Jan 27, 2012

1040 Charitable Checklist: A quick primer on smarter giving.

Here in Colorado, we enjoy the beauty of the Rocky Mountains. I love to take the family camping and a few years ago, I decided to buy an old Jeep to get us into the high-country. I found a deal in the classifieds and drove about 90 minutes to see it. The gentleman selling the Jeep owned the corner store in a small mountain town. The Jeep ran, but you could tell it needed some work. We haggled over prices and I wound up buying it on one condition: he had to throw in a tow strap from his corner store in case the thing broke down on the way home. Well, 90 minutes later I was home, no tow strap needed.
I ran the numbers and the gas mileage for the trip was horrible and I noticed that when I was in the mountains, the thin air really decreased performance. I am certainly no mechanic but I love to tinker. Buy a repair manual… check. Replace the air filter…check. Tweak the carburetor and fill the tires…check. At high altitude, these adjustments made a huge difference in performance. After a few minor repairs the Jeep ran much better and my gas mileage improved as well. My family has enjoyed building memories in that Jeep.

I’d suggest that a minor tune up can lead to big improvements in many areas of our lives. A few minor adjustments in a family’s finances can make a world of difference. When we apply best practices in charitable giving, we are able to give more to the causes we care about and pay less in taxes. The Federal Government encourages charitable giving by offering deductions and a bit of planning may go a long way.

Well, before I started fixing the old Jeep, I had to find a guide; and before a family can improve their charitable giving, they’ll have to know where to start. Unfortunately, you can’t go down to the parts store and pick up a detailed description of your personal finances. There is, however, an organization with some detailed and up-to-date info on how your family finances operate. The IRS!

Grab your family’s tax return and we will start with the 1040 as a guide to tune up your giving. If you don’t have your return handy, don’t worry. Although reviewing your tax return sounds analytical, this exercise is primarily designed to stimulate conversation. Perhaps an idea will strike you and you can dig into the details later. A few families will find that their finances are performing perfectly. Most will be able to make a few minor changes in order to save taxes and give more. In some cases the benefits may be dramatic.
We’ll follow the items right down the front and back of the form. The line items won’t apply to everyone but hopefully one of the tips will fit for your family.
1. Analyze your income. Your income shows up on the first page and is summarized on line 22. From a charitable planning perspective, there are two types of problems: too much income or not enough income. The phrase “too much income” certainly sounds like a joke. Really it’s just financial mumbo-jumbo. It means that you are claiming more income than you really need to live on.
Too much income. Would you say that your total income from line 22 is enough to live on? If so, we can use line items 23-37 on the first page (known as above the line deductions) and lines 38-55 on the back page (known as below the line deductions) to your advantage. By adjusting the types of savings you make and giving gifts efficiently, you may be able to maintain your lifestyle, cut taxes and boost your charitable giving simultaneously. A family may be able to reduce taxes by gifting current income to the nonprofits they care about. A CLT or Charitable Lead Trust may help. You can support a charity for a term of years and rely on the interest and the value of the property to support your needs down the road. These gifts also work well in a low interest rate environment.

Not enough income. For some families, the income portion of the 1040 could use a bit of help. The average American family has about 11% of their total assets in cash while everything else they own consists of stuff: the house, the car, the family business or property. If liquidity is an issue, a family may be able to rely on these other resources to create liquidity, save cash and make an impact. Consider a Charitable Remainder Trust or a Charitable Gift Annuity. These types of gifts allow contributions of appreciated stock, real estate or other assets that create income for the donor. Using these tools, donors avoid taxes on gains, capture a deduction today and leave the remainder to charity down the road.
2. Uncovering hidden assets. We talked about gifting assets other than cash, but let’s use the 1040 to guide us to a few of the assets. Look at lines 8, 9 and 13. These lines direct you to Schedule B and D which are forms that you file to declare interest or dividends from investments or capital gains or losses. If you have info on these lines, see Schedule B and D attached to your return for more details. These assets may be producing income or capital gains, and if these assets are highly appreciated, they may cause a tax burden if sold. If you were to gift these assets, or just the income they are producing, it may help your bottom line and add liquidity.
Business owners. Now turn your eye to line 12 which directs you to Schedule C income. Hello Mr. or Mrs. Business Owner. Did you know that your business can be a wonderful tool for supporting nonprofits? The organizations you support may fall in line with your marketing plan. If so, perhaps supporting the cause by underwriting their annual fundraiser would help. This sort of gift must be a business expense that makes sense, but by showing your support through advertising you may wind up with more customers while reducing taxes across the board.

