Charity and Taxes

By running the numbers, you may find that it makes more sense to use those assets to transfer wealth to children in a lower tax bracket. The children could then sell the stock and potentially only incur a 5% capital gains tax (assuming they are in the 10% or 15% income tax bracket) or even a zero percent tax if they wait until 2008. Keep in mind that the sunset rule kicks in at the end of 2008 and that the child has to be at least age 14 or the "kiddie tax" applies.

If it makes sense for the client to contribute appreciated securities, you need to determine which is the most advantageous stock to gift. One consideration is whether the client is looking for a steady source of income. If so, it may be best to contribute stocks that pay little or no dividends and keep those that are paying higher dividends due to the lower tax rate on dividends.

If transferring appreciated property is not an option for a client, should you consider stock that has decreased in value? Generally speaking, a direct gift of property that has decreased in value is not recommended. That's because your client's tax deduction is limited to the asset's fair market value and they can't typically claim a loss. If the property is held for investment or business purposes, it may make more sense to sell the property first and then donate the cash. In doing so, your client receives the benefit of the loss deduction and a charitable deduction for the fair market value.

Adjusting Assets Given to Trusts

Based on the reduction in long-term capital gains, dividends, and marginal income tax rates, charitable remainder trusts (CRTs) may be less attractive from a tax savings standpoint. If you have clients who already have CRTs in place, you may recommend adjusting its asset mix to maximize the benefit of the lower dividend tax rate and lower long-term capital gains rate. Remember that the person establishing a CRT continues to receive income from the assets they donate and the remainder ultimately passes on to a charity.

With the tiered tax system associated with CRTs, the income distributed from the trust is classified either as ordinary income, capital gains, or tax-exempt income. The most highly taxed income is distributed first and, once it is depleted, the next highest taxed asset is distributed, and so on. By shifting the assets in a CRT from assets that are deemed ordinary income (and taxed up to 35%) to stocks that pay a dividend, your high-net-worth client will enjoy significant tax savings due to the 15% dividend tax rate. Of course, this strategy is only appropriate for clients willing to assume the additional investment risk associated with holding stocks.

JGTRRA should not greatly affect the decision to contribute assets to a charitable lead annuity trust (CLAT). A CLAT is a tax-efficient vehicle for assets that your client wishes to pass to charity and family, assuming they don't need the income generated from those assets. A CLAT is an irrevocable trust that makes payments to charity–including family foundations–for a limited time. When the trust expires, the remaining assets go to non-charitable beneficiaries such as family members.

CLATs, like other "estate tax freeze" techniques, have received much negative attention in recent years for being an ineffective wealth transfer strategy. That's because of the low interest rate environment and the fact that the 7520 rate (the number used to calculate the value of the charity's annuity interest) is 3%. However, since JGTRRA did not address the estate tax, this type of strategy is still very useful for certain clients since they can pass on wealth to their heirs while incurring minimal or no gift tax.

One key consideration in using a CLAT is whether it is structured as a grantor trust or a non-grantor trust. With a grantor trust, your clients receive an income tax deduction in the first year of the trust for the present value of the charitable payments. They would then incur taxes on the trust income each year to "recapture" the up-front deduction. On the other hand, with a non-grantor trust, the trust itself pays taxes on income generated in the portfolio. It then receives the benefit of a charitable income tax deduction up to the value of the annual charitable payments. This deduction is not subject to the limitations that apply to your client's own charitable gifts. For example, the income generated by the trust in excess of the payout to charity is subject to income tax. However, it accrues to the benefit of one's heirs as additional trust capital. Due to the difference in income tax rate structures for individuals and trusts, and the related reductions in individual taxation, it may be more effective to use a non-grantor trust.

As we've seen, the new tax law should prompt a review of the charitable-giving strategies of your high-net-worth clients. In particular, it's more important than ever to analyze a client's assets to determine the most appropriate vehicles to use for their charitable gifting. Only by doing so can you can recommend the best approach to meet their needs.