Mark R. Parthemer, AEP, Glenmede’s Chief Wealth Strategist and Florida Regional Director, and Kenneth E. Spruill, Jr., Managing Director, Center for Family Philanthropy and Wealth Education, hosted a virtual discussion on year-end tax-efficient charitable planning and giving strategies. To watch the replay of the October 2022 event, click here. 

Current volatile markets and rising interest rates can be disconcerting for philanthropically minded individuals and families. Yet there are charitable giving strategies that can help you take advantage of the current economic environment while supporting the causes you cherish.

While this article focuses on tax-efficient techniques for giving, we acknowledge that many people do not predicate their philanthropy solely on the tax benefits available. Instead, they give to support the organizations and causes that are important to them and that are rooted in their values.

Simpler Forms of Giving

There are several forms of giving that are quite straightforward, including:

• Gifts of cash. There is no challenge in valuation (a $10,000 gift is simply a gift of $10,000). One can write a check to a charity, give electronically via the charity’s website, use a mobile payment app and, in some cases, send a text message from a mobile device.
• Appreciated stock and other forms of appreciated assets, including real estate, art and cryptocurrency. While also relatively straightforward, a gift of appreciated stock requires a more detailed process. The donor must contact their broker and request that the stock be transferred to a charitable organization. Most organizations will accept gifts of stock, but if your selected charity does not, it is not tax-efficient to sell the asset, pay capital gains tax and give cash. Instead, consider making the gift in-kind to a donor-advised fund (DAF), which can sell the shares without triggering capital gains tax and use the cash proceeds to fulfill the charitable intent.
• Individuals ages 70 ½ or older can use their IRAs to make qualified charitable distributions (QCDs). If paid directly to a qualified charity (accomplished by having the distribution check made payable to it), an IRA owner does not have to pay tax on up to $100,000 of QCDs per year. These can be made with voluntary withdrawals as well as with required minimum distributions (which begin at age 72). QCDs can go only to qualified charities and not to DAFs, supporting organizations or private foundations.

The Internal Revenue Code provides that gifts to qualified charities are tax deductible, but the ability to take advantage of a deduction on a Form 1040 income tax return is not unlimited. In fact, the deduction is subject to strict limitations based on the asset given (cash or in-kind) and the nature of the charity (public or private, such as a DAF or family foundation), as summarized below. What may be less understood is that the amounts of qualified gifts beyond the limitations are not necessarily lost. Instead, excess amounts typically can be carried forward and used, subject to the same limitations, in the following five tax years.

2022 Charitable Contribution Limitations

Source: Internal Revenue Code of 1986, as amended. This is provided for informational purposes only. Please consult your tax and legal advisors before taking any specific action to determine how this may apply to you.

More Complex Techniques

There are four sophisticated techniques that can be divided into two categories — 1) more efficient in a low interest rate environment and 2) more efficient in a high interest rate environment. The first category includes charitable lead trusts (CLTs) and gifts of a remainder interest in a personal residence or farm, and the second category contains charitable remainder trusts (CRTs) and gift annuities.  These four techniques are referred to as split interest gifts because the benefits are split into one for an individual(s) and another for a charity.

The reason for the disparate impact of interest rates on split interest gifts is due to the formula built into the tax code. Simply, the formulae required by tax law determine the present values of these different interests to determine if the structure passes IRS tests and, if so, how much of a tax deduction or taxable gift results. The mathematics are driven by a key rate, the Section 7520 rate, which is reset monthly.

What is the Section 7520 rate?

Pursuant to Internal Revenue Code Section 7520, the rate for a particular month is the rate that is 120% of the applicable federal midterm rate (compounded annually) for the month in which the valuation date falls. That rate is then rounded to the nearest two-tenths of 1%.

Better in a Low-Rate Environment

 Charitable Lead Trusts (CLTs)

Sometimes referred to as the “Jackie Onassis Trust” because the former First Lady was among the first to popularize it, a CLT is one in which the lead interest is paid over a defined term to charity. At the end of the term, the remaining assets, if any, are paid to individuals, typically the donor’s children or grandchildren, or to trusts for them. In a sense, CLTs can be thought of as generally shifting dollars from estate or gift taxes to a family foundation, DAF or charities.