Business succession. When it comes time for succession planning, remember the nonprofits you care about. Giving shares of your business can create deductions when you need them most. The details of a structured gift of a small business is a bit outside of the scope of this white paper. Get your trusted advisors together and come up with a plan not only to leave the business, but to leave an impact.

Real estate. Line 17 and Schedule E. Whether you are a real estate tycoon or just have a little vacation rental or oil and gas royalties, a gift of the income or the property itself may be possible. Many planned gifts are funded with real property.  

The philanthropic farmer. Schedule F is for farm income and line 18 shows an income or a loss. Often in the ag industry this line can be negative. Planning for farming and ranching families can be challenging. Thankfully there are a few tools specific to the trade.

Farmers and ranchers can gift commodities such as grain or livestock to a charity and keep income, and the taxes associated, off of the books. Conservation Easements are a big gift that often results in a big deduction, but these gifts of the rights to develop your property are set up in perpetuity. In some states, including Colorado, folks who desire to donate a conservation easement will end up with a Federal Deduction and a State Tax Credit which can offset income, or in some cases, can be sold for cash. These types of gifts can also reduce the taxable estate of a farmer or rancher. Estate taxes can threaten the way of life for a family and this strategy can give farmers and ranchers the resources they need to keep the farm in the family. The professionals you work with should be able to help you with the details.

Whether you own securities, a small business, real estate or a farm, planning ahead can create huge opportunities. Consider partnering a gift of appreciated investments with a Donor Advised Fund or a Charitable Trust to avoid capital gains tax and to create a giving fund. You can think of these types of giving accounts as your charitable checkbook.  
3. Charitable change-of-mind in retirement. Line 15 and 16 point to income from tax deferred retirement accounts and annuities. These assets are often very taxing. Distributions from many retirement accounts are taxed at high Ordinary Income Rates. These assets are not only taxed inefficiently during life, but they are expensive in an estate as well. If you are over 70 & 1/2 you may be able to gift IRA assets by using the IRA Charitable Rollover. These gifts work towards your required minimum distribution and don’t show up as income. That means no taxes, plus by giving this lump sum, the monthly amount you were donating is now freed up for other uses.

Itemized vs. standard deductions. There is another bonus. Often folks in retirement have paid off their mortgage and they no longer itemize on their deductions. On your 1040 look at line 40 on page 2. Your Schedule A will inform you if your charitable giving is helping to reduce your taxes. If your total itemized deductions are not as high as the standard deduction, your giving is no longer reducing your tax bill. A Charitable IRA Rollover, a gift of an appreciated asset or other planned giving strategies may help.

Charitable carry-forward. We see families who have given big gifts to nonprofits and because of limits on deductions by the IRS, they max out their usable deductions. The rest are carried forward for use in future years, but they have an expiration date, generally you must use them within 5 years or you lose them. Line 18 on Schedule A lists carry-forward deductions. If this is happening, it might be appropriate to find more income and use the charitable carry-forward to offset it. IRA assets are a great example. By taking a distribution or pairing a charitable carry-forward with a Roth Conversion, you may be able to save substantial taxes and fund a Roth that will give you tax free income in the future.

With a little tune-up and close attention to detail, my Jeep ran better at high altitude. The potential for your family to improve your finances, and to reach new heights of giving, may be just a few tweaks away. A quick tune-up using your tax return is a great start, but this overview is not comprehensive. A charitable giving plan allows families to tap massive potential to give and make a difference that they never thought possible.

If you are interested in finding ways to make more of an impact, we can help. A comprehensive review of your finances will offer an objective second opinion and may allow you to save taxes, meet your needs and make a big difference.
Related Posts Plugin for WordPress, Blogger...
comments powered by Disqus