The purpose of this article is to help Muslims in the United States evaluate the options available to them for Islamic charitable planning.
At some point in life, you want to do more than earn a living. You want to leave a lasting legacy of good works and service. You see problems in the world that some money can potentially help. Your wealth can provide clean water to people who don’t presently have them. It can reduce malaria deaths by providing mosquito nets. It can provide a space for children to learn about the Quran. The possibilities are endless.
Giving in charity, as you may have figured out, involves much more than dropping money in a box, writing a check or filling out an online form. Often, you will find that your ability to give is far greater than you may have thought possible.
When charity is less efficient
When you drop a cash donation in a box, it is harder to prove, and you won’t claim it as a tax deduction. But you probably never cared anyway. You do get a tax deduction when there is a paper trail, like a check or a credit card. A deduction does not give you money back in taxes. The value of a tax deduction for a charitable contribution is the value of the donation (say $1.00), times whatever your highest marginal tax rate is. So if you have a 30% rate, you get to pay thirty cents less in taxes. Of course, that does not mean you should not do it. If you are reading this article, I assume you do this all the time and will continue to do so (as you should). There are other arrows you can add to your quiver though.
But you want more: donating appreciated property
So say instead of donating cash, you give an appreciated asset, like stock. Well, then you get two different benefits from donating to charity. You get the benefit of not having to pay any taxes on the sale of the asset, plus you get a tax deduction for the full value of the asset.
Example: Salman wants to donate one share of stock now worth $10,000 that he purchased for $10. If he sells the stock, he will pay a capital gains tax on the difference between $10 and $10,000. If Salman donated the proceeds, it would be less than the $10,000, since the government would tax him on the transaction. However, if he gives the stock itself, as opposed to selling it and then donating the proceeds, he saves on the taxes you would have had to of paid if he sold the stock plus get a tax deduction for the full value of the stock, $10,000.
The Wasiyyah in Islamic Charitable Planning
Now let’s talk about charity in your estate plan, such as in your Islamic Living Trust. There are just a couple of ways to give to charity from your estate after you pass away. The first is a debt, like a debt of zakat. The second is the wasiyyah. The indebtedness of unpaid zakat is obvious. There is however no way for your successors to know that you have such indebtedness unless it was in your Islamic Estate Plan. The wasiyyah is a Muslim’s ability to give up to ⅓ of his or her estate to a useful purpose, which can go to individuals or institutions, usually charities.
The wasiyyah is a substantial subject in its own right. I’ve written a separate guide to the wasiyyah, in addition to a discussion of it in the Islamic estate planning book. Please take a look at those resources if you would like to know more.
Charitable Remainder Trusts
Charitable Remainder Trusts in concept in simple but it can get complex (and rewarding) quickly. There is a massive variety when it comes towhat it can accomplish For families, particularly those with high net worths. It may also be a great tool in the right circumstances for people with modest net worths but are looking to sell a capital asset, like common stock or commercial building. In many respects, charitable remainder trusts are not actual estate planning, Though it is generally an estate planning attorney who advises on and drafts these trusts. It is, however, a form of financial planning. It is a way to accomplish financial goals, including giving and charity, while making the families who engage in these transactions, wealthier. That is, of course, if you are doing this right.
The tax benefits of charitable remainder trusts are quite compelling. There is a clear policy to encourage the creation of these trusts. The government will give those who create charitable remainder trusts four distinct benefits:
- There is an immediate charitable income tax deduction upon transferring assets to a charitable remainder trust.
- The donor (who is also the trustee) maintains control of his or her investments in the charitable remainder trust.
- The donor continues to have the ability to sell and diversify investments inside the trust in a tax-free environment that is similar to an IRA.
- There is no capital gains tax on the sale of appreciated assets inside the trust.
Let me try to put this into an example:
An Office Building Charitable Remainder Trust Example
Hassan is a 55-year-old man with an office building. He wants to sell it. It had appreciated from $300,000 when Hassan purchased it to $3 million today. He wants to be able to utilize this asset for his retirement, and he also wants to give a sizable gift to a local Islamic School. Hassan is not sure about the real estate market going forward, and he thinks he can do better investing the proceeds of this building into something more diversified. Hassan is concerned though that he sells the building; he would be subject to something called a “capital gains tax.”
