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Charitable moves benefit from higher tax rates

By Doris Meister

Who doesn’t welcome a tax cut? It was good news when the latest tax law cut income tax rates in stages for all taxpayers over the next five years.

But some taxpayers may want to take advantage of the higher tax rates in effect until the end of the year, because it can mean greater tax deductions on charitable giving accomplished now rather than later.

Creating Higher Tax Deductions

As of June 30, 2001, high-income taxpayers pay a top marginal rate of 39.1 percent. That rate drops in stages to 35 percent between now and 2006. In the same time span, rates in the lower tax brackets will also fall: the 35.5 percent rate to 33 percent, for example, and the 30.5 percent rate to 28 percent.

Therefore, if you make a sizable charitable contribution before year-end, your deduction will be worth more than if you wait five years. If your charitable gifts are substantial; acting now can make a big difference.

For many people, charitable giving is accomplished by donating assets to an organization, such as the American Red Cross or the American Cancer Society, which then uses the funds to accomplish its mission. But you may also want to consider establishing a charitable entity through which you can accomplish your philanthropic goals.

For example, community foundations are publicly supported charitable institutions that administer funds given by individuals, as well as other sources. A local board of private citizens governs the foundation. The foundation invests its assets and makes distributions each year in the form of grants. A portion of the grants may be made with the advice of the donor through a donor-advised fund.

By establishing a donor-advised fund through a community foundation, you can transfer a significant amount of assets and receive a sizable current charitable tax deduction. You also can recommend which charitable entity receives distributions from the fund.

Donor-advised funds appeal not only to older investors whose philanthropic plan is integrated with an estate plan, but also to younger people who want a more formal structure for their giving. By giving through an entity such as a donor-advised fund, you can create a tax-advantaged pocket from which to make charitable contributions over a span of time.

Private family foundations, another option, are tax-exempt trusts or corporations that typically make grants to charitable organizations. They can be a good way to involve an entire family in philanthropy. A private foundation can make grants to non-profit organizations as well as to for-profit enterprises such as economic development commissions, a flexibility that appeals to many donors.

A third possibility, supporting organizations, are similar to private foundations except they characteristically share responsibilities for organizational governance with public charities. They appeal to people who wish to combine a program of charitable giving with wealth management strategies.

New Interest in Trusts

Increasingly, people are integrating their philanthropic goals with their wealth management goals, creating foundations and trusts to provide for their families and charities.

A charitable lead trust, for example, names one or more charities as the income beneficiary of an irrevocable trust. The charity receives annual payments from the trust, and noncharitable beneficiaries, such as your heirs, receive the assets when the trust ends. For example, you may state that a charity is to receive three to four percent of the value of assets in the trust for 20 years, after which the remainder of the assets will be given to your heirs.

Assuming the investment management strategy results in greater total return than the annual charitable distributions, your heirs will receive the appreciated assets and no additional gift or estate tax will be incurred. You can take an income tax deduction for the actuarial value of the income paid to the charity, which lowers the gift-tax value of the transfer to heirs.

This strategy takes advantage of another feature of the tax law, an increase in the amount a taxpayer can transfer free of gift tax. This year, up to $675,000 of assets qualify for the combined estate and gift unified credit. The transfer exemption amount for the gift tax is raised to $1 million for 2002 and beyond.

Because of the gradual drop in tax rates, it makes sense to think about strategies for charitable giving that take advantage of today’s higher tax rates. Talk with your legal and financial advisers about how to maximize your charitable tax deductions this year.

Doris Meister is head of Merrill Lynch Private Wealth Services.

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