Although your primary goal in charitable giving is to help make the world a better place, keep in mind that being strategic in your giving may lead to a win-win situation for you and your favorite causes.
One obvious benefit for taxpayers who are able to itemize is that they can deduct charitable contributions. However, the current standard deduction ($12,550 for single and $25,100 for married/joint filers in 2021) limits the number of taxpayers who can itemize.
If you typically can’t itemize, consider “bunching” your charitable donations by giving the amount you planned to contribute over multiple years in a single year, which could allow you to itemize. For example, if you planned to give $3,000 per year over the next five years, you would give $15,000 this year and none over the next four. If you’re a single filer, this would allow you to itemize this year and get a larger deduction.
In addition, under the Coronavirus, Air, Relief, and Economic Security Act (CARES Act), a charitable deduction of up to $300 is allowed for 2021 for those who can’t itemize. And the adjusted gross income (AGI) limitation is waived, allowing you to offset more taxable income. These two items apply only to outright cash contributions to public charities and are not available for contributions to donor advised funds (DAFs) or other supporting organizations. Consult your tax advisor for additional information.
Avoid capital gains taxes
Giving can be as simple as donating cash at a charity’s website. But before you do that, think about different ways to donate that may have tax benefits. Consider this example involving a taxable account:1
Suppose you have $100,000 in a stock you paid $10,000 for several years ago (you must have held it longer than one year for this example). The IRS calls the $10,000 your “cost basis.” If you want to make a significant donation to a charity, you could:
- Sell the stock
- Pay long-term capital gains taxes of up to 20% plus the 3.8% net investment income tax on the $90,000 difference between the proceeds and your cost basis
- Donate what’s left to your favorite charity
On the other hand, you could simply give the stock directly to the charity. The charity is tax-exempt, so it could sell the stock without incurring capital gains tax and wind up having more than if you sold the stock yourself.
This table illustrates what we’re talking about:
|Sell stock and donate proceeds||Give stock directly to charity|
|Proceeds from stock sale||$100,000||$100,000|
|Capital gains tax @ 23.8% on $90,000 gain2||($21,420)||($0)|
|Net received by charity||$78,580||$100,000|
As you can see, not only would the charity receive a greater benefit if you simply donate the stock, but you also avoid a substantial tax amount.
When deciding to make a direct gift of stock or cash, be aware that your deduction may be limited by your income. The limitation is based on the type of organization and type of gift. If you’re looking to maximize your contributions, especially in 2021, consult your tax advisor, who can help determine whether these limitations apply and how to utilize your deduction, if it’s limited.
Help enhance your investment income
Suppose you hold in a taxable account a substantial amount of stock that’s paying you little or no dividends and you’re looking to generate current income. You could sell the stock, pay any capital gains taxes, and use what’s left to purchase other investments or make charitable gifts.
However, if you’d like to avoid capital gains taxes, one strategy to consider is a charitable remainder trust, or CRT.
After you establish a CRT, you can donate the stock that you have owned for longer than one year to the trust, which may give you a tax deduction for a portion of your contribution. The trustee can sell the stock without incurring capital gains taxes and purchase other investments. The trust will make distributions to you. Keep in mind, your annual payout will be taxable to you under the four-tier accounting rules for CRTs.
The annual payout you receive from the CRT (Charitable Remainder Unitrust) is based on a percentage you selected in your trust agreement (not less than 5%) of the annual fair market value for the trust. Your tax and legal advisors will help you with this calculation. Remember the larger your selected payout percentage, the less of a tax deduction you may receive for making the donation.
At your death or the completion of the trust's term, the trustee will distribute what's left in the CRT (the remainder) to the charity or charities you named in the trust document.
Although a CRT offers a number of advantages, there are costs involved. For example, you'll need to enlist an attorney to draw up the trust document, and depending on the trustee you choose, you may have to pay for the trustee's services.
So before you employ this strategy, review your charitable giving goals. If receiving an income payout is not primary among them, work with your tax advisor to calculate the income tax deduction you may receive from an outright charitable gift versus establishing a CRT to determine which strategy may be better for your situation. In today's low-interest-rate and tax environment, an outright gift may provide a better, simpler solution.
Look into donor advised funds
A DAF is a charitable giving vehicle sponsored by a public charity. It allows donors to give to IRS-qualified public charities over time but receive a tax benefit in the year in which the contribution to the DAF is made.
With a DAF, contributions, which are irrevocable and cannot be taken back, are placed into a fund account where they can be invested and potentially grow tax free. The donor, or a person or entity the donor appoints, may recommend grants from the account to any qualified public charity-even years into the future.
While a DAF can be useful with a bunching strategy, they are not considered qualifying charities for the $300 (single filers) or $600 (married filing jointly) above-the-line deduction or expanded AGI limit for cash contributions in 2021 under the CARES Act.
Consider a qualified charitable distribution
If you’re 70½ or older and have an IRA, think about a qualified charitable distribution (QCD), which:
- Lets you gift up to $100,000 per year from your IRA to qualifying charities
- Is a tax-free distribution (may fail the tax-free treatment if benefits [tickets, etc.] are received)
- You can take advantage of even if you don’t itemize2
- Requires you to make the payment directly from the IRA to a qualified charity
- Counts toward satisfying a required minimum distribution (RMD) without increasing taxable income
Although the SECURE Act changed the starting age at which RMDs must begin from 70½ to 72 for those turning 70½ after 2019, you may still want to consider a QCD, if you qualify, as well in years when you have to take an RMD and don't want its taxable income.
You should also be aware that DAFs, CRTs, charitable lead trusts, and other supporting organizations and private non-operating foundations, etc. are not considered qualifying charities under the QCD rules.
- Contact a financial advisor for more information about incorporating tax planning into your charitable giving.
- Work with your tax advisor to determine the strategy, or strategies, that may be right for you.
1 This example is for illustrative purposes only and does not reflect the performance of a specific investment. It assumes no events took place during the time you owned the stock that would affect your cost basis. It also assumes the donor is single with net taxable income of over $445,850.
2 With a QCD, you can still take the standard deduction if you don’t itemize. However, if you do itemize, no deduction is allowed since the distribution is not taxable.
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