Understanding Charitable Gifting Agreements: Exploring Common Types and Strategies

Charitable gifting agreements play an important role in facilitating philanthropy and supporting the cause and mission of your organization. These agreements outline the terms and conditions with which individuals or companies donating to your entity must comply. Understanding the nuances of charitable gifting agreements is essential for donors, yes, but also recipients – to ensure transparency, legal compliance, and the effective use of donated funds.

Charitable gifting agreements are formal contracts between a donor and your not-for-profit organization. The primary purpose is to establish the terms of a charitable gift, including the amount, purpose and any conditions attached to the donation. These agreements provide clarity and accountability for both parties involved in the donation process.

This article covers the common types of charitable gifting agreements and strategies for executing them to support your organization in understanding their intricacies.

Donor Advised Funds (DAFs)

Donor Advised Funds (DAFs), which have become increasingly popular, offer an alternative to private foundations and are often managed by entities like Community Foundations or investment firms. Donors receive tax deductions at the time of contribution to the DAF, while the DAF sponsor retains ultimate control over the funds. Donors and their families can recommend future grant recipients, with the sponsor assuming responsibility for due diligence.

Charitable Gift Annuities

This arrangement involves a donor gifting an asset to a not-for-profit organization, which then, in turn, commits to providing an annuity to the donor for a specified term. Two primary types exist: current payment gift annuities and deferred payment gift annuities, which cater to different donor preferences. Charitable gift annuities are suitable for donors seeking a reliable income stream, especially those with illiquid or highly appreciated assets.

The American Council on Gift Annuities sets the annuity rates, which ensure that a significant portion of the annuity investment benefits the not-for-profit organization.

For example, a married couple, both age 75, want to increase their retirement income and simultaneously support their local not-for-profit organization through a $100,000 charitable gift annuity. They work with the not-for-profit and contribute $100,000 cash. Based on the individuals’ ages, these two are eligible for a current gift annuity that pays an annuity rate of 6.2%, or $6,200 each year, for as long as either of them is living. Of that $6,200 annuity amount, $2,412 is treated as ordinary income and $3,788 is treated as tax-free income (until the year 2040). The married couple can also claim a current federal charitable income tax deduction in the amount of $37,825.

Charitable Remainder Trusts (CRTs)

Charitable Remainder Trusts (CRTs) function as split-interest trusts, providing the donor with an income stream, while your not-for-profit organization receives the remaining assets at the end of the trust term. There are two variations of this gifting strategy: the charitable remainder annuity trust and the charitable remainder unitrust.

Donors find this strategy advantageous, as it provides immediate charitable deductions, deferred capital gains tax and potential estate tax reduction.

Charitable remainder trusts are very attractive in high interest rate environments. At inception, at least a 10% remainder interest must pass to your not-for-profit. Moreover, the IRS states that a trust will not be a qualified charitable remainder annuity trust if there is a greater than 5% chance that the trust fund will be depleted before the trust ends.

Charitable Lead Trusts (CLTs)

Reverse to CRTs, Charitable Lead Trusts (CLTs) prioritize your not-for-profit entity as the lead beneficiary for a specified term, with remainder assets reverting to the donor or other beneficiaries. CLTs are best suited for low-interest rate environments and when transferred assets are expected to outperform IRS actuarial rates. The implications for your organization include earlier receipt of funds, compared to CRTs, and potential variations in asset performance based on donor longevity.

For example, a 60-year-old individual benefits a not-for-profit organization by funding a 5% CLT with securities worth $1 million. At the time of the donation, the Section 7520 rate is 5.2%. The donor designates the not-for-profit as the charitable beneficiary and his/her children as the remainder beneficiaries. The CLT term is 20 years and will pay the organization $50,000 annually. The individual receives a current charitable income tax deduction of $595,840 and is treated as having made a “taxable gift” to his/her children of $404,160. The not-for-profit receives $1 million over a 20-year period. Assuming 6% annual return in the CLT, the individual’s children will receive the CLT’s remaining $1,399,000 balance when the 20-year term ends.

Other Types of Gifts

Beyond DAFs, charitable gift annuities, CRTs and CLTs, donors can make outright lifetime gifts, gifts at death, via beneficiary designations, or through estate gifts. Charitable life estates also offer a unique opportunity for donors to contribute without relinquishing asset ownership.

Charitable gifting agreements offer diverse strategies, each tailored to donors’ preferences, financial situations and philanthropic goals. Understanding these arrangements enables organizational leaders to navigate the landscape of charitable giving effectively, driving positive change to your organization.

Our team understands the nuances of charitable gifting agreements and can support your not-for-profit organization in these efforts. It’s vital for mission-driven organizations to thoroughly vet donations to ensure maximum benefit from your donors. To speak with our professionals, please contact us.

About our Authors

John Loew, JD, is a tax director at Sikich in trust and estate services with nearly 25 years of experience in the estate planning area, including 15 years as a practicing estate planning attorney. John joined Sikich in 2021, having spent the previous seven years in a similar role at a large public accounting firm.

Larry Johnson, CPA, MST, is a senior tax manager with nearly 40 years of experience closely serving clients with their tax preparation and planning needs. Working with both businesses and tax-exempt organizations, Larry has deep expertise in tax reorganization, consulting and charitable giving/planning.

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