No matter where you are on your financial journey, charitable planning and giving are a win-win for all involved. Charities thrive on the time spent and dollars donated from individuals and families like you and yours. Although this is the primary purpose for charitable giving, families, and individuals can achieve many philanthropic goals while benefiting from the significant tax advantages that are available for those with a giving heart.
Given the ever-evolving and changing tax code, understanding the variety of ways in which you can achieve your philanthropic goals while still getting a tax benefit is the first step in building out your charitable giving strategy. While many folks write a check every year to their favorite charities, there are many situations and circumstances in which it makes sense to take a deeper look at strategies in which you can impact your bottom line and still fulfill your philanthropic passions.
Donating Cash Directly to Charity
Prior to the Tax Cuts and Jobs Act that was passed in December of 2017, a larger portion (around 30%) of the population, itemized their deductions rather than taking the standard deduction. Since charitable donations are an itemized item, more folks were able to tap into this tax benefit. However, since the Tax Cuts and Jobs Act became law, it is now estimated that only around 10% of the population will actually itemize versus taking the standard deduction. The reason for this is twofold. First, the standard deduction amount is much higher now. Second, miscellaneous itemized deductions were removed and there are have been caps put in place for certain itemized deductions like state, local, real estate, and property taxes, essentially making it more difficult to itemize versus taking the standard deduction.
What is one to do if they want to maintain the tax benefit of charitable donations but may not be able to itemize? If every year, you donate a certain dollar amount or percentage of your income, you could bunch multiple years together into one instead of spreading them out. This will bump up the dollar amount to itemize in any given year which may push you over the threshold of the standard deduction
Example: A married couple files jointly and normally makes a $10,000 charitable donation every year. On top of that, they have another $15,100 of itemized deductions. This totals up to a $25,100 itemized deduction which is the same amount as the standard deduction for 2021. Essentially, no benefit is had since the standard deduction happens regardless of the charitable donation. BUT, if they combine two years’ worth of donations ($20,000 for 2021 and 2022) and bunched them into a combined donation, they will accumulate a larger itemized deduction of $35,100. This pushes them far above the $25,100 standard deduction. Then in 2022, they would take the standard deduction. In this example, the total deduction between the two years ($35,100 in 2021 + $25,100 in 2022) is greater than spreading out their charitable donations and only taking the standard deduction each year ($25,100 in 2021 + $25,100 in 2022).
Donating Non-Cash Assets
If you are a charitably minded investor who has some highly appreciated stock, there are opportunities to donate the stock (or other assets like it) directly to the charity and avoid paying capital gains tax.
Example: An investor purchased stock 15 years ago for $10,000 (the cost basis). It is now worth $100,000. She decides she wants to donate this stock to a charity. If she sold it and then donated it, she would be taxed on the appreciation at the capital gains tax rate and then only be able to donate the net amount. However, by donating the stock directly, the charity would receive the full value of the assets ($100,000) and she would avoid paying the capital gains tax on the appreciation. In addition, she gets the FULL $100,000 deduction whereas if she sold it first and then gave cash, the deduction would be equal to the net amount after taxes are paid. This is a win-win for both the charitably inclined investor and the charity.
Taking Advantage of Qualified Charitable Distributions (QCDs) from an IRA
Qualified Charitable Distributions are withdrawals from an IRA that are made directly to an eligible charity. The beauty of them is that any amount of a QCD (up to $100,000) made in any given year can count toward your RMD for that year and isn’t included in your taxable income. If you are one of the lucky folks who doesn’t need the entire RMD from your IRA, this might be a great option if you aren’t able to itemize your taxes due to the higher standard deduction.
One caveat to QCD’s; now that you can continue to make contributions to your IRA after age 70.5, if you decide to make a QCD in the same year that you make a pre-tax contribution, the contribution amount reduces the allowable QCD by the same amount.
Example: A 71-year-old contributes $10,000 to a traditional IRA and also donates $15,000 to a charity through a QCD. Because of the contribution, $10,000 of that QCD will be disallowed and will be counted as a regular distribution and therefore as taxable income. Only $5,000 would end up actually counting as a QCD.
For a QCD to work properly, the funds must be transferred directly from the IRA custodian to the eligible charity. The maximum amount that can be donated is $100,000 per person. That means a married couple could donate $100,000 each if they wanted.
Set Up a Donor Advised Fund
A donor-advised fund is like an investment account for the sole purpose of supporting charitable organizations you care about. They are generally an easy, cost-effective, and convenient way to get an upfront tax deduction. You can contribute cash, invested securities, or other assets to the fund. Over time, you can “advise” the fund to disburse assets to your designated charities. Choosing to give back this way can lead to a bigger impact on the charity since the investments have the opportunity to grow over time.
Donor-advised funds (DAF) are very easy to set up and have a lot of flexibility. You can open a DAF at most custodians like Schwab or Fidelity and you can contribute to them as frequently as you like. In addition, you have the flexibility to give to any qualified charity over time. Whenever a deposit is made into the account, the donor receives an immediate tax deduction without the pressure of selecting the charity right away.
Along with the upfront tax deduction from your contribution, there are additional estate planning benefits. Any assets contributed to a DAF leave the donor’s estate. This can help tremendously with overall estate planning and fulfilling one’s charitable planning goals.
Create a Charitable Lead Trust
For those who have philanthropic passions, are close to or beyond the lifetime exemption amount for estate tax to kick in, and still wish to give money to their heirs, a charitable lead trust may be a good solution. A charitable lead trust (CLT) is an irrevocable trust designed to provide financial support to one or more charities for a period of time. Once the term is up, the remaining assets eventually go to family members or other beneficiaries.
These types of trusts can be funded during your lifetime or they are created at death upon the direction of a will. Upon creation, the trust will make payments to a charity on a fixed schedule for the term of the trust. The payments to the charity can be set up as a fixed annuity payment or as a percentage of the trust. What may be surprising to some, is that there is not a required minimum or maximum payment each year to charities as long as they are made at least annually.
Create a Charitable Remainder Trust
A charitable remainder trust (the opposite of a charitable lead trust) is a tax-exempt irrevocable trust that is designed to reduce taxable income of individuals by dispersing income to the trust beneficiaries for a specified period of time and then donates the rest (the “remainder”) to a designated charity after the term is up. Basically, it means that you can exchange the ownership of assets to the trust but also receive income from the trust for a specified period of time. At the end of the term, you will have been able to achieve your charitable gift planning goals, generate income for yourself, and remove assets from your estate.
There are two main types of CRTs:
- Charitable Remainder Annuity Trusts (CRATs) distribute a fixed annuity each year. Does not allow for additional contributions after establishment.
- Charitable Remainder Uni-Trusts (CRUTs) distribute a fixed annual percentage based on the balance of the trust. Does allow for additional contributions after establishment.
No matter where you are on your financial journey, charitable planning should be part of any sound comprehensive financial plan for those with a charitable-minded heart. While anyone can give back, your overall financial plan may benefit from being more strategic about how you give. At ML&R Wealth Management, we can help you explore your options so that you maximize your giving while maximizing the tax benefits at the same time. Please contact us with additional questions about this topic or any other.