Taxes

In the final installment of our series on gifting strategies, we focus on four long-term approaches to charitable giving. These strategies ensure that your philanthropic intentions continue to make an impact well into the future.

1. Legacy Gifts in a Revocable Estate Plan

Your legacy is not only how you want to be remembered but should also comprise a set of guiding principles your family will be encouraged to uphold.  A legacy gift, also known as a bequest, is a gift made through your estate planning documents.  Legacy gifts can be specified as a set amount, a percentage of your estate, or the remainder after other bequests are made.  In addition, charitable beneficiaries can be designated up front as a specific bequest or can be designated as a final or contingent beneficiary, in the event other family members predecease you.  Not only is this an easy way to make a lasting impact on your favorite charity, but a percentage bequest can add up to a substantial legacy gift without burdening your heirs.  For example, a 10% specific bequest to charity in a $1 million estate is a $100,000 gift to charity, while still leaving $900,000 to your heirs.

Pros:

• Flexibility to change your mind during your lifetime
• Simple to set up with the help of an estate planning attorney

Cons:

• No immediate tax benefits during your lifetime
• Dependent on the value of your estate at the time of death

2. Designating Charity as a Direct Beneficiary of a Pre-Tax Retirement Account

If you wish to leave money to charity upon your death, use your IRA, 401(k), or other pre-tax retirement accounts to satisfy your bequest.  Designating the charity as primary or contingent beneficiary on your pre-tax retirement accounts avoids taxes to heirs while preserving the value of the account for your favorite charity.  Keep in mind that if an individual beneficiary inherits a pre-tax retirement account, they face mandatory withdrawals that are taxed as ordinary income and without the benefit of the step-up in cost basis upon your death.

Pros:

• Charities do not pay income tax on the distributions, maximizing the gift
• Simple beneficiary designation form to complete
• Reduces the taxable estate, potentially lowering estate taxes

Cons:

• No immediate tax benefits during your lifetime
• Irrevocable upon your death
• Reduces the funds available for other beneficiaries

3. Charitable Trusts

Charitable trusts, including Charitable Lead Trusts (CLTs) and Charitable Remainder Trusts (CRTs), are sophisticated tools for managing charitable giving while benefiting your heirs and receiving tax advantages.

Charitable Lead Trust (CLT):

A CLT provides annuity or unitrust payments to a charity for a set term, after which time the remaining assets go to your non-charitable beneficiaries—generally family members or trust for their benefit—free of gift and estate taxes.  NOTE:  This strategy works better in lower interest rate environments.

Pros:

• Reduces estate and gift taxes
• Immediate support for charities
• Potential to transfer assets to heirs at a reduced tax cost

Cons:

• Complex and costly to establish and maintain
• Irrevocable once funded
• Market performance risk affecting the remainder for heirs

Charitable Remainder Trust (CRT):

A CRT provides annuity or unitrust payments to you or your beneficiaries (typically you and your spouse during your lifetimes) for a set term, after which time the remaining assets go to the charity or charities you previously designated.  NOTE:  This strategy works better in high interest rate environments.

Pros:

• Immediate tax deduction based on the present value of the remainder interest
• Income stream for you or your beneficiaries
• Avoidance of capital gains tax on appreciated assets

Cons:

• Irrevocable once funded
• Annual administrative requirements
• Market performance risk affecting the income stream and remainder for charity

4. Private Foundation

A private foundation is a charitable organization created and funded by an individual, family, or corporation, which allows for continuous charitable giving across multiple generations.  A private foundation also allows for (a) on-the-job training in charitable giving for younger generations of your family; (b) a layer of privacy and, potentially, anonymity to you and members of your family; and (c) a level of control over stock in family-owned corporations, without the affiliated income and estate tax worries. 

Pros:

• Control over the foundation’s activities and grant-making
• Potential for family involvement across generations
• Immediate tax deductions for contributions

Cons:

• High administrative and compliance costs
• Requires significant funding, generally recommended at least $1-2 million
• Ongoing management and reporting requirements

Conclusion

Long-term charitable giving strategies provide a powerful way to ensure your philanthropic goals are realized beyond your lifetime. From the flexibility of legacy gifts to the structured support of charitable trusts and private foundations, each option offers unique benefits and challenges. Consulting with financial and tax advisors and an estate planning attorney is crucial to navigating these complex strategies effectively.

