Why People Give to Charity

There's a common misconception about why people give to charity. A lot of people think it's because of the tax deduction the IRS and state governments allow. But the tax deduction doesn't eliminate the cost of charitable giving, it only reduces it.

There must be something more basic at work than tax savings. And there is. Studies of philanthropic behavior show that the most important reason why people give is their commitment to the mission and the specific programs of an organization. Every other reason, including tax incentives, is dwarfed by the importance of philanthropic motives. The personal satisfaction of supporting worthwhile causes drives charitable giving.

Where taxes become important is in—

• motivating the marginal giver—the person who needs a little "push" to make a financial commitment to an organization, and
• increasing the size of a gift.
  

Income Tax Charitable Deduction

The deduction for a particular donor depends on a constellation of factors:

• the donor's adjusted gross income (AGI)
• any net operating loss carry back the donor may have
• the type of property contributed
• the donor's holding period in the property contributed
• whether the property would produce gain if sold, and what kind of gain
• the type of charitable organization receiving the contribution
• in certain cases, the use to which the charity puts the gift property
• the fair market value of the gift property or, in other cases, the donor's tax basis in the gift property
• the statutory limitation on the deduction applicable to the particular type of gift
• any special election the donor may make with respect to the deduction.
  

Charitable Gifts of Partial Interests

Often a donor will not give charity his or her entire interest in property, but rather a "partial interest." Strict rules must be met for the value of the charity's partial interest to be deductible in this situation. For example, charitable remainder trusts are recognized exceptions to the partial interest restrictions.

When a qualifying partial interest gift is made, the value of charity's interest must be determined (since it is less than the full value of the property). Treasury publishes mortality tables periodically to make such valuations possible when life contingencies or a term of years are involved. The interest rate for discounting purposes is published monthly by the IRS, and is known as the "applicable federal rate," or simply "AFR."

A donor can use the AFR for the month in which the gift occurred, or select either of the two monthly AFRs preceding the month of the gift. To maximize the charitable deduction, the donor will select the highest available AFR in the case of—

• a charitable remainder annuity trust or unitrust, or
• a charitable gift annuity.
  

A donor interested in maximizing the charitable deduction will select the lowest available AFR in the case of—

• a charitable lead trust, or
• a gift of a remainder interest in a farm or personal residence.
  

Estate and Gift Tax Charitable Deduction

What if we didn't have to worry about any restrictions on the charitable deduction? That's basically the way the estate and gift tax charitable deduction operates. Type of property contributed? Doesn't matter, it's fully deductible. The charity's use of the property? Doesn't matter. Type of charity? Doesn't matter. Deemed amount of contribution? It is always the same as the actual amount the fair market value either at date of death or the alternate valuation date. Percentage limitations on the deduction? There aren't any—if you leave 100% of your net estate to charity, it's all deductible. This simpler approach to deductibility also applies to the gift tax charitable deduction.

Charitable Giving Techniques

• Outright Gift of Cash This is the simplest of all gifts to carry out. The donor transfers cash, writes a check or fills out a credit card charge slip. The gift is fully deductible up to 50% of adjusted gross income, with a 5-year carryover of any excess deduction.

• Outright Gift of Long-Term Capital Gain Property This is an easy gift to carry out. The donor transfers possession of the asset with any document of title to charity. The gift is fully deductible up to 30% of adjusted gross income, with a 5-year carryover of any excess deduction. No capital gains tax is paid on the appreciation.

• Bequests This is the simplest way to leave property to charity at death. The donor specifies in his or her will what property goes to charity. The value of the bequest is deductible by the estate for federal estate tax purposes.

• Charitable Gifts of Life Insurance A gift of life insurance may make a major gift possible cost-effectively. To get the income tax deduction, the donor must transfer ownership of the policy to the charity. Cash gifts to charity for subsequent premium payments (if any) are then deductible. If charity is merely named beneficiary, no income tax deduction is allowed, but an estate tax deduction is permitted at death for the proceeds.

The value of the gift is the lesser of the value of the policy, and the donor's cost basis in the policy. The cost basis is not reduced by dividends unless they were actually paid out. If the policy is paid up, the value of the policy is the replacement cost. If the policy has premium payments remaining, the value is the interpolated reserve value (approximated by the cash value). The deduction ceiling is 50% of adjusted gross income if premium amounts are transferred to the charity, and 30% of AGI if the premiums are paid directly to the life insurance company.

• Charitable Remainder Annuity Trust The charitable remainder annuity trust (CRAT) receives a gift and pays the donor or other beneficiary an annual return of at least 5% but not more than 50% of the initial principal for life, or for a period of up to 20 years. The value of the charitable remainder must be at least 10% of the net fair market value of all property transferred to the trust, as determined at the time of the transfer.

A CRAT cannot receive subsequent contributions. No capital gains tax is paid if appreciated property is used to fund the CRAT. The donor can deduct the present value of charity's remainder interest in the CRAT immediately, subject to the 50% or 30% ceiling, depending on the type of property used. The value of the charitable remainder interest must be at least 10% of the initial value of the assets transferred to the trust.

• Charitable Remainder Unitrust The charitable remainder unitrust (CRUT) receives a gift and pays the donor or other beneficiary an annual return of at least 5% but not more than 50% of the value of the principal, as revalued annually. Payouts last for life, or for a period of up to 20 years. If the principal goes up in value, so will the payout amount as the percentage is applied to a higher base. The value of the charitable remainder must be at least 10% of the net fair market value of all property transferred to the trust, as determined at the time of the transfer.

A CRUT can receive additional contributions (unlike the CRAT). No capital gains tax is paid if appreciated property is transferred to the CRUT. The donor can deduct the present value of the charity's remainder interest immediately, subject to the 50% or 30% ceilings, depending on the type of property contributed.

• Charitable Pooled Income Fund The pooled income fund (PIF) pays an annual income to the donor proportionate to his or her share of fund earnings. There is no guaranteed minimum or cap on the amount of the donor's payout.

The PIF can be funded with smaller gift amounts than the charitable remainder trust, and can receive subsequent contributions (like the CRUT but unlike the CRAT). No capital gains tax is paid if appreciated property is transferred. The PIF cannot pay out tax-exempt income.

The donor can deduct the present value of the charity's remainder interest immediately, subject to the 50% or 30% ceilings, depending on the type of property used.

• Remainder Interest in Personal Residence or Farm The donor can give a personal residence or farm to charity, but reserve the right to live there for life (or joint lifetimes). Personal residence can include a second home.

The donor can deduct the present value of the charity's remainder interest immediately, with certain adjustments for depreciation, and subject to the percentage ceilings on the deduction.

• Charitable Gift Annuity The donor makes a gift to charity and receives back a guaranteed lifetime (or joint lifetime) income. The income amount is based on the age of the beneficiary (or beneficiaries), and is partly tax-free when received. If appreciated property is given, the capital gain is recognized ratably over the donor's life expectancy, provided the donor is a sole or joint annuitant.

The donor can immediately deduct the value of the property given, less the present value of the income stream from the annuity, subject to the percentage ceilings for the type of property given.

• Charitable Lead Trust This is the mirror image of the charitable remainder trust. Here, the charity receives an income from the trust for a period of years, then the remainder is paid to noncharitable beneficiaries (e.g., the donor's family). The tax consequences vary considerably depending on the trust terms.