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Expecting a large lump sum of income? Charitable Planning Can Reduce Your Taxes

Expecting a large lump sum of income? Charitable Planning Can Reduce Your Taxes

April 12, 2024

Often people will have one-time “Income Events” that greatly increase the income tax due in that year. Finding ways to mitigate that additional tax, especially for younger people, can be challenging. In some cases, setting up a Charitable Lead Trust (CLT) in order to receive an upfront income tax deduction might be a viable option. A person who has significant and unusual taxable income in a particular year can establish the grantor-led trust and use the charitable income tax deduction to mitigate the impact of taxes in his or her situation. An example might be someone who has received the proceeds from selling a business, or a stock option at work is coming due. A far more common and likely example is someone who has inherited an IRA. These situations will trigger an unusually large amount of tax because the profits or earnings will be taxed as ordinary income at the highest possible marginal tax bracket.


“Tax planning is something people may not think about until they’re nearing retirement or after filing their tax return and seeing an unexpectedly high bill. You pay the most taxes when you are in your peak earning years and many strategies will only work if you act in the year you’ve made that income, so you can reap substantial benefits by working with an expert as soon as you see your income (and tax bracket) headed upward,” says Paul Kalra, CFP, an Orange County, CA fiduciary financial advisor, tax planner, and succession planning specialist. “And specifically for business owners who will be getting proceeds from selling their business, you need to have a discussion with a succession planning expert before the transaction happens for the best outcome. The sooner, the better.”


It should be noted that the extent to which the donor can use the income tax deduction will be limited to a portion of his or her total income for the year. In addition, the donor can claim unused portions of the deduction in up to 5 additional carry-forward years.


Impact of Tax Reform


Since the passage of the Trump Tax Cuts and Jobs Act, there is a greater incentive for donors to create grantor CLTs. These trusts allow donors to consolidate deductions for future donations into a larger deduction for a single year. Against the backdrop of the increased standard deduction and the elimination of many other deductions, grantor CLTs provide significant benefits to taxpayers who itemize.  In some instances, creating a grantor CLT may enable a donor to itemize who otherwise would be better off taking the standard deduction. For lack of a full legal explanation, the asset is “loaned” to a charity so that the charity can earn income for a certain period of time, and then given back to the donor, which ends the charity’s connection, as if it all never happened. There are more details of course, but in oversimplified terms, would you rather pay taxes now to the IRS, or loan money to a charity for X number of years to a cause you care about and then get the money back? Normally younger people don’t benefit from Charitable Remainder arrangements, but the person’s age is not the calculation that matters, so these CLT arrangements are equally beneficial, young or old.

If you want to make the most of the money you earn, grow, and protect it while saving on taxes, a Lake Forest, CA fiduciary financial advisor and tax planner can help. Reach out to us at Signature America Wealth Management for a complimentary consultation by clicking here or calling 800-677-5001.