This series on gifting strategies has covered a wide range of approaches, from education-specific strategies and direct gifts to advanced trusts and foundations. Each method offers a pathway to making a meaningful impact, preserving your values, and enhancing the value of your estate. By thoughtfully planning your gifts, you can leave a legacy that reflects your passions and commitment to the causes and people you care about most.

As we continue our series on gifting strategies, we turn our focus to charitable giving. Charitable bequests offer a unique opportunity to make a real impact, honor or memorialize a loved one, enhance the value of your estate, demonstrate your values to your children and other heirs, and determine the legacy you leave behind. By planning your charitable contributions strategically, you can maximize the benefits for both the charity and you. Here are four short-term gifting strategies for charities:

1. Bunching

Bunching is a strategy where you consolidate multiple years’ worth of charitable contributions into a single year. This approach allows you to itemize deductions in the year you bunch your donations, potentially exceeding the standard deduction and maximizing your tax benefits.  If payments are significant, this strategy may offer you the ability to itemize every other year.

Pros:

• Maximizes tax deductions by surpassing the standard deduction threshold
• Flexibility in timing and amount of donations
• Can plan donations around high-income years for greater tax savings

Cons:

• Requires careful planning and timing
• Benefits may vary depending on changes in tax laws
• Potentially less consistent support for charities year-to-year

2. Gift of Appreciated Securities

Highly appreciated securities are those securities where the fair market value significantly exceeds the original purchase price or cost basis of the securities, resulting in a significant amount of capital gains upon the sale of such securities. Donating highly appreciated securities, such as stocks, bonds, or mutual funds, directly to a charity can be a tax-efficient way to give—may be even more tax-efficient than donating cash. By donating the securities, you avoid paying capital gains tax on the appreciation (as well as avoiding the 3.8% net investment tax), and you can deduct the fair market value of the securities on the date of the gift.

Pros:

• Avoids capital gains tax on appreciated assets
• Deduction based on the fair market value of the securities
• Benefits both the donor and the charity

Cons:

• May not be suitable for all donors, and not all charitable organizations have the capability to accept securities
• Donation of closely held securities require a valuation and additional paperwork
• Securities must be held for more than one year

3. Donor Advised Fund

A Donor Advised Fund (“DAF”) is a charitable giving vehicle hosted by a public charity that allows you to make a lump-sum charitable contribution, receive an immediate tax deduction, and then recommend grants to charitable organizations from the fund over time. DAFs offer flexibility in timing and can be used to support multiple charities.  As a bonus, at tax time you only need one charitable contribution statement from the DAF organization to provide to your tax preparer, regardless of the numerous charitable grants made from the DAF subsequent to the contribution.

Pros:

• Immediate tax deduction upon contribution to the DAF
• Flexibility to recommend grants over time
• Can be invested for potential growth, increasing the charitable impact

Cons:

• Administrative minimums and fees, along with investment management costs
• Contributions to the DAF are irrevocable
• Limited control once funds are contributed; must adhere to the sponsoring organization’s policies

4. Qualified Charitable Distribution

A Qualified Charitable Distribution (“QCD”) allows individuals aged 70½ or older to transfer up to $100,000 directly from their IRA to a qualified charity on an annual basis. This distribution counts towards the required minimum distribution (RMD) and is excluded from taxable income.  A QCD is in effect “deductible” even for someone who cannot itemize.  In other words, you, as the IRA owner, can satisfy your charitable gifts with a QCD, exclude the QCD from your income, and still take the standard deduction on your tax return.  Here are a few of the taxes and costs you may reduce or avoid by having a lower Adjusted Gross Income (AGI) as a result of satisfying your RMD with a QCD:  (i) 3.8% net investment tax kicks in when AGI is above certain levels; (ii) medical expenses (deductible if they exceed 7% of AGI); (iii) Social Security benefits may be wholly or mostly excludible from gross income based on AGI; (iv) Medicare premiums are higher for higher-income individuals (based on AGI for the tax year that is two years’ prior to the premium year in question); and (v) reduction in state income taxes, as most state income tax returns begin with your federal AGI.

