken worked for seven years on Wall Street as an investment banker at Merrill Lynch and Lehman Brothers where he has extensive experience working on initial public offerings, mergers and acquisitions transactions and other corporate finance advisory work for Fortune 1000 companies. He is admitted to the bar in New York and New Jersey though retired from the practice of law.

Ken’s high level experience and work with clients has been recognized and cited on multiple occasions. He is a noted value investor who has written and spoken extensively on the subject of value investing and intelligent investing. He has been a member of the Value Investors Club – an online members-only group for skilled value investors founded by Joel Greenblatt, SumZero – an online community for professional investors, and has also written for SeekingAlpha – among others. Ken is active in leading professional groups for investment managers as a member of both the CFA Institute and the New York Society of Securities Analysts.