Making a Charitable Donation? Consider These Tax-Saving Strategies
Making a Charitable Donation? Consider These Tax-Saving Strategies
As we head into fall, when charities receive a majority of their annual donations, it’s time to strategically think about how you may choose to donate.
As donation requests arrive in your mailbox, many of us feverishly write checks to our preferred charities, non-profit organizations, or our alma mater.
Before you write that first check, take a moment to consider two important strategies: donating appreciated stock and Qualified Charitable Distributions. The first is available to anyone who owns appreciated investments held outside of IRAs. The second is available only to those who are age 70 1/2 or older.
Let’s begin with the first strategy, which is available to everyone regardless of age.
Strategy #1: Donating Shares vs. Cash
Any gain realized when selling shares of an investment held outside of an IRA is subject to capital gains taxes.
However, when you donate shares of these appreciated investments, as opposed to donating cash, you can potentially avoid these capital gains and potentially make a bigger charitable donation.
Essentially, instead of selling shares of an appreciated investment, paying the capital gains tax, and then donating the proceeds to charity, you can donate the shares directly to the charity prior to selling them.
Let’s walk through a quick fictitious example of someone who itemizes their deductions and is in the 32% federal tax bracket making a $10,000 donation.
Option One: Sell Your Shares and Donate the Proceeds
Let’s assume the investment you purchased years ago for $4,000 is now worth $10,000. If you sold it, $6,000 would be subject to capital gains tax.
At a combined federal and state capital gains tax rate of 25%, you would owe $1,500 in taxes, thus netting $8,500 after taxes.
If you then donated the $8,500 proceeds to charity, the charity would receive $8,500, and your federal income tax savings on your donation would be $2,720 (32% bracket).
Option Two: Donate Your Shares
As an alternative, if you donated the full market value of your shares to the charity directly, $10,000, your tax savings on your donation would be $3,200 (32% tax bracket), and the charity would receive $10,000 instead of $8,500.
Why does this work? Your charity of choice does not pay capital gains tax when they sell your shares because charities don’t pay taxes.
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Mechanics
The mechanics of this are relatively simple. There are two ways to donate stock:
Ask your charity of choice for their gifting instructions for donating securities (account custodian, account number, DTC number, etc.). Most sizable charitable organizations have brokerage accounts which receive charitable donations of shares of stock or mutual/exchange traded funds.
Provide these written instructions to your account custodian, i.e. Charles Schwab, and designate the security you wish to donate and the number of shares.
You would then receive a receipt indicating the fair market value of the donated shares to use for income tax return preparation.
The second way, is to donate appreciated shares to a charitable or donor-advised fund. Once you donate your appreciated shares to this separately designated fund, you qualify for the charitable deduction.
From there, the charitable fund typically sells your appreciated investment holdings, and you instruct the charitable fund custodian to make your desired donations. The account custodian sends a check directly to your charity(s) of choice.
The importance of this method is two-fold:
• First, it helps simplify the process because you only have to donate shares to one fund instead of multiple charities.
• The second key component is it allows you to combine charitable contributions you would have made in subsequent years into the current year, potentially qualifying you for a larger itemized deduction. The donor advised fund then allows you to make donations on your timetable. This is very important because of the larger $14,600 standard deduction most Americans have ($29,200 for those filing jointly) and $16,550/$32,300 for those over age 65 respectively, thus potentially eliminating the added tax benefits of making charitable donations because you would not have enough itemized deductions to surpass the standard deduction. Bunching your charitable donations into a single year could propel you over the standard deduction amount.
Strategy #2: Qualified Charitable Distributions
If you have charitable intentions and you have reached age 70 ½, take a close look at Qualified Charitable Distributions (QCD), i.e. making donations directly from your IRA.
There are two important tax concepts at work here.
RMD and QCD: Once you reach age 73 (formerly age 70 ½), the IRS mandates that you withdraw a certain amount from your IRA each year and pay income taxes on the amount withdrawn. This is known as a required minimum distribution.
As with Strategy #1, where most Americans write a check to a charity after they have paid capital gains in order to free up the cash, many also do so after paying taxes on their required minimum distributions.
With a qualified charitable distribution (QCD), you may make charitable donations directly from your IRA to the charity of your choice once you have reached age 70 ½, thus bypassing the multiple-step transaction of making your required IRA withdrawal, paying income taxes, making a charitable contribution with the net amount, and claiming a tax-deductible itemized charitable contribution.
** After the SECURE Act was passed, the Required Minimum Distribution age was increased to 73 or later depending on the year of your birth, but the age requirement for QCDs remains at 70 ½.
Itemized vs. Standard Deduction: If you already make charitable donations, what makes the QCD strategy so important is the change in tax law with the 2017 Tax Cuts and Jobs Act regarding itemized vs. standard deductions which roughly doubled the standard deduction.
Couple this with the itemized deduction limit for state and property taxes of $10,000, and it’s more likely that you are using the standard deduction because your itemized deductions may not exceed that $29,200 limit for married filers.
While this is generally good news because filing is much simpler, it may mean that your charitable donations offer you no greater tax benefits because charitable donations are considered itemized deductions.
The benefit of the QCD in this case is you may still receive the tax saving benefits from a charitable contribution even though you file using a standard deduction.
For example, if your itemized deductions, which include your charitable donations, total $29,000, you would file using the standard deduction of $29,200, assuming you file jointly and your charitable donations would not have provided any additional tax benefits.
However, if you donate directly from your IRA to the charity, you are able to receive a tax break even if you file using the standard deduction because the QCD offsets the RMD you are required to take by the IRS.
If your RMD for the year was $50,000 and you made a qualified charitable distribution of $5,000 from your IRA, you would only pay income taxes on $45,000 instead of $50,000.
To request a QCD, simply provide the your IRA custodian (i.e. Schwab, Fidelity, etc.) with the name of the charity and the amount you wish to donate, sign the appropriate form, and the custodian withdraws funds from your IRA and sends a check to you payable to the charity for you to present. Some custodians offer the ability to send QCD checks directly to the charity from your IRA.
Intentional and Strategic
The key with each of these strategies is to be intentional and strategic with everything you do financially, even when it comes to making charitable donations.
While making charitable donations is a noble thing to do, taking a few minutes to explore your options not only has the potential to increase your tax benefits, but the receiving organization can also reap more benefits.
If you would like to explore any of these strategies in greater detail as they relate to your own unique situation, please consult your financial professional.
Whether you’re thinking about switching financial advisors or are considering hiring one for the first time, download Savant’s Advisor Evaluation Checklist. This resource can help ensure the firm you pick fits your needs.
Source: IRS.gov
This is intended for informational purposes only. You should not assume that any discussion or information contained in this document serves as the receipt of, or as a substitute for, personalized investment advice from Savant.