Pros:

• Reduces taxable income by excluding the distribution from income
• Satisfies RMD requirements—provided that QCD is taken out first
• Direct transfer simplifies the process

Cons:

• Limited to individuals aged 70½ or older
• Annual limit of $100,000 per individual
• Must be transferred directly from the IRA to the charity to qualify

Conclusion

Charitable giving is a powerful way to make a lasting impact and shape your legacy. Whether you choose to bunch your donations, gift appreciated securities, utilize a Donor Advised Fund, or make a Qualified Charitable Distribution, each strategy offers unique benefits and considerations. By thoughtfully planning your charitable contributions, you can maximize the benefits for both the charities you support and yourself, ensuring that your generosity continues to make a difference for years to come. Consulting with a financial advisor and estate planning attorney can help you determine the best approach for your individual circumstances and philanthropic goals.

Continuing from our previous discussion on education-specific gifting strategies, this article delves into four additional gifting strategies for your children. While outright gifts and intrafamily loans are relatively straightforward, Intentionally Defective Grantor Trusts (“IDGT”) and Spousal Lifetime Access Trusts (“SLAT”) are more advanced strategies that require careful planning and execution. Below we will explore each of these strategies, along with their respective advantages and disadvantages.

1. Outright Gifts

Outright gifts are perhaps the simplest way to transfer wealth to your children. You can give cash, stocks, real estate, or other assets directly to them. Each year, you can give up to the annual exclusion amount ($18,000 per recipient for 2024) without incurring gift tax or triggering the obligation to file a federal gift tax return. If you exceed this amount, you must file a federal gift tax return and the excess will count against your lifetime gift and estate tax exemption ($13.61 million per person for 2024).

Pros:

• Simple and straightforward
• Immediate benefit to the recipient
• Ability to evaluate the beneficiary’s management and use of the gifted assets
• No need for complex legal arrangements

Cons:

• Loss of control over the gifted assets
• Potential for a gift tax return if the annual exclusion is exceeded
• Assets may be subject to creditors or poor financial decisions by the recipient

2. Intrafamily Loans and Loan Forgiveness

Intrafamily loans involve lending money to your children and charging interest at the applicable federal rate (“AFR”) – the minimum rate required between related parties.  In today’s interest rate environment, the AFR is significantly lower than what they would receive from a commercial lender.  Parents can also offer more favorable and flexible terms than commercial lenders, such as no downpayments, interest only loans, or extended payment periods.  Parents could later choose to forgive portions of the loan, effectively converting it into a gift.

Pros:

• Lower interest rates than commercial loans
• Flexibility in repayment terms
• Can be structured to avoid gift tax implications initially

Cons:

• Requires formal documentation and adherence to IRS rules to avoid being reclassified as a gift
• Potential strain on family relationships if repayment becomes an issue
• Interest income is taxable to the lender

3. Intentionally Defective Grantor Trust (“IDGT”)

An IDGT is an irrevocable trust that allows you to transfer assets out of your estate while retaining certain tax benefits. The trust is considered “defective” for income tax purposes because you, as the grantor, are still liable for the income tax on the trust’s earnings. This reduces the size of your taxable estate while allowing the trust assets to grow tax-free.  An IDGT can offer asset and creditor protection, while also servings as an effective prenuptial agreement for children, protecting their inheritance from potential future spouses without the awkwardness, hassle, and legal costs of negotiating with a child’s fiancée.

Pros:

• Removes assets from your estate, reducing estate taxes
• Allows for tax-free growth of trust assets
• You pay income tax on IDGT earnings, further reducing your taxable estate

Cons:

• Complex strategy that requires legal expertise to set up
• Irrevocable, meaning you unable to amend, restate, or revoke the IDGT
• You cannot reclaim the assets without consideration (or without adequate consideration) once transferred

4. Spousal Lifetime Access Trust (“SLAT”)

A non-reciprocal SLAT is an irrevocable trust where one spouse creates and funds a trust during their lifetime for the benefit of the other spouse and, potentially, children and grandchildren. The SLAT assets are removed from your estate, but the beneficiary spouse can still access the income and principal of the SLAT, providing you with indirect benefits. A SLAT works best for married couples who want to make significant lifetime gifts to children but have serious concerns about permanently giving away a significant portion of their assets that they may need later in life to maintain their lifestyle or to provide for their long-term care.

Pros:

• Removes assets from your taxable estate
• Provides financial support to the beneficiary spouse
• Potential for significant estate tax savings

Cons:

• Complex and requires careful planning and legal expertise
• Irrevocable, limiting flexibility
• If the beneficiary spouse dies, your indirect access to the SLAT may be lost

Conclusion

Choosing the right gifting strategy depends on your financial goals, the needs of your children, and your comfort with the complexity of each approach. Outright gifts and intrafamily loans offer simplicity and flexibility, making them ideal for more straightforward situations. For those with larger estates or more complex needs, IDGTs and SLATs provide advanced strategies to minimize taxes and protect assets. Consulting with an estate planning attorney can help you navigate these options and create a plan that best fits your family’s unique circumstances.

