Strategies For Charitable Giving

Many people look for ways of combining their desire to help the causes they believe in with their desire to save on taxes.  Getting a tax break for your generosity can make it even more gratifying, but it may take thinking about things a little differently going forward.

Tax laws affect your giving

Generally, if you itemize your deductions, making charitable contributions can decrease your tax bill.  With the tax laws passed in 2018, however, fewer people are expected to itemize going forward and will instead take the standard deduction ($12,000 for individual taxpayers and $24,000 for married filing jointly).

A primary factor in this decision is the limited $10,000 deduction for state and local income taxes (SALT).  If you live in a high tax region like the NY/NJ metropolitan area, then this limitation may affect you directly.  But if you live in a high tax region and still have a decent sized mortgage, then perhaps you are on the cusp of deciding whether to itemize or take the standard deduction.  After the $10,000 SALT deduction, you have a deduction gap of $2,000 ($12,000 minus $10,000 = $2,000) if your single and $14,000 ($24,000 minus $10,000 = $14,000) if you’re married before itemizing deductions becomes a viable option.

This is where your charitable giving can play a role.

Break the check habit?

Many people who contribute to charity on a regular basis have always written checks, so it’s considered the easiest way to go.  If your regular charitable giving by check will push your itemized deductions to exceed your standard deduction, then this will be helpful for lowering your taxes.

If it would take several years of your regular giving for this to be the case, however, then you could consider “bunching” your charitable contributions (making several years worth of contributions all in one tax year) in order to be able to itemize them and get a benefit for the current tax year.

This could be done by giving your bunched contribution to the charity(s) of your choice, or by using a Donor Advised Fund (DAF).  A DAF allows you to take the deduction for your charitable contribution in the current tax year, but spread out your specific gifts (grants) over a number of years.  DAFs are easy to set up with as little as $1,000 and are available through many sponsors (Fidelity, Schwab, Vanguard, etc.).

The new tax law allows you take a charitable deduction up to 60% of your adjusted gross income(AGI) for any cash you donate to either a charity or DAF.

When considering bunching charitable contributions with all the benefits of donating long-term appreciated securities, however, you may want to further reconsider your strategy.

Give 20% more for the same dollar amount contributed

After the long bull market we’ve been enjoying for the past several years, contributing long-term appreciated assets to charity can be a highly effective tax strategy for eliminating capital gains taxes and “bunching” charitable contributions, especially for people with investments that have increased significantly in value.

If you bought a stock for $20,000 years ago and today those shares are worth $50,000, you have a $30,000 unrealized gain.  Donating such appreciated shares not only will make for a significant charitable contribution, but will also eliminate $7,140 in long-term capital gains (and potentially Medicare surcharge taxes) that would be realized if you sold the stock.

The charitable recipient (be it the charity itself or a DAF you establish) will be able to sell the security without owing capital gains taxes and will receive the full market value of the security(s) you donate.  With capital gains rates at 20% for higher earners, and 23.8% for the highest, your giving can be more effective by donating, rather, than selling and donating, any long-term appreciated securities you own.

Realize a charitable deduction

Not only does a direct contribution of a long-term appreciated security enable you to offset the capital gains tax bill, it may also offer the additional benefit of increasing the size of your itemized deductions.

For taxpayers who itemize their deductions, you can claim the fair market value of the securities (most publicly traded securities) you donate as an itemized deduction on your federal tax return – up to 30% of  your adjusted gross income.  So, in addition to eliminating long-term capital gains taxes on appreciated securities you own, you also create a charitable income tax deduction at the same time.

If you are on the cusp of choosing the standard deduction ($12,000 for individual taxpayers and $24,000 for married taxpayers filing jointly) versus itemizing your deductions, then making charitable contributions could push you over the limit and be more effective in lowering your taxes.

Donate and Replace

Consider the following example:  Leslie is charitable and typically donates almost $5,000 per year toward various causes.  This is not enough to bring her itemized deductions above her standard deduction and so she’s faced with not getting any tax benefit for her charitable giving going forward or at least until 2026 when the current tax laws are scheduled to ‘sunset’.

Leslie also holds a portfolio of investments with substantial capital gains, thanks to the recent years’ bull market run.

To help work through her cumulative capital gains, Leslie makes a one-time $25,000 contribution to a donor-advised fund of her most appreciated investment: a stock fund that was originally purchased for just $10,000.  By making the $25,000 charitable contribution, she receives a $25,000 tax deduction, which is enough to push her itemized deductions well above her standard deduction, and her $15,000 embedded capital gain disappears entirely.

Over the next five years, Leslie then takes the $5,000 per year that she would have contributed to charity, and instead adds it back to her portfolio to replace the stock fund that was donated to the donor-advised fund in the first place.

At the same time, Leslie continues to make the $5,000 of annual charitable contributions she originally intended by making these from her DAF and the outcome is better for her tax wise than if she had just continued giving by check.

To the extent that the donor-advised fund grows — given these funds can remain invested and even managed by her current advisor in a DAF — she can perhaps end up covering six or seven years’ worth of her charitable giving.  And as she ultimately replaces the $25,000 or more of portfolio investments with new portfolio contributions, each of her incremental portfolio contributions will have a new higher cost basis set at the time that Leslie makes each investment, rather than retaining the much lower cost basis and big capital gain from her original investment years ago.

Offset the tax costs of Roth IRA conversions

Many investors consider converting traditional IRAs to Roth IRAs, which can create income taxes owed on any pretax IRA contributions that have been converted.

Converting in a year in which you can claim a large tax deduction, such as in a year where you are bunch your charitable deductions, can be helpful to offsetting conversion taxes.

Qualified IRA Charitable Distribution (“QCD”)

QCDs can be particularly helpful for taxpayers who are 70.5 years or older and do not itemize, but rather take the standard deduction on their tax return.  Taxpayers who take the standard deduction receive no tax benefit from charitable contributions.

A QCD is an IRA distribution that goes directly from your IRA custodian to a qualifying public charity.  A QCD is not considered income for tax purposes, but the withdrawal will count toward satisfying your IRA Required Minimum Distributions (RMD) for the year.  Even if you are already itemizing deductions, a QCD may still be helpful by limiting your adjusted gross income, which impacts tax rate, the imposition of Medicare surcharges or even how much of your social security benefit is subject to tax.

Most custodians will provide you with a checkbook for your IRA so that you can write checks (make QCDs) directly to the charity of your choice.

Reporting a QCD on your tax return is different, but routine.  With this and before undertaking any giving strategies, you should consult your legal, tax advisor or financial advisor.  But properly employed, each of these strategies represents a tax-advantaged way to make the most of your charitable giving under the new tax laws.

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