One month from now we’ll celebrate the second anniversary of the election of 2008. Back then, in the midst of the worst financial meltdown of our lives fueled by greed, deceit, and an increasingly unpopular war, a majority of Americans went to the polls and voted for change. And man, did we get it. The change set in motion a new way of doing business in Washington. We have since been ruled by a Congress and President determined to redistribute the wealth at all costs—even if it costs all. Two years later one thing remains very clear: This is not a Congress or Administration that cares about getting it right, it is about getting even. In a blurred line of redistribution and reparations for past capitalist sins, Washington declared a war on wealth. The enemy is the capitalist, the American investor, the business owner, the physician, grandparents, and the free market system.
The WMD in this war are not weapons of mass destruction but rather weapons of mass re-distribution, otherwise known as taxes. Sitting in our fox-holes, we can hear the bullets fly overhead; a tax on income, another tax on investment earnings, yet another tax on capital gains, an additional tax on estate transfers, and a tax on retirement plan distributions. Worse yet all these taxes are scheduled to increase as the Bush tax cuts sunset at the end of the year with a Congress too timid to deal with an extension. The result of the WMD in the War on Wealth is to create a targeted class of taxpayers I call accidental philanthropists.
We think of a philanthropist as the person who willingly gives of his or her wealth to the social causes that carry some personal meaning. They name buildings after these people. Anaccidental philanthropist is the poor slob who has his tax dollars redistributed to the causes that are important to the government in the form of entitlements, rebates, special programs, bailouts and “stimulus.” No one will name anything after him; they don’t even know he exists. As accidental philanthropists we have no say as to who we give our money to, or how much we give them. The Government takes, the Government decides—who and how much.
There is a way to fight back. There is a way to take control of your tax dollars and how they are spent. The best way to avoid the redistribution of wealth through taxation is by avoiding the taxation in the first place—legally. The best way to avoid becoming an accidental philanthropist is by becoming an active one by using the specific strategy I call charitable leverage.
You accomplish this by placing some of your targeted assets, like stocks or mutual funds, into an IRS approved tool called a charitable remainder trust (CRT). The CRT provides you, the donor, with an upfront income tax deduction, bypass of capital gains tax, and stream of income and principal to you over the life of the trust. The assets in the trust are not subject to tax. At the end of the trust term, whatever remains goes to the charities you choose. The result of charitably leveraged planning is that dollars you would normally lose to taxes are re-routed to causes you actually care about—to be used exactly the way you want. The cash-flow generated by the CRT may be used to fund a supplemental retirement account for you, your children, or grandchildren. Add a life insurance policy (also funded by the CRT) and you could create an amazing wealth accumulation and preservation tool.
Let’s say you own a stock valued at $100,000 with a cost basis of $20,000. Further let’s assume the stock pays you a 2% divided, or $2,000 per year (subject to the dividend tax of 15%). Your annual net income from the stock is $1,700. You might like to sell that stock, but if you do, you’ll subject the $80,000 of profit to capital gains tax. At the current 15% capital gains rate, the tax you’d pay would be $12,000, leaving you with $88,000 to re-invest. What happened to your $100,000 investment? Accidental philanthropy! To make matters worse the capital gains rate is scheduled to increase to 20% when the Bush tax cuts expire.
You could choose instead to transfer that same stock to a Charitable Remainder Annuity Trust (CRAT) with a 15 year term and a fixed 6% distribution--and then sell it. Here’s what happens: first, you’d get about a $30,000 income tax deduction this year for the gift you’ll be giving to charity in 15 years. Next the CRAT will sell stock and avoid the tax on capital gains. Your $100,000 of stock will be valued at the same $100,000 after the sale, as opposed to $88,000. Third your annual income would jump to $6,000 per year instead of $2,000. Both are subject to the 15% tax, so net-net you’d still be ahead $5,100 as opposed to $1,700.
So far, you saved $12,000 in capital gains tax, used a $30,000 income tax deduction for your current tax planning, and increased your net income by 300%!
Obviously, you must have some degree of charitable intent to enjoy the full power of this strategy. At the end of the 15th year, your CRAT will be going to the charities you select. If you feel like you’ll be disinheriting your kids you can use some of the annual increased income to buy a permanent life insurance policy. The death benefit of the insurance policy will replace the value passing to charity directly to your children --usually tax free.
Charitable leverage offers a new type of wealth management. It is an approach that allows you to become a partner with charity to gain control over your tax destiny and provide for you and your family in the bargain. Charitable Leverage is about putting you back in control of your money. No more accidental philanthropy!
This is not a do-it-yourself strategy. I am not an attorney or an accountant and I don’t provide legal or tax advice. If anything I said here makes you want to take a closer look, please talk with a qualified legal or tax professional.