A donor has several options when creating a lead trust:

• A CLT may be in the form of an annuity trust or a unitrust. Under a charitable lead annuity trust (CLAT), the payout to charity is a set annuity based on the original funding value. Under the charitable lead unitrust (CLUT) approach, the payout is on a set percentage of the value of the trust, updated annually. For example, in a 20-year, 5% CLAT, the impact of the rising Section 7520 rate from 1% in October 2021 to 4% in October 2022 causes over a 300% increase in the taxable value.
• Another option is to make the CLT a grantor or non-grantor trust, which changes dramatically the income tax treatment of the trust and funding. CLTs are not tax-exempt, so income tax must be paid on income from the trust, such as interest, dividends and capital gains. If the CLT is a non-grantor trust, the trust pays the income tax, but no deduction is provided to the donor in the year of funding. In contrast, if a grantor trust, the donor receives a charitable contribution deduction when a CLT is funded; however, the donor must pay the income tax on the trust income throughout the lead term. Whether the trust should be grantor or non-grantor is determined on a case-by-case basis, largely depending on the donor’s tax situation and goals. Returning to the example above but contrasting the deduction on a grantor form of CLAT, the rise in the Section 7520 rate would reduce the income tax deduction from a little over $900,000 to less than $680,000.

Gift of Qualified Remainder Interest

Similarly, more beneficial in a low interest rate environment is a special form of a gift available for the remainder interest in a personal residence or farm. In this technique, the donor retains a life estate and donates the remainder interest to charity. Often, married persons retain a joint life estate. The present value of the retained life estate is deducted from the fair market value of property on the date of funding, and the difference equals an income tax deduction. Again, if a 70-year-old person donated the remainder interest on a $1 million parcel of qualified property, the rise in the Section 7520 rate from October 2021 (1%) to October 2022 (4%) would reduce the income tax deduction from $860,200 to $571,800.

Better in a High-Rate Environment

Charitable Remainder Trusts (CRTs)

The first of two techniques that are likely better in a higher interest rate environment is the inverse of a charitable lead trust, known as a charitable remainder trust (CRT). In this structure, the annuity (CRAT) or unitrust (CRUT) interest is paid over a period of years, or for the lifetime/lifetimes of specified persons. The remainder after that period transfers to charity. Unlike the lead trust, the remainder trust is tax-exempt, making it favored for low-basis assets.

A good measure of the impact of a rising rate is the amount of income tax deduction generated on the funding of a CRT. The October 2021 versus October 2022 example, a $1 million, 20-year, 5% CRAT under the October 2021 rate would fail to pass IRS qualification tests, so no deduction would be allowed. Under the October 2022 rate, an income tax deduction of $320,485 would be generated.

Gift annuity

In a gift annuity, the donor makes an irrevocable gift of an asset to a charity in exchange for an annuity payable for as long as the donor lives (married donors often retain the annuity for both spouses). Of course, general tax law provides for taxation of capital gains whenever an asset is sold or exchanged; however, there is a special exception for qualified gift annuities. No capital gains taxes are due so long as the annuity falls within the parameters of current tax law. Suffice to say, when rates are low, it is more difficult to meet those tax law requirements.

According to the American Council on Gift Annuities (www.acga-web.org), 97% of charities that issue gift annuities base their payouts on rates published by the Council. The October 2022 rate for a 70-year-old is 5.3% versus the October 2021 rate of 4.7%. But the Council publishes changes, if any, effective July 1. In fact, there may be a timing nuance: The 2022 meeting, in which the July 1, 2022, rates were set, was in May 2022, and the increase in rates during 2022 mostly occurred after May. Thus, someone contemplating a gift annuity may want to consider whether waiting until the 2023 rates are released would be worthwhile.

Conclusion

Rising interest rates impact the tax consequences of many forms of charitable giving, while other forms could be affected by volatile markets. In this article, we outlined in general the impact on the seven major forms of giving. If you have any questions, please reach out to your Glenmede Relationship Manager who, along with your tax advisors, can guide you as to how the current economic environment would impact your particular situation.