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Americans are notoriously generous when it comes to charitable giving. According to Giving USA, Americans gave $484.85 billion to charity in 2021, a 4% increase from 2020.1 The end of the year is the most popular time to give to charity, with 30% of annual giving occurring in the month of December, and a full 10% of donations made during the last three days of the year.2
If, like many Americans, you’re planning on making a charitable donation before the end of the year, it’s important to be aware of the following.
Cash isn’t always the most efficient option.
If you’re used to writing a check each year to your favorite charity, you may want to reconsider. Contributing appreciated securities, such as stocks, bonds or mutual funds, can be a great way to both maximize your donation and lower your tax liabilities for the year. Consider the following example.
Jan decides to donate a $2,000 appreciated stock holding to her favorite charity. Her cost basis on the stock is $400. If she sells the stock for $2,000 before donating it, she will owe capital gains taxes on $1,600. Assuming a 15% capital gains rate, Jan would owe $240 in taxes following the sale, leaving her with $1,760 to donate to the charity. She would then be eligible for a charitable deduction of $1,760, assuming she itemizes deductions on her return.
On the other hand, if Jan were to transfer the appreciated stock in kind to the organization, she would avoid triggering a taxable event, and the charity would receive the entire value of the stock ($2,000). Because charitable organizations are tax-exempt, the charity could then sell the stock without triggering a taxable event. As a result, Jan can claim a charitable deduction of $2,000 on her itemized tax return, and the charity receives the full market value of the stock (also $2,000). That’s a win-win for both Jan and her charity.
You may not want to give every year.
Following tax law changes that went into effect as part of the 2017 Tax Cuts and Jobs Act (TCJA), fewer taxpayers now have an incentive to itemize. And, because you must itemize in order to claim a charitable deduction, fewer individuals are eligible to receive end-of-year tax benefits for donating to charity.
So, how can you reap the benefits of donating to charity if you don’t currently itemize? One option is to use a bunching strategy. Instead of making a charitable donation every year, it may make sense to save up several years’ worth of donations and contribute them all at once.
For example, if you typically donate $4,000 per year to charities, it may make sense to instead “bunch up” those contributions and donate $20,000 every five years. The key is to make sure you donate an amount high enough that itemizing your taxes makes sense.
Your RMD can actually lower your tax liability for the year.
Many retirees dread taking required minimum distributions (RMDs) from their tax-deferred retirement accounts each year because RMDs are taxed as ordinary income. This increase in taxable income can cause you to fall into a higher tax bracket, increase your Medicare premiums and even increase the taxable amount of your Social Security income benefits.
However, if you’re a charitably minded individual over age 70 ½, you may be eligible to contribute up to $100,000 from your retirement account directly to a charity without increasing your taxable income. This type of distribution is called a qualified charitable distribution (QCD).
As with many gifting strategies, there are specific requirements you must follow to ensure your RMD donation qualifies as a QCD:
- A QCD can only be made by individuals age 70 ½ and older.
- The charity that receives the donation must be a 501(c)(3) organization and cannot be a private foundation, donor-advised fund or supporting organization.
- In order for the QCD to be applied toward the current year’s RMD, the funds must come from the tax-deferred retirement account before the RMD deadline (typically December 31). Because year-end is a busy time for processing requests, it’s best to contact your wealth advisor now to make sure this is completed in time.
- The distribution must be made payable directly to the organization from the retirement account’s trustee.
- Upon completing the QCD, it’s wise to obtain confirmation from the receiving organization of your donation. This documentation is necessary when filing your taxes in order to ensure the QCD is excluded from your taxable income on Form 1040.
You can make a charitable gift without designating an organization right away.
Ready to make a charitable donation but unsure what organization(s) you’d like to support? No problem. A donor-advised fund (DAF) is a great option for individuals seeking both tax benefits and control over future donations. A DAF is a 501(c)(3) charitable fund that can receive irrevocable charitable gifts from you (as the donor), and you retain control over both the timing of distributions and the organizations to which donations are made.
One of the main benefits of establishing a DAF is that you can make a single large contribution of cash, stock or other assets to the DAF and receive a federal income tax deduction in the current year while distributing assets to charities over several years. This practice can help save you from tax liabilities in high-income years, such as when you receive a large inheritance or bonus.
Another benefit is that the assets within the DAF can be invested and grow income tax-free within the account. This practice provides you with an opportunity to establish a charitable legacy for future generations of family members, as children and grandchildren can have a say in how assets are donated to various organizations.
As with most financial planning strategies, the charitable giving strategy that’s right for you depends on multiple factors, including your age, your current financial situation, your taxable income, your goals for the future, and more.
One of the best ways to maximize your charitable impact while lowering your tax liability is by working with a qualified wealth manager. But don’t worry, Creative Planning is here for you. If you’d like help with your charitable giving and tax planning strategies, schedule a call with a member of our team. We look forward to working with you.