As we approach year-end, many individuals will begin to think about taking the opportunity to give back to their communities and those in need through charitable giving. This also happens to coincide with the time it becomes necessary to finalize our tax plans for the year, which may include looking for every possible income deduction. Fortunately, there are several strategies that can help optimize our charitable giving in the most tax-efficient way. We’ve put together a list of the four strategies everyone should consider before making their gifting decisions.
1. Donate stock
This is a simple strategy that can make a big difference on your tax bill. Whatever dollar amount you had set aside to donate, instead of using cash, find a highly appreciated stock or fund and donate shares instead. You’ll get the same deduction benefit but with the added bonus that instead of needing to sell the stocks and deal with a big tax bill, you can donate them directly. These shares can then be sold by the receiving entity with no tax owed.
2. Make a qualified charitable distribution (QCD)
For those taking required minimum distributions (RMDs) out of their IRA, this is another easy way to give more effectively. In a standard RMD, the distribution is made in cash out of the IRA, which is immediately treated as income and thus subject to taxes owed. However, there’s the option to have your RMD made directly to a charitable organization (instead of taking a withdrawal payable to yourself). By doing this, it never shows up as income and therefore reduces your tax liability, even if you’re not itemizing.
3. “Bunch” your charitable gifts
While we don’t know what the standard deduction will be after the effects of the Tax Cuts and Jobs Acts sunset in 2025, we do know they’re historically high right now — $27,700 for a married couple filing jointly. At this level, only about 10% of filers are choosing to itemize each year. For those not itemizing, or those barely itemizing above the standard deduction, this strategy can help give you more bang for your buck. The idea is to “bunch” your charitable giving into larger donations every other year. This practice allows you to take the standard deduction one year while gifting nothing, then give a larger donation the next year, which will allow for itemization.
Example: John and Mary gift $30,000 each year and have no other deductions. Right now, their deductions look as follows:
Year 1: $30,000
Year 2: $30,000
However, if instead of giving $30,000 each year they save up and give $60,000 every other year, their taxable deductions become as below:
Year 1: $27,700 (standard deduction)
Year 2: $60,000
Over the course of two years, this simple strategy would have reduced their taxable income by $27,700 without them changing the amount they gave.
4. Create a donor-advised fund (DAF)
A DAF is a separate account earmarked for charitable giving that grows tax-free and can receive stock donations directly. The idea is very similar to our first strategy of giving stock directly, but with the added bonus of flexibility. If you have highly appreciated shares of stock and the charity you want to support CAN’T receive stock directly, you can simply create a DAF, donate the stock and get the same tax benefit — then immediately liquidate the position and donate the cash with no penalty. Another benefit of a DAF is that it can be invested similarly to any other account, but the growth is tax-free.
This strategy is great for an individual who wants to earmark a large chunk of assets for charitable giving but isn’t committed to giving it all away immediately. This person can move a big chunk or make regular contributions into the DAF and then let funds grow until they decide where/how much to gift.
As we approach year-end and contemplate giving back through charitable donations, optimizing your strategy can lead to more impactful and tax-efficient contributions. Whether it’s donating appreciated stock, making a QCD from your IRA, strategically “bunching” your gifts or establishing a DAF for added flexibility, these tactics can enhance the effectiveness of your charitable giving while minimizing your tax liability. Consider incorporating these approaches into your philanthropic endeavors to make a lasting difference in the lives of others while maximizing the benefits for yourself. Happy giving!