Charitable gifting is an honorable pursuit in and of itself. Changes in tax laws provide certain incentives which might also make certain gifting strategies more favorable to donors than others. In this article we offer four simple ways to maximize personal benefits while giving generously.
Whenever Possible, Give Appreciated Assets Instead of Cash
Most charitable gifts in the United States are made with cash, however most personal wealth is concentrated in less liquid assets like stocks and Exchange Traded Funds (“ETFs”). Gifting shares of appreciated assets like stock can both accomplish your charitable goals and be more tax-advantageous to you.
Let’s say you bought 100 shares of stock XYZ, Inc. 3 years ago and paid $50 per share. Now, suppose that those shares are trading at $100. You would currently have an unrealized long-term gain of $5,000. If you sell the XYZ shares and make a charitable gift with the cash proceeds, you will first have to “realize” the gain and pay capital gains tax. In this case that could mean losing as much as $1,150 of value to federal taxes ($5,000 long term gain x 23%) plus any state income tax due. This would reduce the net charitable gift from $10,000 to $8,850.
Instead, you could elect to gift XYZ shares directly to the charity of your choice; many charities maintain accounts at brokerages for the specific purpose of receiving these gifts. Provided that the charity is a 501c3 nonprofit organization, the organization would not be taxed on the gain when they sell the XYZ shares, and you would be credited with a $10,000 gift instead of $8,850.
If you prefer not to deplete your investment portfolio by $10,000 you could simply reimburse your portfolio with cash and buy shares of XYZ back.
Use a Donor Advised Fund to Simplify Charitable Gifts
Take a look at your most recent 1040 Schedule A. To how many organizations did you make gifts to during the year? If there are more than two or three, you might consider opening a Donor Advised Fund (“DAF”) to streamline your charitable gifting. How does a DAF work?
A DAF is an account owned by a sponsor which is itself a 501c3 non-profit organization, so any gifts you make to this account are tax-deductible. However, the sponsor allows you, the donor, to direct (technically advise them to make) gifts from this account to third parties, provided those, too, are 501c3 organizations.
When you make a gift to the DAF, you will receive a single gift receipt, which you can use if you itemize deductions. Then you can identify charities you want to support and direct / advise the DAF sponsor to distribute grants to these charities. This simplifies your tax record keeping process and because you don’t need to immediately make the grants from the DAF, it allows you to separate the need for tax-planning from the timing of gifts and pledges.
You can also make gifts of stock or other appreciated assets to a DAF, and many sponsors will help with complex gifting as well if you have real estate or shares in a closely held business which you choose to donate.
Front-load Charitable Gifts to Maximize Deductions
The 2018 Tax Cuts and Jobs Act (“TCJA”) made several important changes to how tax filers deduct allowable expenses. One change was received poorly by states with high income tax rates: the federal deductibility of state and local taxes (income, sales, property, and excise) was capped at $10,000. Another TCJA change raised the standard deduction initially from $6,500 to $12,000 for individual filers, and from $13,000 to $24,000 for joint filers. While raising the standard deduction lowered income taxes for many people, it also meant that the opportunity to itemize deductions became less prevalent: most taxpayers did not have total deductions greater than $12,000 ($24,000 joint), so the standard deduction was preferable.
However, the standard deduction is always available, so it acts like a deduction floor. One way to take advantage of this floor is to front-load charitable gifts in one year, itemize your deductions, then return to taking the standard deduction in the next year. Let’s look at an example of a single filer.
Suppose a single taxpayer had $8,000 of state and local taxes and intended to make $4,000 of charitable gifts. Under current limitations, this filer could deduct $13,850 using the standard deduction. Itemizing $12,000 of deductions wouldn’t make sense since it would be lower than the standard deduction. If the filer was able – perhaps through gifting appreciated property like in the example above – the taxpayer could make two years’ worth of charitable gifts this year ($4,000 x 2 = $8,000), which when combined with $8,000 of state and local taxes would equal $16,000. In this case, itemizing would raise deductions by $2,150. The following year, the taxpayer wouldn’t make charitable gifts but since the standard deduction acts like a floor, no tax benefit was lost.
Use a Qualified Charitable Distribution to Lower Income Taxes in Retirement
During their working years, retirement savers enjoy the ability to save in a 401(k) or 403(b) plan on a pre-tax basis. Lowering your taxable income means lowering your tax payments. The IRS eventually wants their share, so at age 72 you must begin taking money out and paying income taxes on those distributions. The minimum amount you are required to withdraw is called your Required Minimum Distribution (“RMD”). For retirees who have high income tax payments, this extra income tax may be undesirable.
Beginning in 2006, retirees can eliminate or reduce these required income tax payments by electing to make Qualified Charitable Distributions (“QCDs”). Subject to a $100,000 annual limit, taxpayers subject to an RMD may instead direct those distributions to individual charities.
There are some key limitations. One is that unlike a normal charitable gift, QCDs are not tax deductible. This makes sense as the benefit of a QCD is not paying tax on an RMD. The other limitation to be aware of is that QCDs must be made directly to public charities, and not to DAFs, supporting organizations, or private foundations.
Past performance is no guarantee of future results. Investing involves risk, including possible loss of principal. Diversification may not protect against market risk or loss of principal. The opinions expressed above should be construed as neither investment advice nor a solicitation to buy or sell securities. Actual investor results may vary.
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