Wealth has powerful potential for good. About 85% of high-net-worth (HNW) households in the U.S. make charitable donations. People with a net worth of at least $30 million — a group that makes up just 0.00003% of the world’s population — provide almost 25% of all global philanthropic giving. However, private wealth gifts do not all carry the same weight in terms of taxes.
Should you make direct gifts or set up a fund? Is it smart to donate art, your old Lexus or an unused vacation condominium? To do the greatest amount of good with your wealth, you need to understand the potential tax benefits — and pitfalls — of different kinds of charitable gifts.
There’s a good reason why charitable contributions comprise a large part of many HNW tax optimization strategies. Gifts to charity offset your taxable income starting with your highest tax bracket, which can be up to 37% in 2023 and 2024.
For example, if you have taxable income of $1 million and are married-filing-jointly, the top tax bracket applies to your income above $731,201. The federal tax bite would be $99,456. If you made a charitable donation worth $268,800, you could wipe out nearly $100,000 in federal taxes. The next-highest tax bracket applies a levy of 35% on income between $487,451 and $731,200. So, you can contribute up to an additional $243,749 and reduce your tax bill by roughly another $85,000.
Now, depending on the types of assets you’re contributing, you might hit your charitable contribution deduction limit. The limitations vary depending on whether the contribution is cash or appreciated property, as well as whether the recipient organization is a public charity or a private foundation.
For example, at the high end, you can deduct cash gifts (or a combination of asset types) to public charities up to 60% of your adjusted gross income (AGI). At the low end, you can deduct gifts of appreciated property to private foundations only up to 20% of your AGI.
Want to achieve tax-efficient charitable giving other than direct contributions to charitable organizations? Here are some alternatives.
A donor-advised fund (DAF) is an investment account maintained and operated by a sponsoring organization and composed of charitable contributions made by an individual donor. You, as the donor, can direct the distribution of the funds in your account. When you donate cash, marketable securities or other assets to the DAF, you get an immediate tax deduction up to the AGI limitations for the asset type (60% of AGI for cash and 30% for appreciated property for the 2023 and 2024 tax years). Your money stays in the DAF and grows tax-free until it’s distributed.
DAFs are administratively simple and relatively inexpensive. Donating to a DAF can also be an excellent way to “bunch” charitable donations, a strategy where you make a large gift in one year and then distribute it over several years. Keep in mind, though, that contributions to a DAF are irrevocable. Brokerage firms administer most of these funds and have their own rules for the time period within which you have to make contributions.
Unlike a public charity, which receives contributions from many sources, a private foundation typically has a single primary funding source, such as one family group or a company. Most private foundations make grants to other charitable organizations, supporting many different causes or a singular cause, such as financial literacy education.
Private foundations are more difficult to maintain than DAFs because of the required annual filings and minimum charitable giving requirements. However, if you have a private foundation and don’t want it to burden your heirs, you can set it up to convert to a DAF.
Many HNW individuals use charitable trusts to provide income streams to charities and other beneficiaries. It’s crucial to understand the differences between charitable trusts because each has specific rules regarding the flow and timing of benefits both to the income recipients and the charitable beneficiaries:
Qualified charitable distributions (QCDs) are direct transfers from retirement accounts, such as IRAs and 401(k) accounts, to public charities. This can be a very tax-efficient way to contribute to charity if you have reached the age of required minimum distributions (RMDs), which are income taxed at ordinary tax rates. Now that QCD limits are adjusted annually for inflation, the 2024 limit is $105,000, up from its previous level of $100,000. You can start using QCDs at age 70½.
QCDs have restrictions, such as the prohibition against directing funds to DAFs or private foundations. Be sure to discuss with your tax advisor whether taking QCDs would positively impact your taxable income.
When it comes to what you donate, thinking outside the traditional box of cash donations can help you make an even deeper impact on the causes you care about while preserving wealth and minimizing the tax bite.
You likely have one or more high-value, noncash assets — from fine art to precious metals to luxury cars, boats or vacation homes — that could benefit one or more charitable organizations. Without careful attention to tax rules, however, taxes can eat away at your gift and lessen the impact you want to make.
Contributing art and collectibles can be a great way to further your philanthropic goals. You can donate items directly to a charity or create a funding stream that will benefit multiple charities. But keep the related use rule in mind.
