“Beep! Beep! Beep! December’s here! Little Blue Truck is full of cheer.” (Little Blue Truck’s Christmas)
Yes, December is here again, which means that our living room is littered with children’s Christmas books, which means that my brain is littered with lines from Little Blue Truck’s Christmas, How The Grinch Stole Christmas, and many others.
There is a common theme that runs through most of these books, and that is the theme of giving. Indeed, December is often referred to as the season of giving: not only because families and friends gather during the holidays to give presents, but also because of the tremendous surge of philanthropic support that tends to occur during the final month of the year. According to one study, roughly one third of all charitable giving takes place in December.
All of this charitable giving is wonderful, and the federal government recognizes that it is wonderful, which is why you are allowed to deduct these donations on your tax return. However, the rules are nuanced, and not all donations are treated the same from a tax standpoint.
With this in mind, let’s take a closer look at tax-savvy charitable giving. After all, it is better to give than to receive, and it’s even better to receive the maximum tax benefit when you give.
Two quick notes before we get started:
- Saving taxes should not be the primary motivation for charitable giving. I’m simply making the point that you might as well make the most of whatever tax-saving opportunities are available to you when you’ve already decided to give to causes and organizations you care about.
- The information in this article is not exhaustive. As I mentioned before, the tax laws that govern charitable deductions are complicated, and vary based on A) the type of property being donated, and B) the kind of organization/entity receiving the donation. If any of these strategies spark ideas, be sure to consult with your accountant.
“Lumping” Your Donations
To begin with, charitable contributions only offer a tax benefit if you itemize your deductions. If you take the standard deduction, you’re not saving any taxes by giving to charity (although this year, thanks to the CARES Act, the IRS will allow a married couple filing jointly to deduct up to $600 of charitable gifts even if they don’t itemize).
For those who take the standard deduction but still give to charity, one strategy that may provide a tax benefit is “lumping” your charitable donations (i.e. combining multiple years of charitable giving into a single tax year). Say, for example, a married couple gives $15,000 a year to charity – a sizeable amount, but not enough to push their itemized deductions above the standard deduction threshold ($25,100 in 2021). Assuming they have sufficient resources, they could “lump” two years’ worth of giving together this year ($30,000 total), itemize their deductions (reducing their taxable income by $4,900 more than if they had taken the standard deduction), and then take the standard deduction again in 2022 (which will have risen to $25,900). Going through this exercise every couple of years could save them thousands of dollars in income taxes, while achieving the same charitable giving goals.
Another situation in which “lumping” can be beneficial is if your earnings are exceptionally high in a given year. Whether you’re selling a business, or you get a big bonus, or you’re about to retire and will soon enter a lower tax bracket, some years provide more compelling tax-savings opportunities than others. This year, thanks to the CARES Act, you are even allowed to deduct up to 100% of your AGI (subject to certain rules and restrictions), well above the typical 60% limitation, presenting a unique opportunity for certain taxpayers to take advantage of this “lumping” strategy.
Giving Low-Basis Stock
Believe it or not, there is one strategy that results in a double tax-savings. When you donate appreciated securities, you are allowed to deduct the fair market value (FMV) of the asset AND avoid paying capital gains tax on the earnings. What’s more, the charity won’t have to pay capital gains on the appreciation if they sell it, due to their tax-exempt status.
NOTE: This is only available for securities with long-term capital gains (i.e. the position has been held longer than 12 months). If you give a security with a short-term capital gain (i.e. the position has been held less than 12 months), your charitable deduction will be limited to the cost basis, which is nowhere near as advantageous.
For example, assume a taxpayer in the top (37%) marginal tax bracket makes a $100,000 charitable gift of stock that was originally purchased (more than 12 months ago) for $10,000. The chart below illustrates the twofold tax advantage of this strategy:
Many, though not all, charitable organizations have investment accounts that enable them to receive gifts of stock and other marketable securities, so be sure to confirm that this option is available first.
Qualified Charitable Distributions (QCDs)
QCDs are gifts made directly from an IRA account to a charity, and they are only available to taxpayers who are A) 72 or older, and B) have a Traditional IRA account. In other words, folks who are taking their Required Minimum Distributions (RMDs) on an annual basis.
Notice that I used the word “directly.” If you deposit the money in your checking account and then make the donation, it’s not a QCD. What’s the difference? A regular cash donation has to be treated as an itemized deduction, so if you don’t itemize, you’re not getting a tax benefit for the donation. However, a QCD simply doesn’t count toward your AGI. Thus, it offers a simple way to reduce your taxable income whether you itemize your deductions or not. The annual limit for QCDs is $100,000 per taxpayer, regardless of your RMD.
NOTE: If you do a QCD, make sure your financial advisor includes a note with the check so that the charity knows to send you a donation receipt for tax filing purposes.
Donor-Advised Funds (DAFs)
So far, I’ve addressed several methods of donating directly to charitable organizations. Another way to give involves establishing a charitable entity that receives your donation and then disburses the funds to the charitable organizations you wish to support. Broadly, these entities tend to fall into one of three categories:
- Private Foundations
- Charitable Trusts
- Donor-Advised Funds
In this article, I’m going to focus on DAFs, mostly because private foundations and charitable trusts are much more complicated and deserve their own separate articles. Furthermore, I would argue that DAFs make sense for a much, much larger segment of the population than the other options.
So, what is a DAF? Essentially, it is a “Private Foundation Lite.” You set up an account at a supporting tax-exempt organization, give your account a name (e.g. The Smith Family Charitable Fund), and fund it with cash or securities. Once the account is funded, you can invest the assets just as you would in your personal accounts, and whenever you want to, you can distribute money from the DAF to a charity of your choice.
With that being said, there are a few caveats. One is that, once you make a gift to a DAF, it is irrevocable; you can’t get it back. Another is that, once the DAF receives your gift, technically, you relinquish control to the DAF company. In practice, however, you and your financial advisor will still call the shots in terms of how the account is invested and how the funds are distributed.
In my experience, DAFs are a great solution for people who meet one or both of the following criteria:
- They want to make a significant gift to charity, but they don’t want the charity (or charities) to receive the gift all at once. Instead, they would like to get the upfront tax benefit of donating to the DAF, but spread the distributions to the charitable beneficiaries over multiple years.
- They want to create a lasting charitable legacy – perhaps one that their descendants can continue to steward across multiple generations. Since a DAF can be designed to last into perpetuity (its investments continue to grow even as it regularly distributes money to charity), it can serve as a powerful legacy vehicle for folks who want their hard-earned money to benefit the causes they care about for generations to come.
We’ve covered a lot of ground in this article, yet we’ve also only scratched the surface of charitable giving strategies. My main purpose is simply to illuminate a few, key tax-savings opportunities for you to consider (with the help of your accountant).
More importantly, I hope that you are reminded this season of the gifts that you’ve been given, the joy of giving, and the things in life worth giving your time and resources to.
And Now For Something Completely Different...
'Tis the season for incredible ski videos, too, and this one is pretty epic.