With the risks of rising inflation, ongoing discussions in Congress relating to tax reform and the looming increase in tax rates for ‘wealthy’ taxpayers, one valuable tool to reduce taxes remains as relevant and important as ever: Charitable Contributions. Cash contributions that are donated to qualified organizations provide a dollar-for-dollar tax deduction to the donor[...]
With the risks of rising inflation, ongoing discussions in Congress relating to tax reform and the looming increase in tax rates for ‘wealthy’ taxpayers, one valuable tool to reduce taxes remains as relevant and important as ever: Charitable Contributions.
Cash contributions that are donated to qualified organizations provide a dollar-for-dollar tax deduction to the donor up to certain Adjusted Gross Income (AGI) limitations, as discussed below.
Cash contributions that are donated to qualified organizations provide a dollar-for-dollar tax deduction to the donor up to certain Adjusted Gross Income (AGI) limitations, as discussed below.
Taxpayers that use charitable giving as part of their overall tax planning strategy will often make year-end calculations of amounts that are to be donated to mitigate their tax liability. This results in the need to give large donations on short notice without having the ability or resources decide upon and pay the funds to the charitable organizations that the charitably inclined donor chooses. There are two options available to alleviate this issue:
- the Non-Operating Private Foundation
- the Donor Advised Fund (DAF)
Both options provide donors with the ability to ‘park’ the money and receive an immediate charitable deduction. The funds can then be further distributed to the ultimate beneficiary organizations at the taxpayer’s discretion.
Non-Operating Private Foundation:
A non-operating private foundation is a Sec. 501(c)(3) not-for-profit organization that is not a public charity. It can be established by an individual, family, or corporation and typically involves a large initial donation. For the most part, further donations come from the individual, family, or corporation and are managed by the foundation. Non-operating private foundations generally do not solicit funds from the public and do not operate any type of business related to the charitable purpose (e.g. libraries, research facilities, museums, or zoos etc.). They exist solely to hold and distribute funds as a furtherance of their charitable purpose. To maintain its tax-exempt status, a non-operating private foundation supports charitable, educational, religious, or other activities that serve the public good. Thus, the foundations will temporarily hold donated funds which need to be further distributed and paid to the actual charitable causes. The deduction to non-operating private foundations is limited to 30% of the donor’s AGI.
The initial setup of the foundation has an administrative cost as it involves setting up a legal entity and requesting tax exempt status from the IRS. It is therefore contingent upon the IRS approval of the application, which is usually granted, but can take time to complete the process.
There are additional compliance requirements on the foundation including annual tax filings and required minimum charitable distributions equal to 5% of the prior year average net investment assets. Investment income earned by the foundation are subject to a 1.39% excise tax (tax rate of 2% prior to 2020), but the funds can be held and invested at the discretion of management. There are also self-dealing rules that prohibit the foundation from entering into financial relationships with its managers and their family members with penal excise taxes for violations.
Control of the funds can be maintained in a single family which can help create a family’s legacy and allow successive generations to participate. This is especially important for high-net-worth families who may be looking to fund a foundation.