Typically, when you donate property you’ve owned for over a year, the tax code allows a deduction equal to the property’s fair market value (FMV). However, the related use rule puts additional restrictions on art and collectibles donations. If the charity sells the gift or uses it in a way inconsistent with its charitable purpose, your tax deduction is limited to the lesser of your cost basis (generally, your original cost) or the asset’s FMV. To qualify for the higher deduction, the charity must use the asset to further its charitable purpose.
For example: Ten years ago, you bought a painting for $300,000. Now, you want to donate it to a local museum. You pay for a qualified appraisal (see below for why this step is critical), and the appraiser values the painting at $1 million. The museum is thrilled to add the painting to its permanent collection.
Given the museum will use the asset for its charitable purpose of exhibiting artwork, you happily deduct the full $1 million from your federal taxable income. Even better, this $1 million piece of artwork has been removed from your taxable estate.
But what if, instead, you donated the painting to the United Way, which helps communities to boost education, economic mobility and health resources ? Since displaying artwork does not further this charitable purpose, your contribution would be limited to your cost basis of $300,000.
Here’s some good news: Congress recently relaxed the AGI limitation for art and collectibles gifts, allowing taxpayers limited to cost-basis deductions for art and collectible gifts to take those deductions up to 60% of their AGI.
Let’s say you do want to support the United Way. And given the impending sunset of the historically high estate tax exemption, you’re motivated to remove this $1 million painting from your estate. What’s the best way to achieve both goals? Should you contribute the painting outright or sell it first and donate the proceeds? The answer depends on a few factors, but most importantly, it depends on your cost basis in the asset.
Does your need for a charitable deduction outweigh the motivation to minimize capital gains? If so, then selling the painting and making a cash gift of the net proceeds could be more beneficial for you (and easier for the charity). For example, this might be true if your basis in the painting is very high, so you would recognize minimal taxable gains upon selling.
Does your need to eliminate capital gains outweigh the need for a charitable deduction? This might be the case if your basis in the painting is low. Here’s why: Art and collectibles fall into a category that not only incurs the highest capital gains tax rate of 28% but also incurs the net investment income tax. When you add on that, you would be looking at a tax rate of 31.8%, which is much higher than the maximum rate for other capital assets such as long-term publicly held stock or real estate. Given this high capital gains tax rate for art and collectibles, sometimes it can be beneficial to donate the asset outright.
You might consider donating many types of real estate, such as a vacation home your family no longer uses. Or perhaps you inherited a home or rental property you don’t want to sell or fix up. Any type of real estate can be contributed to charity, from commercial buildings to rental homes, farmland and even vacant lots.
When you donate property that would have qualified for long-term capital gains treatment if you’d sold it rather than donating it — in other words, you’ve owned the property for more than one year — you’re generally allowed to deduct an amount equal to the property’s FMV. So, you can contribute property that has significantly appreciated in value and then claim a large deduction based on the FMV. The appreciation in value of the property remains untaxed forever. If you’ve held the property for a year or less, the deduction is limited to your cost basis.
When donating to a public charity, your current charitable deduction for appreciated property can reach up to 30% of your adjusted gross income (AGI). When donating to a private foundation, you can deduct appreciated property up to 20% of your AGI. Any remainder above these limits may be carried forward for up to five years.
Thankfully, the related use rule does not apply to real estate contributions. However, many other considerations influence the charitable deduction amount you can claim from donating property, including:
There are several ways to determine the FMV of your vehicle. If you use an online pricing guide, such as Edmunds or Kelly Blue Book, make sure you use the same make, model and trim package of your vehicle. You can also enter your vehicle identification number to get the most accurate assessment for the vehicle. Save your search results with your tax records should the IRS ever question your vehicle’s valuation. For vehicles appraised above $5,000, a written appraisal from a qualified professional is required.
Donating luxury or other noncash assets is tricky. Make sure you have a knowledgeable tax advisor to help you navigate potential pitfalls such as:
Keep in mind that tax laws are constantly evolving. To establish and maintain the most tax-efficient philanthropic strategy, it’s important to consult regularly with your tax and other financial advisors (and sometimes legal counsel).
Not sure if you and your recipients are missing out on benefits from your charitable donations? Don’t let complexity and uncertainty hinder your philanthropic and tax planning goals. Find out how our high-net-worth tax planning professionals can help you maximize your philanthropic legacy with a customized giving strategy.
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