By Justin Haschke, CPA/PFS™, CFP®
Owner/President, Wealth Advisor
If you’re like your fellow Americans, you probably have a generous spirit toward the organizations and causes you care about. In 2021, Americans gave $484.85 billion to charitable entities—a 4% increase from the year prior. The majority of those gifts came from individuals. And despite inflation worries and higher interest rates, 2022 will likely be a repeat.
The last three months of the year are the perfect time to think about year-end charitable giving. By this point in the year, you likely have a clear idea about your income and what strategies will allow you to give in the most tax efficient way. Even better, there’s still time to research the organizations you want to support.
That said, don’t wait until you’re heading out the door to your New Year’s Eve party to make your plan. There’s no time like the present.
Tax benefits of giving
They say that giving is its own reward, but it doesn’t hurt to get some tax relief for your generosity too. With the right tax planning, charitable giving has the potential to reduce your tax burden in three ways: income, capital gains and estate.
Income tax. If you itemize your deductions, you can deduct up to 60% of your adjusted gross income (AGI).
Capital gains tax. Instead of selling your securities and donating cash, it’s possible to donate securities directly to your favorite charity and avoid getting taxed on your capital gains. Gifting highly appreciated stock allows you to claim the deduction at the current fair market value, even though you may have paid a much lower amount to acquire the asset.
For example, if you paid $10,000 for a stock 15 years ago, but today it’s worth $100,000, you can deduct the full $100,000 from your taxes. In addition, you won’t pay taxes on the gain. Assuming your federal long-term capital gains tax rate is 15%, that would amount to a $13,500 tax savings.
On caveat: deductions of stock are limited to 30% of your AGI (and only 20% if your gift is to a private foundation).
Estate tax. If you are charitably inclined, there are several ways to leave a charitable donation after your death, depending on your goals. For example, you can name a charity as a beneficiary of a highly appreciated asset, such as stocks or real estate. This will take that asset out of your estate. With a smaller estate, your heirs can reduce (or eliminate) the amount of estate tax they will owe.
Tax strategies to consider
While charitable deductions offer tax benefits, there is no one size fits all strategy that will make sense for every tax payer, every year. Your particular charitable giving strategy is a function of your income, giving goals, legacy planning and timing.
Here are some common strategies we recommend to our clients.
Bunching. Since the passage of the Tax and Jobs Act of 2017, the standard deduction nearly doubled, drastically reducing the number of taxpayers who itemize. In 2022, the standard deduction for a single taxpayer is $12,950 and $25,900 for married taxpayers filing jointly. At the same time, the new law increased the amount of charitable deductions that you can deduct from 50% of AGI to 60%.
But the law also capped state and local tax deductions at $10,000 for married couples. That means your other deductions must be worth more than $15,900 (for married couples filing jointly) to make itemizing worthwhile. As a result, smaller charitable deductions aren’t as valuable from a tax standpoint as they once were.
That’s why we recommend a bunching strategy. Let’s assume you intend to give your church regular contributions of $1,000 a month, or $12,000 a year. Instead of making that same gift each year, we would recommend you make several years’ worth of charitable contributions in a single year. This way you are able to gift the same amount you would otherwise, but you’ll get a bigger tax deduction in the first year.
Retirement income tax planning. Those who have reached the age when they must start taking the required minimum distribution from their retirement accounts (currently age 72), but want to minimize your tax income, can use their IRAs for charitable contributions as a way to do so.
Using a strategy known as a qualified charitable distribution, you can fund your charitable giving directly from your IRA, up to $100,000 a year, without recognizing the withdrawal as taxable income. In fact, each spouse can contribute up to $100,000 each year, allowing a couple to jointly give $200,000. This is a good strategy for people who have other sources of income that may have a lower tax rate, such as a Roth IRA or 401(k).
Similarly, people who are have inherited an IRA can use the account as a source for charitable contributions in order to minimize their tax liability. The contributed amount coming directly from the IRA does not need to be reported as taxable income.
Estate planning. There are a number of ways to make charitable giving part of your legacy planning. One strategy we like to use is a charitable remainder trust, which allows you to place highly appreciated stocks into the trust.
While you are alive, you can use any income generated by the asset. Upon your death the charity will receive the remaining principal. This gives you several tax benefits. For starters, you can deduct the value of the highly appreciated stock from your income tax. In addition, the asset won’t be part of your estate, thereby reducing the amount of estate tax that your heirs will owe.
Donor-advised funds offer flexibility
Many of the strategies we have talked about above can be even more effective when using a donor-advised fund, or DAF, an account that is set up for the sole purpose of making charitable contributions to qualifying public charities. You can donate cash, publicly traded stocks or stocks of private businesses to the DAF.
A DAF has other benefits too. Contributions to a DAF allow you to take an immediate income tax deduction. However, you do not need to distribute the funds immediately, making a DAF a great vehicle for the bunching strategy. If your charitable giving plans will span more than a few years, you can invest your donation, potentially growing the amount of money available for charitable giving. Best of all, you won’t be taxed on any of the gains because the money is no longer technically yours.
Finally, one of the biggest benefits of a DAF is the simplicity. Instead of writing checks to multiple charities and maintaining multiple records, you write just one check to the DAF and only have to keep track of that to get your deduction. What’s more, the DAF will only distribute your donations to a qualified 501(c)3 charity, so you can be assured that your donation is going to a legitimate organization and will qualify for a tax deduction.
Taxes should never drive your charitable giving. Your giving should always be a reflection of your values and your desire to make an impact. Nonetheless, charitable giving that’s tax efficient way lets you express your values while also reducing your tax burden—a win-win for both you and the causes you support.
This piece is not intended to provide specific legal, tax, or other professional advice. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.