One of the most impactful ways to ensure your legacy is by investing in the education of your children or grandchildren. Various gifting strategies can help you provide for their educational needs while also offering potential tax benefits. Here are four education-specific gifting strategies and the pros and cons of each strategy:

1. Outright Payments Made Directly to the Educational Institution

One of the simplest and most effective ways to contribute to a child’s education is by making outright payments directly to the educational institution. Payments for tuition only are not considered taxable gifts and do not count against your annual or lifetime gift tax exemptions. Payments made for other educational expenses, such as room and board, books, fees, and equipment are considered taxable gifts, but they qualify for the annual gift tax exclusion—for 2024, the annual exclusion amount is $18,000 per recipient.

• PROS: Easy to implement. This cost-effective option allows you to significantly reduce the financial burden on the student, while reducing your taxable estate and avoiding gift taxes. This is the ideal strategy for those who want to make a substantial impact immediately.
• CONS: This strategy only covers present gifts; future gifts are uncertain.

2. UGMA/UTMA Accounts

The Uniform Gifts to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) accounts are custodial accounts held for the benefit of a minor beneficiary until they reach the age of majority (which varies by state). For example, in Ohio, UGMA/UTMA accounts can be held for the benefit of the minor beneficiary until they reach age 25. While contributions to UGMA/UTMA accounts are considered taxable gifts, they qualify for the annual gift tax exclusion.

• PROS: Better investment options than 529 plans; lower administrative costs than trusts; greater flexibility in how the funds can be used, including for education; and income is taxed to the minor beneficiary (i.e., likely a much lower tax rate than the donor).
• CONS: Higher administrative costs than outright payments; a countable asset for financial aid; and a potential windfall to the beneficiary at the age of majority, when they gain full control over the account and can use the funds as they desire.

3. Education Trust

An irrevocable trust created with the purpose of paying for the education costs of one or more beneficiaries. This type of trust can be tailored to fit specific needs and can cover a wide range of educational expenses, including tuition, books, and even living expenses. Extra care must be taken in drafting this trust to qualify any contributions for the annual gift tax exclusion. By creating the education trust as a grantor trust, the income taxes can be reported and paid for by the individual that establishes the trust (known as the grantor), allowing the education trust assets to grow income tax free and, thus, amplifying the gift(s) to the education trust.

• PROS: Flexibility at the drafting stage on the purpose of the trust; control over distributions for a longer period of time than UGMA/UTMA accounts; and grantor trust status amplifies gifts.
• CONS: Higher administrative costs than the other the other three options; more advanced estate planning is required; and extra care must be taken at the outset as the irrevocable trust, by its nature, is unable to be amended, restated, or revoked.

4. 529 Plans

A 529 Plan is a tax-advantaged savings plan designed specifically for education expenses. Contributions to a 529 Plan grow tax-free, and withdrawals used for qualified education expenses are also tax-free. These plans offer significant flexibility, allowing the funds to be used for a variety of education-related costs, including public or private K-12 tuition and higher education expenses. Additionally, 529 Plans have high contribution limits and offer potential state tax benefits, making them an excellent choice for long-term education savings.

• PROS: Very easy to establish; tax-free growth of assets; tax-deductible contributions for the donor at the state level; ability of the owner to change the beneficiary; and the ability for the donor to front-load 5 years’ worth of annual exclusion gifts.
• CONS: Limited investment options, compared to the education trust and UTMA/UGMA accounts; limits on ownership changes; lack of flexibility on the purpose of the funds; and can cause issues with financial aid depending on the owner.

Conclusion

Investing in your children’s or grandchildren’s education is a meaningful way to leave a lasting legacy. By understanding and utilizing one or more of these four gifting strategies, you can help secure their educational future while also taking advantage of potential tax benefits. Each strategy has its own set of pros and cons, so it is important to evaluate which one aligns best with your financial goals and family needs. Consulting with an estate planning attorney can provide personalized guidance to ensure your gifts are both impactful and tax efficient.

Understanding the basics of gifts and transfer taxes is an essential foundation for any discussion on wealth transfer strategies and effective estate planning. This article provides a basic overview of what gifts and transfer taxes are, how they work, and their implications for your estate plan.

