Understanding Tax-Efficient Options for Charitable Giving

Most of us give cash to the non-profits about which we are passionate. Fundraising appeals received from non-profits emphasize cash because it’s the easiest, most accessible, way to donate. There’s nothing wrong with giving cash. It makes sense for those who don’t have a larger investment portfolio or incomes high enough to create tax headaches. 

When you cross these thresholds, however, “cash is king” no longer holds true. In fact, for many people, cash is the most tax inefficient way to make a charitable donation.  

Let me explain:

Tax Implications of Cash Charitable Contributions 

When you give cash to a non-profit, you are eligible for a tax deduction of up to 60% of your adjusted gross income (AGI) for that year. If your AGI was $300,000 you could theoretically make a $180,000 cash charitable gift and reduce your AGI to $120,000 ($300,000-$180,000). 

But things aren’t that simple. While the above example holds true, the 2017 Tax Cuts and Jobs Act (TCJA) changed the landscape of itemized deductions such that many individuals and families won’t deduct charitable contributions at all. 

Specifically, the TCJA increased the standard deduction available to all taxpayers:

• In the 2022 tax filing year, single filers may claim a $12,950 standard deduction, while married couples filing jointly can claim a $25,900 standard deduction.

• This means that a married couple would need to have itemized deductions (including charitable donations, state/local taxes, medical expenses, mortgage interest up to $750,000, et cetera) of more than $25,900 to be able to itemize their taxes and realize a tax deduction from a cash charitable gift.

• This, combined with a $10,000 cap on the amount of state and local taxes that can be deducted, means that just over 10% of Americans are itemizing their taxes*, dropping from over 30% before the TCJA passed. 

To summarize: if you aren’t itemizing your taxes, you are getting no tax savings from making cash gifts to non-profits. 

Tax-Efficient Alternatives to Cash Charitable Gifts

For charitable contributions that won’t be eligible for a tax-deduction, donors can still find ways to realize a tax benefit. Below are several easy ways to maximize the tax-efficiency of your charitable gifts, regardless of how much you give.

Give stocks or bonds to charity as a tax-efficient alternative to cash donations

If you have stocks or mutual funds in your portfolio that have significantly increased in value since they were purchased, you have what the investment industry refers to as high “embedded capital gains.” This means that if you sold these positions, you would realize capital gains (the difference between the price at which you purchased an asset and the price you sell it for). These capital gains are taxable at the federal level, and possibly at the state level depending on where you live. 

Rather than selling these positions and realizing/paying taxes on capital gains, you can choose to donate them to the non-profit of your choice. Because non-profits are tax-exempt organizations, they can sell the positions upon receipt and will not have to pay taxes on the proceeds. As a bonus, donors who contribute stock to a non-profit and itemize their taxes will receive the double benefit of (1) avoiding capital gains tax and (2) receiving a deduction of up to 30% of their AGI for that year. 

Bunch annual giving through a Donor Advised Fund

Donors with more financial flexibility may choose to “bunch” several years worth of donations into a Donor Advised Fund. The benefit of bunching gifts is that it may allow you to make one larger gift, itemize your taxes, and take advantage of an AGI deduction in the year of the gift. Savvy donors will fund a DAF with appreciated stock or other non-cash assets to take advantage of both avoiding capital gains taxes and the AGI deduction. 

A Donor Advised Fund (DAF) is a giving vehicle that allows you to make a lump-sum contribution (and receive the associated tax deduction, if applicable) into the fund in year 1 but does not require any future timeline for gifting that initial contribution out to non-profits. For example:

• A donor may make a $200,000 gift to a DAF in 2022.

• That DAF is technically outside the donors control, but they have the ability to “advise” the sponsoring organization where they would like gifts to go.

• This donor gives the American Red Cross $20,000 annually. Rather than making that gift from cash or stock contributions for the next 10 years, those gifts will come out of the donor’s DAF.

• As a bonus, funds held in a DAF are invested in the market according to your own risk tolerance. If this donor experiences strong market performance, their initial $200,000 contribution may fund more than 10 years of giving at $20,000/year. 

Make Qualified Charitable Distributions (QCDs) from an IRA to give more tax-efficiently

For individuals with an IRA who are over 70½ one of the most tax efficient gifting options is distributing a portion of your IRA to a non-profit as a Qualified Charitable Distribution (QCD). These IRA distributions go directly to charitable partners and are not counted as income on your taxes. 

For individuals who have not yet started RMDs, QCDs reduce your IRA balance and lower your future Required Minimum Distributions (RMDs), decreasing your future expected tax burden. For individuals who are already taking RMDs but don’t require the full amount of their distribution, the amount of the QCD taken counts toward the total RMD requirement. 

QCD’s are limited to $100,000 per year and are one of the best giving options for individuals who have large IRA balances and do not need the full amount of their RMD to fund cash flow needs on an annual basis. 

Conclusion 

Giving back to charitable organizations is a key responsibility for wealthy individuals. While I believe that taxation is an essential part of a functioning democratic society, I also advise individuals and families to be aware of easy changes that can lower their tax bill and allow them to continue supporting non-profits at a level they find meaningful.  For help building a plan to give away larger sums of money in a way that aligns with your goals and vision for your financial future, Contact Katherine or schedule a call to build a strategy that works for you and your family.

*Source: https://smartasset.com/taxes/how-did-the-trump-tax-bill-affect-itemized-deductions-2021#