The Charitable Deduction Did Not Go Away–It Just Moved Next Door

For many Americans the new tax act, now known as TCJA 2017, means they will no longer itemize their tax deductions. While this may make their tax filing simpler, it also means that giving money to charity will no longer be tax deductible. And, while surveys indicate that we Americans don’t give because of the tax savings, there is a consensus that giving will drop precipitously. Some estimates I’ve seen suggest that annual giving will drop by $30 Billion. With 1.5 Million charities fighting for every donation possible, this could mark a tremendous upheaval in the non-profit world. While it should take one or two tax years before anyone really knows what the impact is and how the giving populous has adjusted, charities and advisors ought to be prepared with solutions to help their donors regain the confidence to keep giving and to save taxes, if possible.

Many of the traditional planned giving vehicles fill the bill, of course. Charitable Remainder Trusts, Charitable Lead Trusts, Pooled Income Funds and Gift annuities all should be considered and reviewed on behalf of any donor or client trying to find a way to continue to give. The charitable IRA rollover also deserves more attention for those that are over age 70 ½. While these solutions will be applicable to some, it may be a good idea to think a little differently now.

One interesting idea to add to the charitable planning arsenal is actually nothing new but an adaptation of a long-accepted tool: the non-grantor trust. Non-grantor trusts are a traditional estate planning vehicle, often used to move assets outside of the taxable estate for the benefit of the next generation. The “non-grantor” status means that the trust pays income tax on its earnings based on trust tax rates. Taxable trusts pay tax at a higher rate sooner than individuals do so it would seem counter-intuitive to suggest that this type of trust would be of benefit. However, income that is distributed to a beneficiary is generally deductible to the trust and taxed at the beneficiary’s income tax rate. Thus, if the beneficiary is a charity, the charity’s tax rate is zero.

Here’s an example:
Client who regularly gives $5-10,000 year to his charities of choice sets up a non-grantor trust that allows him to give money to charity and also naming his children as discretionary beneficiaries. He transfers $250,000 of cash, files a gift tax return, using part of his lifetime gifting exemption of $11.2 million. He invests the $250,000 is a high dividend portfolio that should produce 2-4% per year of income. At the end of year one there is $7,500 of dividend income which he directs the trustee to give to his favorite charity. The trust sends 100% of the dividends out to charity and has zero taxable income. The client has no tax on the earnings of the trust and since he gifted it away, it is no longer appearing on his personal return, effectively saving him state and federal tax on $7,500 of income. That’s essentially the same as a $7,500 income tax charitable deduction that may no longer be available to him. Voilà, we have worked tax planning magic.

While this may seem complex, it’s really quite simple to accomplish and may work for a significant population of donors. New laws present new challenges and new opportunities. As advisors, it’s our responsibility to help our clients achieve their ideal outcomes. Learning new applications of old tools is just another way to add value for our clients.