First, to be clear, it only makes sense to give money to a charity if you are passionate about their cause. As a kind of "thank-you", Congress and the IRS have built in some potential tax benefits for your donations, but only with careful planning can we realize these benefits. For example, let’s say you currently donate $10,000 annually to your favorite charity. Over the next 10 years, this will, of course, add up to $100,000 in total giving. Your generosity will make a big difference to this charity, but in this format, under current tax laws and without additional planning, you could potentially receive zero tax benefit. As mentioned, we give to charity to support the cause and not for the tax benefit, but if we can, we might as well get the tax benefit.
Using this scenario, depending on your situation, the strategies in this article could potentially save you $15,000 to $50,000+ over the course of ten years.1 Throughout the article, we are going to use this example of an individual giving $10k annually. If you give more than this amount, these strategies are even more powerful.
Under the Tax Cuts and Jobs Act (TCJA) passed in 2017, the standard deduction for a married couple filing jointly (MFJ) increased from $12,700 in 2017 to $24,000 in 2018 and for 2021 is all the way up to $25,100.2 This is before the additional deductions for being over the age of 65 and/or for being blind. Whereas before the TCJA, 31% of taxpayers were able to itemize, now only an estimated 11.5% of taxpayers are able to itemize deductions.3 This increase in the standard deduction means that most people are now unable to receive a tax benefit for their contributions.
With the Standard Deduction So High, What Options are Available?
Even with the standard deduction for MFJ taxpayers at $25,100 (or as much as $30,500 if both spouses are over the age of 65 and blind4), there are multiple options available for giving in a tax-efficient way. Here are some of our favorites:
Donor Advised Funds
Now commonly available with most custodians and without major hurdles of prohibitive minimum balances, this is a tool that many taxpayers can take advantage of. A donor advised fund allows a taxpayer to essentially make a commitment for multiple years of giving and take the deduction on their tax return all at once. The funds can still be invested at the taxpayer’s discretion and, just as importantly, given to charities of the taxpayer's choosing. This option still provides the taxpayer with flexibility on how and when the funds are distributed but maximizes the tax benefit all at once. For example, if a taxpayer typically gives $10,000 a year to charity, they are never getting a tax benefit from that donation. If, however they establish a donor advised fund and contribute 5 years of giving all at once, they would be able to deduct the entire $50,000 (assuming they had the required income to offset) and still be able to give $10,000 each year to their favorite charities. Just in this example, if we assume a 22% tax bracket, you may be able to achieve nearly $5,500 in tax savings that you would otherwise have completely missed out on ($50,000 contribution minus standard deduction of $25,100 multiplied by their marginal tax rate).
Qualified Charitable Distributions (QCDs)
QCDs are a fantastic way for taxpayers 70.5 or older (not 72, RMD age went up, but QCD age did not) to donate to charity because:
- They reduce adjusted gross income, not just taxable income
- They do not go on schedule A so there is a tax benefit regardless of the dollar amount
- They can reduce or completely offset a taxpayer’s RMD. (related article: Required Minimum Distributions (RMD): Rules: Key Things Every Retiree Should Know)
Like any tax planning strategy, we must be mindful of the details, but here is a high-level overview of the key issues to be aware of:
- Must be made by the end of the calendar year
- Only the portion that goes to supporting the organization counts, not the value of anything received in return - donate to the girl scouts, don't buy girl scout cookies.
- There must be cash in your IRA for the amount of the donation if you use an IRA checkbook. You can’t write checks from your AAPL stock (although you can gift stocks, more on that in the next section)
- The maximum annual exclusion for QCDs is $100,000. Any QCD in excess of the $100,000 exclusion limit is included in income as any other distribution. If you file a joint return, your spouse can also have a QCD and exclude up to $100,000.5
Giving Appreciated Assets to Charity
Taxpayers can potentially double up on their tax savings by making gifts of appreciated securities or real estate instead of giving cash. Instead of selling appreciated securities, paying capital gains tax on the proceeds that exceeded the original basis, and then gifting cash, a taxpayer can simply donate the security. In this situation, the taxpayer has avoided the capital gains tax (and the charity is not subject to it) and, if you are itemizing, also potentially reduce your ordinary income.
This strategy can also be used by donating real estate.
There are limitations on how much can be deducted in a single year. For appreciated securities, the deduction is capped between 20% and 50% of adjusted gross income, depending on the type of gift. However, the excess benefit can be carried forward up to 5 years (further reinforcing the value of doing multi-year tax planning).6 There is no limitation on how much capital gain income is avoided and therefore not subject to tax. The limitation is on how much the contribution can further reduce ordinary income. You will also be subject to annual gifting limits ($15,000 per person in 2021 and $16,000 in 2022).7 (related article: Tax Strategies for Retirees That You May Not Be Thinking About) The value of the gifted asset on the day of the transfer constitutes the amount of the gift.
This is a less sophisticated strategy, but it can still be impactful. The idea behind this strategy is to be intentional about the timing of making charitable contributions. If you consistently give to charity but are also consistently under or barely over the standard deduction threshold, a simple way to get a bigger tax benefit would be to make donations every other year instead of every year.
As an example, let’s take our previous example of an individual who donates $10,000 a year to charity but let’s also assume they have $15,000 in other itemized deductions from home mortgage interest and state and local taxes. In this situation, they have deductions totaling $25,000, just under the standard deduction, and none of those items are actually providing a tax benefit. If the individual simply donated $30,000 every other year, they would now be getting an extra tax benefit of $3,200 every other year ($15,000 over the standard deduction at a 22% tax rate).
You, of course, want to make sure that this still allows you to support the causes you care about in an effective way. Being aware that this strategy also potentially creates opportunities in years when a taxpayer has higher than expected deductions from areas like medical expenses. If you have a year with significant medical expenses that pushes you over the standard deduction anyway, it could be worth having a conversation about increasing planned charitable giving in that year as well.
Many small business owners will donate to charities through their businesses, classify the donation as a charitable contribution, and that contribution is passed through to the individual and is subject to all of the limitations and rules around charitable giving. There is a better way.
In many cases (nearly all with a little bit of effort), charitable giving through a business can be classified as Advertising expense instead of charitable giving and directly reduce the amount of taxable income generated by the business. This is not as simple as moving the amount from one line to another. You do need to make sure there is a valid business purpose for calling it advertising. This can be as simple as your name and logo appearing in a publication, mailing, brochure, pamphlet, or article that they send to their donors. Most organizations have something they put out in writing or online that they would be happy to put the name of your business on.
This is a win for the charity because they get to show that great local businesses support their cause, and it's, of course, a win for the taxpayer because it allows for a more tax-efficient way to give. Like QCDs, this has the added benefit of reducing adjusted gross income, not just taxable income, which is used in determining all sorts of thresholds on a taxpayer’s return (including whether they are subject to the net investment income tax).
Putting It All Together
This article is all about charitable giving, but always remember that tax planning strategies are not necessarily mutually exclusive. You may consider some combination of all these charitable giving options. Charitable giving can potentially bring down taxable income, but you may also want to consider whether there are opportunities to accelerate income into years where large charitable giving is happening.
And the reverse is true as well. If you are looking at the potential of accelerating income into a particular year (i.e., Roth conversions or Capital Gains harvesting), consider whether there is an opportunity for taking advantage of these charitable giving strategies in the same year to maximize the tax benefit.
- Assumes 15% to 35% ordinary income tax rates and up to 20% capital gains tax rates.
Neither Blake Wealth Management, RFG Advisory nor Private Client Services are engaged in the practice of law or accounting. Content in this article should not be construed as legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.