In this article we will discuss how to set up a simple and tax effective charitable giving fund account with as little as $2,000 in after tax dollars and increase tax credits.
I was recently approached by a client of mine who was interested in a better, more efficient way to support the charities they gift to on a yearly basis. They were finding it increasingly more difficult to keep track of all their tax receipts and found the endless solicitation from other charities that had acquired their names annoying.
The tax-effective solution we came up with was able to increase the tax credit they received. It allowed them to receive one tax receipt upfront for the full years contribution and make donations without ever having to reveal their mailing address or name, thus removing them from future mail and call lists.
The solution we used was a “donor-advised fund”. A donor-advised fund is a charitable giving vehicle administered by a third party and created for the purpose of managing charitable donations on behalf of an organization, family, or individual. This accompanied by the recent changes in tax laws has made setting up your own charitable giving fund account, tax efficient and cost-effective. There are no set-up cost and no client administration is required. The minimum initial contribution is typically $25,000, but as we’ll show you below, the out of pocket expense can be as little as $2,000.
There are two main ways to fund the donor-advised fund account. The first approach which offers additional tax savings is to contribute existing shares of public companies that have unrealized capital gains. Under the recent changes to tax laws, you can eliminate the capital gains accumulated on those shares by donating them in kind. The donation tax receipt from the charitable foundation would be equal to the market value of those shares on the day they were contributed. The additional tax savings would come from not having to pay capital gains tax. Under this approach, the greater the unrealized capital gains, the greater the tax savings.
The second approach, the approach we ended up using is the most tax effective. As the client didn’t own shares of a public company with significant capital gains, we were able to create an additional tax benefit by making the initial investment in a flow-through shares. Flow-through shares have been around since the 1980’s and offer special tax treatment to the resource and mining industries in Canada. The special tax treatment allows investors to write off most of the investment in the flow-through shares against their personal income. This in turn reduces by the value written off.
Here are the basics of how it worked: An initial investment of $25,000 into a flow-through share was made. The tax savings from this initial investment was approximately $11,500 (assuming a marginal tax rate of 46%). After 18 months (typically holding period for a flow through share is 12 to 24 months), those shares were donated to the charitable foundation account. The shares were donated without any capital gains tax being realized and a donation tax receipt was issued from the charitable foundation for the market value of the flow through shares. At the time of the donation, the value was still $25,000. This resulted in an additional tax saving of $11,500. The requirement from that point onwards is that the charitable foundation needs to gift between 3.5 to 5% of the $25,000 each year to the the client’s preferred registered charities. In brief: an investment of $25,000 reduced the clients taxes by $11,500 for the investment in the flow- through shares. The contributions of those shares to the charitable foundation resulted in an additional tax reduction of $11,500, leaving the client out of pocket $2,000.
By using this approach, you can continue to support your charities in a tax-efficient manner, avoid keeping track of tax receipts, contribute anonymously through your donor-advised fund account to avoid all the junk mail and phone calls, as well as all the legal and accounting cost of setting up your own private foundation. As your charitable giving fund account allows you to appoint successors, this is also a great initiative to involve, educate and eventually pass down to your children.
Before implementing this strategy, it would be advisable to discuss it with your accountant to ensure an advantageous outcome for your particular situation. While historically flow-through investments have done well, they are speculative by nature.