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Financial Planning

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by Rick Imhoff

When making a donation to your favorite charity, group or organization, you can fulfill your charitable obligation and feel good about helping a particular cause. As an added benefit, the IRS provides some income, gift and estate tax advantages to donors for donations made to qualifying organizations, which are described in Code Section 170(b)(1)(A).

These may include churches, educational organizations, hospitals and medical research organizations, certain private foundations, or governmental units, to name a few.

The most common method of making a donation is the outright gift of cash. The donor can take an income tax deduction on the entire value of the donation. In addition, the amount of the donation would be removed from the donor's taxable estate and would therefore avoid estate taxes.

Some individuals want to keep control of all their money until their deaths, when their wills or trust agreements can include a charitable bequest of a certain percentage or a dollar amount.

The individual using this method will not receive any income tax benefits because he retained control of his funds during his lifetime.

However, he will receive an estate tax charitable deduction which will reduce the size of his taxable estate.

This is particularly beneficial for someone with a taxable estate in excess of the estate tax exemption equivalent, which is $625,000 for the 1998 tax year.

A donor can also make a gift of his life insurance policy, making the charity the owner and beneficiary of the policy. The charity can either surrender the policy for the cash value or accept additional donations from the donor to make the premium payments. This keeps the policy in force until the donor's death, providing a larger benefit to the charity.

The donor would receive an income tax deduction based on the cash value of the policy at the time of the gift.

In addition, an income tax deduction is available on future donations made to the charity to help it pay for the premiums. Since the donor would no longer be the owner of the policy, the death benefits would not be included in the donor's gross estate.

A little more sophisticated method for making donations is for the donor to create a charitable remainder trust. This arrangement provides a stream of income to the donor, or another party, for a stated period.

At the end of the stated period, the balance remaining in the trust passes to the named charity. This type of arrangement can be established during the donor's lifetime or become effective at the donor's death.

If the donor created the charitable remainder trust during his lifetime, he would receive an income tax deduction based on the value of the remaining property that is eventually passed on to the charity.

Since the actual value of the remainder interest is unknown, a calculation is made to estimate the remaining value. This calculation considers the age of the income beneficiary, the number of years the income is to be paid and the total distributions desired by the donor.

This is a particularly useful method if you would like to convert highly appreciated assets such as stocks and real estate, that pay little to no income to something that pays a higher level of income for yourself.

The donor would avoid paying capital gains tax, and distributions to the income beneficiary would be partially considered a return of principal and the remainder considered taxable income. This type of arrangement would remove the property and any future appreciation from the donor's gross estate, as well as the income derived from it, if paid to someone other than the donor.

It is important to note that there are limitations on the income tax deduction available to the donor based on the type of property donated to a qualifying charitable organization.

If the property is cash, or what is called ordinary income property, then the donor can deduct up to 50 percent of his adjusted gross income in a tax year. There is a five-year carryover of any unused deduction.

If the property is considered long-term capital gain property, then the donor can deduct up to 30 percent of his adjusted gross income in a tax year with a five-year carryover.

Due to continuous changes in the tax law and the unique situation of each donor, it is important to seek professional advice regarding the specific income and estate tax benefit of any charitable donation.

(Rick Imhoff is a certified financial planner and trust officer for Empire Bank in Springfield.)

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