More On Tax Planningfrom The Advisor's Professional Library
- IRAs: In General Individual Retirement Accounts are highly popular tools for contributing funds that grow on a tax deferred basis. Depending on the type of IRA, the accumulation can be tax free.
- Annuities: Variable Annuities Annuities are hot. The tax rules vary with the circumstances. Advisors must be aware of these intricacies when discussing annuities with clients.
Once again, it’s the time of year when clients seek advice about making moves to reduce overall income tax liability. Deferring income and accelerating deductions become part of the playbook for a winning game plan. But for many clients, the ability to defer income is not a possibility, and any available deductions have already been maximized. What can these clients do? The answer: Give some wealth away.
Your clients still have time to make meaningful gifts that may not only benefit their tax bill but also a host of charitable organizations that have suffered due to the challenging economic climate. Yet with only a few weeks left to make a donation that will reduce 2011 income tax liability, you should consider simplicity when implementing a year-end gifting strategy.
Consider a DAF
The simplest way to make a gift would be to give cash or property to the charitable organizations your client may wish to support. That is certainly effective, but some clients may not feel comfortable making a significant gift if they haven’t had enough time to perform adequate due diligence on the specific charities or causes. For such clients, a donor-advised fund (DAF) is worthy of consideration. With a DAF, clients can receive the income tax benefits associated with a direct gift to charity without the pressure of having to know exactly which charities will ultimately benefit from the gift.
In basic terms, a DAF is an account created at a charity to accept donations from a donor (i.e., your client) that may be managed by the donor’s financial advisor (i.e., you) and eventually distributed to other charities sometime in the future. Donations to the DAF are generally tax-deductible in the year in which they are made.
Once the donor has contributed to the DAF, he or she assumes the role of “grant advisor.” In this capacity, he or she can make recommendations to the sponsoring charity as to the timing, amount and recipients of future distributions from the fund. Although the grant advisor’s recommendations are nonbinding, as long as the recommended distribution is to a qualified charity, the sponsoring charity (i.e., the DAF) will generally follow the suggestion.
An Excellent Tax and Giving Tool
For clients who itemize deductions, the DAF is a powerful means for reducing taxes. Contributions to it are deductible to the same extent as direct gifts to a public charity. The deduction is based on several factors, including the fair market value of the donated property, the type of property donated (long-term versus short-term capital gain), and the client’s adjusted gross income (AGI).
For donations of cash, deductions are generally limited to 50% of a client’s AGI; however, if a client contributes long-term capital gain property, the limitation is 30%
A DAF is also a great planning tool for receiving contributions of highly appreciated assets grown within a client’s portfolio. Because the DAF is tax-exempt, a client can donate his or her highly appreciated positions, receive a tax deduction, and avoid the recognition of capital gains built into the contributed assets. So when planning to make a contribution to a DAF or directly to the sponsoring charity, clients should always consider highly appreciated assets.
IRA Distributions to Charity
In general, an IRA is viewed as an unattractive option to serve as a source for making charitable gifts. This is because the IRA owner would incur income tax liability upon distribution of the amount subsequently gifted to the charity. A tax deduction for the donation may be available, but the deduction may not fully offset the tax liability associated with the distribution due to AGI limitations on such charitable deductions. For some clients, however, now may be an ideal time to use their IRAs to meet charitable giving goals through a charitable rollover.
The charitable rollover allows certain individuals (at least age 70½) to make gifts totaling up to $100,000 directly from their IRAs to charities without recognizing the income associated with the distribution. For clients who don’t need income from their IRAs but who take required minimum distributions, it represents a great opportunity. But these clients must act now. Legislation regarding charitable rollovers is set to expire at the end of 2011. After the legislation expires, it is unclear whether the charitable rollover will be made available in the future.
Commonwealth Financial Network does not provide legal or tax advice. You should consult a tax or legal professional regarding your individual situation.
Gavin Morrissey is the vice president of wealth management at Commonwealth Financial Network®, member FINRA/SIPC, a registered investment adviser, in San Diego, Calif. He is available at firstname.lastname@example.org.