Maximizing the 2-Fold Benefits of Your Charitable Donations

Image Credit: © Tomasz Zajda

Many dermatologists have charities to which they would like to donate, but they are not sure of the best way to do so, tax-wise. This article will address a tool that can effectively achieve 2-fold benefits: the charitable remainder trust.

Achieving a Win-Win

Properly done, charitable planning can create a win-win scenario: a gift to a worthy cause and tax benefits for the donor and their family. In fact, with some techniques, like the one we will describe, there can even be a third “win”—creating an income stream for the donor’s family.

The Charitable Remainder Trust

Let us assume you have a charity to which you would like to donate. You also have a highly appreciated asset you wish to sell but are reluctant to do so because of the significant capital gains taxes you would owe. Furthermore, you do not want your heirs to pay estate taxes on this asset (or others because of the total value of your estate). At the same time, you would like to reduce your current year’s taxable income and receive an ongoing income stream. In this situation, a charitable remainder trust (CRT) may be an ideal option for you. Used properly, a CRT can potentially:

• Reduce current income taxes with a sizable income tax deduction
• Eliminate immediate capital gains taxes on the sale of appreciated assets, such as stocks, bonds, real estate, and about any other asset
• Increase your disposable income throughout the remainder of your life
• Create a significant charitable gift
• Reduce estate taxes that your estate might have to pay upon your death, thus leaving more for your heirs
• Avoid probate and maximize the assets your family will receive after your death
• Protect your highly appreciated property from future creditors

Think of a CRT as a tax-exempt trust that benefits 2 parties. The parties are the individual(s) receiving income and the chosen charity or charities. The “income beneficiaries” (usually you or your family members) typically receive income from the trust for either their lifetimes or a specified number of years (20 or less). At the end of the trust term, the chosen charity will receive the remaining principal to utilize for its charitable purposes.

How a CRT Works

A CRT is an irrevocable trust that makes annual or more frequent payments to you, typically until you die. What remains in the trust then passes to a qualified charity of your choice.

Several tax-saving advantages may flow from the CRT. First, you will obtain a current income tax deduction for the value of the charity’s interest in the trust. The deduction is permitted when the trust is created, even though the charity may have to wait until your death to receive anything. Second, the CRT is a vehicle that can enhance your investment return. Because the CRT pays no income taxes, the CRT can sell an appreciated asset without recognizing any gain or paying any tax on the sale. This enables the trustee to reinvest the full proceeds from a sale and thus generate larger payments to you for the rest of your life.

Life Insurance as “Wealth Replacement”

Many dermatologists might be more motivated to make gifts to charities, but they are afraid that they will not leave an adequate inheritance to their heirs. Dermatologists should understand that they can make donations during their lifetimes, save income taxes, and find a way to leverage the tax deduction to achieve a similar, or sometimes larger, inheritance for their heirs than if they had not utilized charitable planning. This is the concept of using life insurance for wealth replacement.

A CRT is eligible for the estate tax deduction if it passes assets to 1 or more qualified charities at the time of one’s death. If you wish to replace the value of the contributed property for heirs who might otherwise have received it, you could use some of your cash savings from the charitable income tax deduction to purchase a life insurance policy on your life held in an irrevocable life insurance trust for the benefit of your heirs. This is called a wealth replacement trust.

Often, through the leveraging effect of life insurance, it is possible to pass on assets of greater value than those contributed to the trust. In this way, your heirs are not deprived of property they had expected to inherit. Your heirs may find it advantageous to receive cash as proceeds from a death benefit instead of an asset they do not want or know how to manage. The Figure examines how this works.

1. You gift a highly appreciated asset to the CRT and receive a current income tax deduction that you can use to reduce your income tax liability for up to 5 years.
2. The CRT sells the asset. Neither you nor the CRT pays any taxes on the sale. The total value of the asset is preserved and invested in a tax-free environment.
3. You receive a larger annual distribution from the CRT than you would have received if you had paid taxes on the asset’s sale and invested the proceeds in a taxable situation.
4. Although the annual distribution is taxable, it is taxed in accordance with how it was earned in the trust. This form of taxation is beneficial, given the lower dividend and capital gains tax rates. The income beneficiary could save a significant amount in taxes each year.
5. After the death of all income beneficiaries, the remaining assets from the CRT go to your selected charity.
6. A wealth replacement trust can be funded with insurance to replace those assets given to charity and give the family even more than they would have received had no charitable planning been done.

Conclusion

This article briefly explains charitable and estate planning strategies, which require certain expertise to maximize their benefits. We encourage you to work with experienced advisers to evaluate whether these tactics and tools may make sense in your planning. The authors invite your inquiries.

David Mandell, JD, MBA, is an attorney and author of more than a dozen books for doctors. He is a partner in the wealth management firm OJM Group (www.ojmgroup.com).

Carole Foos, CPA, is a partner and tax consultant. They can be reached at 877-656-4362 or mandell@ojmgroup.com.

Disclosure:

OJM Group, LLC. (“OJM”) is an SEC-registered investment adviser with its principal place of business in the State of Ohio. SEC registration does not constitute an endorsement of OJM by the SEC nor does it indicate that OJM has attained a particular level of skill or ability. OJM and its representatives are in compliance with the current notice filing and registration requirements imposed upon registered investment advisers by those states in which OJM maintains clients. OJM may only transact business in those states in which it is registered or qualifies for an exemption or exclusion from registration requirements. For information pertaining to the registration status of OJM, please contact OJM or refer to the Investment Adviser Public Disclosure website www.adviserinfo.sec.gov.

For additional information about OJM, including fees and services, send for our disclosure brochure as set forth on Form ADV using the contact information herein. Please read the disclosure statement carefully before you invest or send money. This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized legal or tax advice, or as a recommendation of any particular security or strategy. There is no guarantee that the views and opinions expressed in this article will be appropriate for your particular circumstances. Tax law changes frequently; accordingly, information presented herein is subject to change without notice. You should seek professional tax and legal advice before implementing any strategy discussed herein.