In our last article, we looked at ways to reduce your taxable estate via gifting, particularly in the context of the expiration of the tax breaks provided by the Tax Cut and Job Act (TCJA) of 2018, which are set to go away at the end of 2025.
At that point, the Unified Tax Credit, which is a combination of Lifetime Gift Tax Exemptions and Estate Tax Exemptions, will revert to pre-TCJA levels. But that doesn’t mean you are stuck with those levels if you are still in your prime – you can still maximize your exemption potential, as any gifts or donations conducted today will be grandfathered in.
In this article, we’ll go into the charitable strategies you can utilize to reduce your taxable estate – particularly relevant in the season of the giving. Plus, if you discover some of these strategies may work for you, you have time to take action before the end of the year.
With that said, let’s head straight in.
Thanksgiving tends to bring out the charitable side of us. Through the simple act of giving thanks, we understand that we’re fortunate and privileged to have our loved ones around us, property that we can call our own, and a chance to forge our own path and livelihood in life. Not everyone has that chance!
So, in response, we give back to our communities as a way of saying thank you and giving other people the opportunity to create a great life for themselves. And by doing so, we can also improve our own financial fortunes.
If there is a cause you care for, consider finding a charity that aids said cause and give them a gift in the form of cash. You’ll get an immediate tax deduction for your generosity, potentially keeping you in a lower tax bracket for the year and reducing your estate.
You may even be able to pay online, saving you a trip. However, retaining all communications, amounts, dates, and receipts is important to prove that it was indeed a charitable donation.
If you’re a reader of our emails, you may have noticed our calls to stay the course – hold through the down markets, up markets, and flat markets. However, an appreciated asset, such as a mutual fund, ETF, stock, or bond, may need to go at some point to keep your portfolio aligned with your risk profile. If you sell that asset, you get hit with a tax. If you give away that asset, you not only get to avoid paying the tax on any appreciation (you never actually sold it for a profit), but you also get to deduct the value of that asset from your net worth.
By donating an appreciated asset instead of selling it, you effectively keep the cash that would have otherwise gone toward paying capital gains taxes. You can use those ‘savings’ to help purchase other assets necessary to rebalance your portfolio if the initial donation wasn’t enough.
The government will eventually make you start withdrawing from your IRA, like it or not. These are called Required Minimum Distributions (RMDs). Not only are you forced to take them, but they also count as taxable income and may even push you up a tax bracket.
A QDC will help you manage your tax bracket (maybe other financial actions could fill that tax bracket first) and also potentially keep Medicare premiums B and D down, which are adjusted according to your income.
You can donate other things, but as financial advisors, our expertise lies in money and investments, so we won’t go into the kinds of property you can donate. Now, we’ll go into how you can donate.
Donating directly to a charity is straightforward, effective, and has an immediate impact. Plus, if you itemize deductions on your tax return, you can deduct the amount of your charitable gift. Since it is so simple and immediate, you can quickly donate at the end of the year to affect your tax situation while time is left.
However, not all charities can accept assets like stocks and bonds, so be sure to do your due diligence before choosing what to donate.
For those who prefer a structured approach to philanthropy, a Donor-Advised Fund (DAF) offers a blend of flexibility and strategic planning. Here’s how it works. First, you contribute to the DAF and receive an immediate tax deduction for the year. Then, the assets in the DAF can grow tax-free, increasing your donation’s impact on the charity once it reaches it. You will also retain influence over what charity receives the funds and when.
This is a great way to have influence over your donated assets for years to come while reaping the tax advantages of your goodwill.
When considering trusts as a means of donating and reducing taxes, two types stand out for their immediate and long-term benefits.
You can put assets like stock or property into a CRT and get an immediate tax break based on the value these assets will eventually provide to a charity. You don’t have to pay capital gains tax if these assets have grown in value since you first bought them. You or someone you choose can receive income from these assets for a set period. After that period, or when you pass away, whatever’s left in the CRT goes to the charity you picked.
A CLT is like a CRT but flipped. When you put assets into the CLT, you also get an immediate tax break. But in this case, the charity receives the income from these assets first, for a number of years you decide. Once that time is up, the remaining assets go to your family members or other heirs. It’s a way to help charities now and still look after your family’s future.
Both CRTs and CLTs are complicated to establish. They need lawyers, financial advisors, and CPAs to ensure everything is done correctly and works well with your financial plan. If you’re considering setting up one of these trusts, it’s best to get started sooner rather than later. But once they’re up and running, they can be a powerful part of your yearly financial and charitable strategy, blending generosity with smart tax planning.
Whether through simple cash donations, the transfer of appreciated assets, or the establishment of trusts, there are many ways to integrate your charitable intentions within your financial plans – and help prepare for the eventual sunset of TCJA.
At Walters Strategic Advisors, our expertise as both CPAs and financial advisors positions us to optimize your investments with sophisticated tax strategies to reach your long-term goals. If you’re looking to maximize the impact of your charitable contributions this season and beyond, we’re here to guide you. Just click the button below to schedule a consultation.