Observations

Looking Out for Your Financial Future

5 - Aug 2020

My Favorite Tax Savings Structures, Part One

Almost everyone wants to save money on their federal taxes, but that is difficult to achieve, and there are no silver bullets. Our tax system is a complex set of rules, and each taxpayer’s specific fact pattern will, therefore, have a different application of the numerous tax rules. Successful tax savings must also match the fact pattern and align with the planned actions of that particular taxpayer.

Since we are in tax season right now, I’d like to share one of my favorite ways to save on federal income taxes, which can apply to a large number of taxpayers. 

The Donor Advised Fund

One of the best and easiest structures to use for federal income tax savings is the Donor Advised Fund. It will apply to any investor who itemizes deductions on their tax returns and, most importantly, plans on making charitable gifts that qualify as tax-deductible. According to Wikipedia, the first donor advised fund was created in 1931, known as the New York Community Trust. As of 2015, donor advised funds were the fastest growing charitable giving vehicle in the U.S. 

Here’s a quick description of the tax result: You can transfer a highly appreciated security to the donor advised fund, which is a charitable entity, and you get the deduction upon the transfer, at the full fair market value. The most important requirement is that the security must be in a long-term, capital gain position and be readily traded on the open market. The benefit comes from avoiding the capital gain and associated capital gains tax. Since the fund is itself a charity, the fund can sell the position and report no taxable gain because a charity is tax-exempt, but you still get the full fair market value as the amount of the deduction. Your transfer to the fund is an irrevocable gift. You never have to pay any capital gains tax on the security, and you get a full fair market value amount for the deduction, which reduces your otherwise taxable ordinary income. That is a pretty good result and feels like a double benefit.

Your new position in this structure is that of the advisor of the fund, which means you can direct the distribution of cash from the fund to the charity you want to support. For example, you could make a $10,000 contribution to the fund in one tax year and then give $1,000 to 10 charitable organizations in any year you wish. You can time the transfer of the initial gift to the fund when you find it preferable, and you can make single or periodic gifts to any charity you want, whenever you find it preferable. I also like the added benefit of simple record keeping for your tax return. It is easy to document any amount transferred to the fund, and that transfer is the entire documentation needed for tax purposes, even if you ultimately use the money to fund hundreds of gifts to different charitable organizations.  

The structure is also very simple. When using Schwab Charitable as the donor advised fund, the fund is essentially just a separate account in your portfolio that contains an amount of value that is appropriated to charitable purposes only.  

M. Andrew Shaul

Author:

Andy Shaul began his career in financial planning at Arthur Andersen & Co. in 1986, where he specialized in estate and tax planning for individuals. He earned an early promotion to Manager, and to this day, many of his clients have been clients since that time. He left Andersen in 1993 to work with Cliff Paessler at the accounting firm of Dunavant, Dickey, Paessler & Shaul. He and Paessler founded Financial Strategy Group in 1999 to provide comprehensive financial planning services.

Shaul graduated from the University of Tennessee with a bachelor’s degree in business, and holds a Master of Science in Taxation from the University of Memphis. He is both a CPA and a Personal Financial Specialist (PFS).