Financing can allow you to enhance your charitable gift by 10x. Charitable Gift Financing is a strategy that enables charitably inclined high-net-worth individuals to use a third-party loan to make a tax-deductible contribution to charitable organizations.
As an example, imagine that you would love to help provide motorbikes to pastors around the world. A motorbike allows them to see more people and cover more ground in a shorter time. This, in turn, allows the pastor to get the Gospel to more people faster. Now let’s say a motorbike costs around $2,000. For a $50,000 contribution you could provide 25 motorbikes that could be used to get the Gospel to more people. Can you imagine the impact that could have? But how to come up with the $50,000? On one hand, you could just write a check, but then those funds are gone. You have personally capitalized the project. Or you could consider Charitable Financing. This, in effect, allows you to collateralize and amortize your gift while retaining your capital. So how does it work?
To begin, the IRS has ruled that when debt to a third party is used to make a charitable contribution, the taxpayer is entitled to a charitable contribution deduction under IRC §170(a) in the year the gift was made. The deduction may not be postponed until the taxpayer pays the indebtedness – Rev. Rul. 78-38, 1978-1C.B.67, Granan v. Comm. 55 T.C. 753 (1971). Of course, there are often many questions that arise when considering this concept.
Grantor Trust
To start, how do I get a personal deduction if I am using a grantor trust? To be effective, a grantor trust must be employed, but then it does beg the question of how one can get a personal deduction. According to the IRS, a grantor trust is one in which the grantor, i.e., the person establishing the trust, retains control over the trust’s income, assets, and debt IRC§ 673. As a result, the deductions and income of a grantor trust are passed to the grantor as an individual IRC§ 671, Treas. Reg. §1.671-2. Furthermore, the trust is not required to file a separate tax return.
Interest Rate
The next question that often comes up is what would be the interest rate for the loan? The interest rate is set at the IRS applicable federal rate (AFR) for a demand note. The rate changes all the time; however, over the past 30 years, it has averaged 3%. As of this writing, the current rate is 3.44%.
How Much Deduction?
Next, how much can be claimed as a tax deduction? You can claim up to 60% of your income after adjusting for other deductions. A donor may deduct up to 60% of his or her Adjusted Gross Income (AGI) in one year. A gift or cash may be transferred and deducted in that year. If the donor’s contribution exceeds the 60% limit, the excess is carried forward and may be deducted over the next five years. Reg. 1.170A-10(b)
Source of Capital
Who, then, provides the capital for the loan? The capital for the loan is provided by endowment funds, donor-advised funds, private foundations, and various charitably inclined private organizations, etc. These organizations have yearly budgets and seek to increase overall charitable giving in local communities, which they accomplish by giving loans.
Repayment
Another question concerns how to pay the interest and repay the loan. In the first year, you will prepay three years of interest up front. In the fourth year, the interest will be rolled up into the loan. The loan plus any unpaid interest will be repaid out of your estate after you pass away. The executor of your estate will use the proceeds of life insurance to repay the loan.
In summary, utilizing charitable financing can give you the ability to make larger private charitable gifts with minimum cash outflow, allowing you to leverage your impact. In addition, charitable financing can help to minimize income tax and capital gain tax liabilities while giving access to a rolling line of credit with a low interest rate and no personal guarantee required in most cases.
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Please Note: All charts and numbers are for illustration purposes only. Accuracy is neither warrantied nor implied. We are not attorneys or tax advisors. This information is educational only. Not to be considered as advice or recommendations. It is imperative that you consult with a tax advisor and/or attorney when considering any of these concepts. In addition, it is critical that the attorney, tax advisor, and financial advisor are knowledgeable and practiced in these areas. If you would like help finding such an advisor, we will be glad to introduce you to an experienced planner with your best interest in mind. Please give us a call at 1-800-522-4324.