What Constitutes a Gift?

A gift is any transfer of property or assets from one person to another without receiving something of equal value in return (known as consideration). Gifts can include money, real estate, stocks, or other valuable assets. With any discussion about gifts, it is important to distinguish between reportable gifts and those excluded from gift taxes:

• Reportable Gifts: These are gifts that exceed the annual exclusion amount set by the IRS. For 2024, the annual exclusion amount is $18,000 per recipient (i.e., the $18,000 is the sum of all your gifts to a specific individual during the calendar year). Any gift above this amount must be reported to the IRS on a federal gift tax return (IRS Form 709) and will count against your lifetime exemption (see discussion below).
• Excluded Gifts: Certain types of gifts are excluded from gift taxes and do not need to be reported. These include direct payments for qualified education expenses (such as tuition) and medical expenses made directly to the institution or provider. Additionally, gifts to your spouse, charitable organizations, and political organizations are also excluded from gift taxes.

Understanding these distinctions can help you make informed decisions about gifting and ensure compliance with IRS regulations.

What are Transfer Taxes?

Transfer taxes are levied by the federal government and by some state governments on the transfer of property from one person to another without consideration (or without adequate consideration). This includes transfers during a person’s lifetime (known as gifts) and transfers upon death (known as an inheritance).

Types of Transfer Taxes

The transfer tax system includes three separate taxes: gift tax, estate tax, and generation-skipping transfer (“GST”) tax. Here is a closer look at each tax:

Gift Tax

Gift tax is a federal tax imposed on transfers of property during life without consideration (or without adequate consideration). Key points to understand about gift taxes include:

• Annual Exclusion: Each year, you can give a certain amount to any number of individuals without incurring gift tax. For 2024, the annual exclusion amount is $18,000 per recipient.
• Lifetime Exemption: In addition to the annual exclusion, there is a lifetime exemption amount applicable to each person that applies to gift and estate taxes combined. For 2024, each U.S. citizen has a lifetime exemption of $13.61 million.
• Tax Rate: If your gifts exceed the annual exclusion and the lifetime exemption, the excess amount is subject to gift tax at a rate that can be as high as 40%.

Estate Tax

Estate tax is a federal tax imposed on the fair market value of all assets includible in your estate at the time of your death and the value of taxable gifts made during your lifetime. Key points to understand about estate taxes include:

• Estate Tax Exemption: The same lifetime exemption that applies to gift taxes also applies to estate taxes. For 2024, the exemption amount is $13.61 million.
• Estate Tax Rate: Similar to gift taxes, the estate tax rate can be as high as 40% on the value of the estate that exceeds the exemption amount.
• Portability: Married couples can take advantage of portability, allowing the surviving spouse to use the unused portion of the deceased spouse’s exemption.

Generation-Skipping Transfer (GST) Tax

GST tax is a federal tax imposed in addition to the gift and estate tax on direct or indirect transfers or bequests made to a “skip person.” A skip person is typically a grandchild or someone who is at least 37.5 years younger than the donor. The GST tax is designed to prevent individuals from avoiding estate taxes by skipping a generation when transferring wealth. Key points to understand about estate taxes include:

• GST Tax Exemption: For 2024, each U.S. citizen has a lifetime GST exemption of $13.61 million.
• GST Tax Rate: The GST tax rate is a flat 40% on the value of the transfer that exceeds the GST exemption amount.
• No Portability: The GST exemption amount is a use it or lose it exemption. Unlike the federal estate tax exemption, any GST tax exemption unused at one spouse’s death cannot be used by the surviving spouse.

Planning Considerations

Effective estate planning can help minimize the impact of gift and transfer taxes. Here are some strategies to consider:

• Annual Gifting: Take advantage of the annual exclusion by making regular gifts to family members or others. This can help reduce the size of your taxable estate.
• Trusts: Setting up certain types of trusts can help manage and reduce gift and transfer taxes. Trusts can provide control over how and when your assets are distributed.
• Charitable Contributions: Gifts to qualified charitable organizations are generally exempt from gift and transfer taxes. Charitable giving can be a valuable part of your estate plan.

Conclusion

By being informed about gifts and transfer taxes, you can take proactive steps to protect your assets and provide for your loved ones in the most tax-efficient manner possible. Consulting with an estate planning attorney can help you navigate these complex tax rules and create a comprehensive plan that meets your needs.