This tax would eat away at much of the equity that he has built up over the past few years. If Hassan can invest all of the money from the sale towards his retirement, he might have a better retirement. He may be able to do this while also donating a significant sum to charity.
Creating a Trust
So Hassan creates a charitable remainder trust. He sells his building for $3 million and uses the entire amount to fund a charitable remainder trust. Right now, Hassan has named a local Islamic school as the beneficiary of the trust. It goes to charity for sure. However, he does have the ability to change this charity in the future if he sees fit.
Hassan Is the trustee of his trust. He gets to buy and sell assets inside the trust without really worrying about taxes at all while the assets are inside the trust. Hassan also gives himself an income from this trust. He pays taxes on the actual income at what works out to be a favorable rate. He also gets a substantial tax deduction for the year that he creates this trust.
After he dies, whatever remains in the trust goes to charity (thus the name). However, because of these various benefits, Hassan has projected that during the rest of his life, if he lives to 75, he and his family would get significantly more money from the charitable remainder trust then if he did not create one at all. Furthermore, this arrangement allows him to give millions of dollars in charity after he dies.
A Split-Interest Trust and Islamic Issues
Conceptually, think of a charitable remainder trust as a “split interest” trust. We split the interests of assets frequently. We would have a “present interest” and a “future interest.” A weakness in the charitable remainder trust concept that I mentioned above is that the distribution to charity happens at death. The word for assets passed on after death is called “inheritance,” which Islam regulates. See my guide to Islamic Inheritance for more on this. It is easy enough to construct one that distributes everything to charity after 20 years.
However, a charitable remainder trust is different from other assets that are distributed after death. The charitable remainder trust is an entirely separate entity. It is an irrevocable trust. Once you give money to that trust, the money is gone. Now it is technically possible to get out of the charitable remainder trust, Hassan can’t do it free of any consequences. Hassan is giving money away to charity during his lifetime and not after death.
Furthermore, because of the way a charitable remainder trust is frequently structured, Hassan’s family may be getting more than what they would have otherwise received. I say “may” because he may die earlier than what the illustration projected.
Another thing to consider is that Hassan likely did not put all of his wealth into the charitable remainder trust. He only gave away what he thought would be fine giving away to a charitable trust.
The Variety of Charitable Remainder Trusts
We can design charitable remainder trusts in a variety of different ways to fulfill many goals. In broad strokes, though, they can be designed as “unitrusts” or “annuity trusts.” A unitrust can be where Hassan takes 5% of the total trust value every year to fund his retirement. If the stock market performed worse this year than last year, his payout would be lower. If it did better, his payout would be higher.
In an annuity trust, Hassan decides he wants $10,000 a month for his retirement. If his investments go to the moon, he still only gets $10,000, and any benefit would be for charity. If his investments do poorly, he keeps getting $10,000 until his trust is out of money.
It starts with an illustration
Hassan or anyone else who wants to create one would need to discuss their goals, both for personal finances and charitable purposes, to find out what kind of charitable remainder trust an Attorney should draft. If Hassan It is just on the cusp of retirement, his trust might look very different than if he is 20 years away from retirement. His attorney will also need to discuss the needs of his children, the charity, and other considerations.
The attorney will typically prepare an illustration for a charitable remainder trust before actually drafting it. It will provide an outline of the potential benefits of the specific type of charitable remainder trust Hassan is contemplating.
Charitable Lead Trusts
A charitable lead trust is a charitable planning strategy that is conceptually the exact opposite of the charitable remainder trust. There is a charitable trust that pays either a “unitrust” or “Annuity trust” amount ( see above for an explanation of what these terms mean) to charity for a set number of years, like 20 years. After 20 years, the asset goes back to Hassan or his family members.
This technique is often used in conjunction with estate tax planning, including business planning and for other purposes. It can be immensely useful in the right circumstances. There are a variety of reasons why this kind of trust may be a good idea. I wrote about one example here.
Charitable Gift Annuity
One of the most popular charitable planning techniques is something called a “charitable gift annuity.” It is often marketed by charities since it is relatively easy to understand, tends to be appealing to the elderly and does not require lawyers. Typically, it is a one-page contract.
For Example, Salma, 77, gives One million-dollar gift to an Islamic Organization that she likes. An exchange, the Islamic organization, offers Salma a promise that they will pay her $40,000 a year for the rest of her life. The assets of the organization guarantee the payment. Salma likes this because $40,000 a year (along with her social security and pension) is more than enough for her needs.
