How the Government Can Subsidize your Charitable Giving
November 27, 2023- Charitable giving is part of the bedrock of society and a vital piece of the financial plan for anyone who is inclined to give. Many people who give regularly do so haphazardly throughout the year and then rush to develop a plan at year-end. This works well for some, but while year-end is the busy season of charitable giving, if you create a plan now, you can be more intentional in your giving all year long. Structuring how you give leads to giving in the most tax-efficient way possible, which in turn benefits both the charitable organizations and your financial goals.
What are Tax Efficient Ways to Give to Charity?
Bunching Charitable Contributions
The Tax Cuts & Jobs Act of 2017 significantly changed tax planning for charitable giving by increasing the standard deduction to nearly double what it had been previously. For many people, the standard deduction is now a better option than itemizing deductions. To plan around this, you might consider bunching your giving into every other year. This enables you to itemize in the years you double up on giving to get a tax benefit and take the standard deduction in the other years.
Example: Joe Smith gives $10K to charity annually and is a single filer in the 24% tax bracket. His itemized deductions total $16.35K, which is $2.5K higher than the standard deduction. In 2023, he hires a financial planner who introduces him to bunching contributions. For 2023, Joe gives his normal $10K to charity throughout the year, and then he gives an additional $10K in December, letting his charities know this is in lieu of giving during 2024. This increases his itemized deduction to $26.35K for 2023 and allows him to take the standard deduction of $14.6K in 2024, for a total of $40.95K of deductions over the two years compared to a total of $32.7K in deductions if he didn’t bunch give. This strategy gives Joe an additional $8.25K in tax deductions, saving him $1.98K in federal taxes.
Donor-Advised Fund
Many people would prefer to give to their favorite charity throughout the year every year rather than bunching their gifts every other year, while others may be able to fund several years of giving at one time. In both situations, a donor-advised fund could be a good solution. It allows you to give a large contribution to the donor-advised fund and take the tax deduction and then give to charities from that fund anytime in the future. This enables you to get the biggest tax benefit for your giving while still allowing you to give when you want to. This strategy works best if you have a large contribution to make (i.e., $50K or more), as account fees would make a smaller contribution not worth it.
Example: Jane and John Smith give $20K to charity annually and are joint filers in the 24% tax bracket. They have itemized deductions of $30K, which is $2.7K above the standard deduction. Jane’s company had a great year, and she is receiving a one-time bonus of $100K, which is pushing them into the 32% tax bracket. She does not expect to receive another bonus this large in the next few years. Following the advice of their financial planner, Jane and John decide to contribute the $100K from her bonus to a donor-advised fund, which will be their giving for five years. Over the next few years, they advise the fund to give $20K each year to the charities they choose. As a result of this strategy, their itemized deduction this year increases to $110K, bringing them back to the 24% tax bracket, and allows them to take the standard deduction of $29.2K for the following four years. This gives them total deductions over five years of $226.8K, compared to $150K if they had not implemented this giving strategy, and results in tax savings of approximately $24.8K.
Qualified Charitable Distributions (QCDs)
The most tax-efficient way to give for someone over 70.5 years old who has an IRA is through qualified charitable distributions. These are distributions directly from an IRA to a qualified charity and can be counted toward satisfying a required minimum distribution for the year. Instead of being an itemized deduction like a normal charitable contribution, QCDs are not included in taxable income, like most withdrawals from an IRA. This results in a lower adjusted gross income (AGI), which can impact other tax items like social security and Medicare. QCDs also don’t require itemized deductions, which means you can get the tax benefit of the charitable contribution while still taking the full standard deduction.
Example: Jenna Smith is a 72-year-old widow with a required minimum distribution of $20K, capital gains of $12K, social security income of $12K, charitable giving of $20K, and other itemized deductions of $5K. After meeting with her financial planner, Jenna starts giving $20K to charity through QCDs instead of cash. This allows her to reduce her AGI by $20K, making her social security income tax free, and allows her to take the standard deduction of $15.7K. In total, this reduces her taxable income to $0.
Appreciated Stock
One of the most tax-efficient ways to give is by giving appreciated stock. If you have stock that has large unrealized long-term gains in a taxable account, this is a great strategy. If you were to sell the stock, you would incur capital gains tax. Alternatively, giving that stock to a charity, who can then sell the stock without incurring any tax, avoids capital gains. You would then receive a tax deduction for the contribution equal to the fair market value of the stock at the time of the contribution. This is a great way to give away capital gains and free up the cash you would have given to charity to then reinvest.
Example: James Smith gives $50K to charity annually and is a single filer in the 35% tax bracket. James was an early investor in NVIDIA and has $50K worth of NVIDIA stock that he purchased 10 years ago for $400. If James sold his NVIDIA stock, he would pay federal long-term capital gains tax of $9.92K. After talking to his financial planner, James decided to give the NVIDIA stock to his favorite charity, who then sells the stock without having to pay capital gains tax. James then takes the $50K cash he would have given to charity and reinvests this in the stock market. Through this strategy, James has given away his capital gain, saving $9.92K in tax, while still giving $50K to charity.
Charitable giving is a personal decision. Whatever amount you decide to give, it is important to plan to do it in a way that reduces taxes, effectively having the government subsidize your giving.
Is it too early in the year to start planning? No. Now is a great time to develop a new plan or review your current plan. It is always a good idea to evaluate your personal situation with your financial planner or accountant based on your unique circumstances.
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Information presented is for educational purposes only and is not personalized investment, financial, legal, tax, or accounting advice. Nothing on this website should be interpreted to state or imply that past performance is an indication of future performance. All investments involve risk and unless otherwise stated are not guaranteed. Be sure to consult with tax, legal, accounting, and financial professionals about your specific situation before implementing any planning strategies. Investment Advisory Services offered through Timberchase Financial, LLC, a Registered Investment Adviser with the U.S. Securities & Exchange Commission. Registration does not imply a certain level of skill or training.