Jill and Harry have always set aside a small portion of their budget for charitable donations. In addition to feeling good about supporting a number of worthy causes, they’ve been able to deduct—from their federal income tax return—all the charitable gifts they’ve made. Now, the couple think it is time to make a rather substantial charitable contribution. Their intent is to donate a piece of artwork they purchased years ago for $1,000 that has since risen to $50,000 in value. However, before they move ahead, they realize there are several issues that need to be resolved. For instance, Harry is a bit reluctant about making the donation because, by doing so, he realizes their children will never reap the benefits of its appreciated value. On the other hand, Jill wants to make sure the donation is executed in a manner that is both advantageous to them and to the charity. Upon careful review, they have come up with a plan that alleviates their concerns. Here’s a closer look.
The first step is to address Harry’s concerns. They’ll do this by purchasing a life insurance policy in an amount that is equal to the value of the artwork—that is, $50,000. That way, they can help ensure their children ultimately will receive a benefit that generally is commensurate with the value of the donated art. Certainly, they will increase their expenses because of the policy’s premiums. But, as you’ll soon see, donating the artwork will actually help pay for the policy.
Next up, addressing Jill’s concern by donating the actual artwork to the charity, rather than sell it and then donate the proceeds. There are two reasons for this:
First, if they sold the artwork, they’d realize a gain of $49,000 ($50,000 - $1,000) that would, in turn, result in a tax of $7,350 ($49,000 x 15%). Therefore, the couple’s donation would be reduced from $50,000 to $42,650. By donating the art directly to the charity, any appreciation in its value is not taxed (either to Jill and Harry or to the charity). Secondly, the income tax deduction for a charitable gift is based on the fair market value (FMV) of the gift and their federal income tax bracket.
So, assuming Jill and Harry are in the 28% Federal income tax bracket, a gift of $50,000 would give them a $14,000 charitable income tax deduction ($50,000 x 28%). On the other hand, a gift of $42,650 would give them only an $11,942 charitable income tax deduction ($42,650 x 28%). In effect, donating the appreciated artwork outright produces a greater current year tax deduction than selling it and donating the proceeds after taxes.
Ultimately, it is the substantial tax deduction that will help offset the costs associated with the life insurance policy. The end result truly is a “win-win-win” situation. The charity wins because they receive the full value of the artwork, Jill and Harry win because they get a significant (and maximized) charitable income tax deduction, and their children win because they eventually will receive a life insurance death benefit that replaces some, or all, of the value of the art.
Making the Most of It
If you would like to maximize the tax benefits of charitable giving, be sure to consult a qualified tax professional. There are some limitations on charitable giving based on the type of gift, the type of organization receiving the gift, and your adjusted gross income (AGI) for federal income tax purposes. Nevertheless, the ability to receive a potentially substantial income tax deduction and possibly replace some of the donated wealth with life insurance makes charitable giving pay off for you and for the organizations whose work you wish to suppor