Many Muslims can instantly see the problem with this. The charitable gift annuity looks a lot like riba (interest). It may also be unduly speculative (gharar). This is quite different from a charitable remainder trust because the contract is with another entity as opposed to Salma, making this agreement with herself. These agreements may also be somewhat exploitative, though I suppose that is a value judgment.
Foundations and Similar
Many families like to incorporate charitable giving as a fundamental value to be passed on from one generation to the next. As a result, they would like to have their children and grandchildren be involved with charitable decision-making. Instead of donating a large sum to a big charity to fulfill that charity’s mission, they make long term charity their mission. They may create a family foundation to make this happen.
Generally speaking, a private foundation is charitable contributions that are mostly sourced from a single place and are under the control of a family. This kind of charity is going to be treated differently by the government since wealthy families have historically abused them to help themselves without doing much of anything legitimately charitable (think of a particular President).
A family does not control a public charity and frequently goes out into the world to get donations. Of course, public charities have also been subject to abuse, and they are still regulated, both by the state and federal governments. They are subject to somewhat fewer constraints than private foundations. Depending on the type of assets that the families have, it may be financially advantageous to donate to a public charity rather than to a private foundation.
For many families, instead of going through the administrative and regulatory hassle of actually running a charity, they will partner with existing public charities. The most common way families manage long-term charitable aims is through a “Donor-advised fund.”
Donor Advised Funds
A Donor Advised Fund is operated by a public charity, so the donor does not need to create one. They get guidance on how to spend charitable dollars; they do compliance and due diligence. It sounds great so far. However, there are several problems. The main one is perhaps also true of private foundations, but unlike are not regulated for potential harm. Many families who give to donor advised funds at the end of the year don’t give to any charitable cause, often ever. They don’t need to. Add to this, the money cannot be used to benefit family either.
Nearly all major financial services companies have set up their own donor advised funds, set up as “public charities.” Those organizations then manage the money and collect fees. The companies can bank on this money management business for years to come since they know many “donors” don’t use the funds for any real charitable purpose and they also can’t use the money for themselves or give it to their families.
For financial services companies, Donor Advised Funds is not much more than a video game for money hoarding. While many do not intend to look at it that way, that is what they have become. In many instances, donor advised funds are not Islamic Charitable Planning.
Donor Advised funds can be used for good purposes however. As a donor, you need to “fish or cut bait.” Give to the valuable charitable causes out there right away. One good purpose of donor advised funds is to use it to pass through donations to small nonprofits that don’t know what to do with donations in stock or crypto. Sometimes informal groups give donations as groups, and use a donor advised fund as a vessel. Otherwise, don’t get caught in the trap of giving charity” with no actual purpose.
Say Hassan supports a Masjid. He wants his family to continue to support specific projects on an ongoing basis, like salaries and textbooks for Sunday School. But he wants his family to continue to have input in this project. What if in 20 years, the Masjid’s values changed, they closed down or went to serve another community? He would like the endowment to help another institution. Hassan can basically do this with a supporting organization. It is a public charity, but his family members get seats on the board of the supporting organization and continue to have input in the ongoing contributions on a continuous basis.
Foundation and equivalent given can be done in conjunction with some of the other strategies I mentioned above or on its own.
There is so much to this, but don’t forget your primary obligations.
There are many ways to structure gifts. You can gift income streams, parts of businesses, future interests, make bargain sales, and much more. However, in all of this, never forget your obligations.
I have seen instances where prominent people give large amounts to charitable causes in public ways, yet have children and close family members who are homeless. Some sorts of “charity” are not so much charitable as it is ego-feeding. Sometimes, “charity” is a way horrible people delude themselves and the rest of the world into showing how good they are. In Islam, gifts are not valid if they are intended to injure family members, including their future inheritance.
Islam gives Muslims obligations. These include not cutting family ties and the Islamic Rules of Inheritance. Don’t ever do any charitable gift planning until you are sure you have fulfilled your obligations to the people closest to you. Also, if you are doing your Islamic Charitable planning primarily for the tax benefits, you are doing it wrong. To schedule a mini-consultation with Islamic Estate Planning Attorney Ahmed Shaikh, click here.