People look at philanthropy in different ways. Some people have very little interest in giving. Others are deeply devoted and have built foundations and structured their philanthropy such that their giving continues long beyond their lifetimes. Most of us, however, are somewhere in the middle. We give because we care, because we can, and because we are asked to. We give because we believe. We give modestly, but we give.
Giving typically comes with tax benefits. But the tax system has changed to where the benefit, reducing our taxable income, isn’t as easily accomplished as it once was. Of course, we don’t give just for the tax benefit, but we want to use the tax code to our advantage, particularly when we are doing something selfless like donating to a charity.
What has changed in the tax laws? The major culprit is the significant increase in the standard deduction. The single taxpayer needs itemized deductions in excess of $12,500—a joint filer, $25,100—to take advantage of itemizing deductions, and thereby including their charitable contributions as deductions. For most Americans real estate taxes (now capped with a SALT limitation), medical (another convoluted math problem), mortgage interest, and charitable contributions don’t exceed those figures. As such, most Americans don’t itemize.
So does this mean that we can’t get a tax benefit from our charitable contributions? A joint filer can still get up to $600 cash in deductions. But what about a $5,000 contribution? Well if you don’t do some planning with your CPA, the charity, and your financial planner, you might not get the benefit you could. This is why it’s so important to talk to your advisors, including the charity’s development officers.
A case study
So how can you take advantage of the standard deduction and still get a deduction for your charitable contribution?
Consider a husband and wife, retired, no mortgage, real estate taxes of $10,000 per year, and phased out from being able to deduct medical expenses. They give $5,000 annually to hospice. To make it worth their while to itemize and get the tax deduction for their contribution, they need more than $25,100 in deductions.
One option is to give the charity more than their usual annual contribution. A $20,000 contribution of cash or securities would give them a total of roughly $30,000 in itemized deductions and they could benefit by, roughly, a $5,000 reduction of taxable income.
But they might also use a donor advised fund (DAF) and bundle their contributions. They could contribute $50,000, for example, receive the full deduction above the standard for that year, then distribute $5,000 per year over the next ten years to hospice. They could also leverage their contribution by donating highly appreciated securities, like stocks or mutual funds, to the DAF, then sell them without incurring a tax obligation, and diversify the investment over time with the goal of growing and protecting the principal and extending the contribution. They could change charities if they wish, accelerating the donations one year, decreasing the amount the next, without affecting their deduction. Donor advised funds are easy to establish and can be done so through most custodians, such as Schwab.
Additional benefits
Your charitable deductions might also lower your tax bracket and allow you to take portfolio gains at lower tax rates. They might allow for low enough tax rates to convert part or all of a traditional IRA to a ROTH, thus creating ongoing tax-free growth. You can also have your IRA required minimum distribution (RMD) paid directly to the charity, further driving down your tax bracket by eliminating the RMD amount you would otherwise have to claim as ordinary income.
Other options include charitable lead trusts and charitable remainder trusts. Either provides for the deduction, and allows you to liquidate appreciated stock and create a stream of income either to the charity or to yourself.
So if you are charitably inclined, write the check, donate the stock, and do all the good you can—but also find the best way to donate and generate a tax deduction. A quick conversation with a planner, your CPA, or a development officer at your charity can help you make a difference and avoid paying unnecessary taxes.
IMPORTANT DISCLOSURES
The information included in this document is for general, informational purposes only. It does not contain any investment advice and does not address any individual facts and circumstances. As such, it cannot be relied on as providing any investment advice. If you would like investment advice regarding your specific facts and circumstances, please contact a qualified financial advisor.
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