Have you stopped to think about how much you would like to give to charities this year? How about how much you would like to give over the course of your lifetime?
If donating a significant portion of your wealth is important to you, then it’s wise to make a plan now.
You should never give only to save taxes. But finding the most tax-efficient manner to give can allow you to give more over the course of your lifetime.
When does it make sense to do tax planning around charitable giving?
First, you should determine if you will receive a tax benefit from charitable giving. The new tax law doubled the standard deduction which means many Americans won’t receive tax benefits from giving any more. If you generally won’t receive a tax benefit, then it may make sense to wait until you will.
I wrote about stacking deductions in one year in order to itemize your tax deductions in *some* years and then taking the standard deduction in future years. For a lot of you – this is the best way to receive a tax benefit for charitable giving at lower levels of giving.
What are the best ways to give?
Well, let’s start with the worst way give: sending money to your favorite charity directly from your bank account. This method gives you the least tax benefits — you essentially end up with only a tax deduction.
Instead, gift assets inside a taxable brokerage account with capital gains. Here’s an example:
Let’s say you bought some Apple stock for $1,000 many years ago and it is now worth $5,000. If you gift the stock directly, you avoid paying tax on $4,000 of long-term capital gains. This saves you $600 in capital gains taxes. You also get a tax deduction for the full $5,000 value of the stock. This effectively realizes double tax benefits compared with $5,000 sent from your bank account which would not save you the additional $600 of capital gains tax.
Real estate or other types of property with high gains are also eligible to be donated but may require complex transfer provisions. Feel free to reach out with any property-related donation questions.
How can I transfer assets to my favorite charity?
The quick answer is, you shouldn’t do it directly to the charity. Not all charities are equipped to handle asset transfers outside of checks and it could make the time effort not worth the tax savings. Instead, you should open up a donor-advised fund at any local community foundation. This is like a checking account that you only use for charitable giving. The benefit is that you get a tax deduction whenever you put money into the account. However, you can keep the money inside of the account forever (or until you die). This makes it very easy to stack many years’ worth of charitable giving into the account in order to get a tax benefit now, and then distribute the money evenly over the next few years or in whatever manner you chose.
What about long-term charitable strategies?
A charitable trust is essentially a donor-advised fund that can hold investments. The key difference is that you can continue to grow the assets to eventually fund an even larger payout to your intended charity. All growth within the trust is tax-free. However, you do not receive any deduction for the growth that occurs inside the account. If your goal is to leave a large sum of money upon your death to select charities, then a charitable trust is likely the best way for you to achieve this.
What if I want to give all of my wealth to charity eventually?
You can utilize more complex trust structures to achieve this goal. For example, a charitable remainder trust gives you a partial tax deduction for assets now while you maintain the ability to receive income from the assets until your death. This strategy can give you a huge tax deduction while avoiding all capital gains on the donated assets and provide you with higher lifetime income than holding the assets outside of the trust. This can also help you diversify out of a concentrated position with a high tax cost. Charitable remainder trusts are complex and require an attorney to properly set up.
None of this applies to me because I don’t want to give THAT much
Well, the last option is actually the best option for most and that would be to wait to do your giving when you are 70 1/2+ years old and do it directly from your Traditional IRA using a Qualified Charitable Distribution (QCD). If you use the standard deduction for your taxes – you should absolutely use a QCD to do all of your charitable giving. The mechanics behind it are slightly complicated – but essentially a QCD counts as a Required Minimum Distribution (RMD) but doesn’t show up on your tax return as income at all. This is an above-the-line deduction which is the best type of tax deduction there is. If you had an RMD of $3,000 and you sent $3,000 using a QCD – you would show no IRA income on your tax return.
Note: you have to very careful here and communicate with your tax preparer the amount of your IRA distribution that was a QCD because the 1099-R issued will NOT give them that information. This is why it is always best to work with a financial planner that also does your taxes.
Any questions?
Contact us about developing a charitable giving strategy that is right for you. Taking advantage of tax incentives can help you give more over your lifetime and we are happy to explore all the options for your unique situation.