Summary/TL;DR
Being strategic with your charitable giving goals can save you a ton in taxes. Strategies such as donating highly appreciated stock, bunching two years’ worth of donations into a single year, opening a donor advised fund or charitable trust, and utilizing little-known IRA rules such as qualified charitable distributions can go a long way in making the most of your generosity.
Introduction
Many that have been fortunate enough to earn a lot of money or to have built a lot of wealth feel a desire to “give back”. Whether it be to their church, a private organization, or a public charity, a lifetime of charitable giving is a goal that many in America share. Fortunately, charitable giving can also present opportunities to save taxes as well. This post is devoted to exploring 5 strategies that can help you maximize the tax advantages that come with charitable giving.
1. Donate highly appreciated stock
When you donate to a charity, you don’t just have to give cash. You can also donate in the form of securities (stocks, bonds, funds, etc), and there are often large tax incentives to do so. Ordinarily, when you sell a security for a gain, you will pay capital gains taxes on that gain, which are commonly a flat 15% or 20%. For example, if you bought Apple stock for $10,000, and it has since grown to $50,000, you would pay capital gains taxes on the $40,000 in growth, which comes out to $6,000 assuming you’re taxed at the 15% rate.
However, if you instead donated this Apple stock to charity, then you wouldn’t have to pay the taxes! Furthermore, charities are tax-exempt organizations, meaning they can immediately sell your donation of Apple stock tax-free and use the funds as if you had just donated cash. And you don’t just avoid capital gains taxes, you also get a charitable deduction equal to the fair market value of your stock, in this case $40,000! If you’re in the 32% tax bracket, this is an additional tax savings of $12,800, for a total tax savings of $17,300!
Finally, let’s assume you didn’t want to get rid of your Apple stock. There’s nothing preventing you from selling other securities in your portfolio (presumably for less of a gain or no gain at all) or contributing more cash to your portfolio and immediately repurchasing Apple stock.
2. Charitable trusts
While rarely needed, charitable trusts can be exceptionally powerful tools when the circumstances fit. There are two main types of charitable trusts: charitable lead trusts (CLTs), and charitable remainder trusts (CRTs). Both involve funding the trust upfront and can be used to generate income for either yourself or a charity during your lifetime.
CLTs put the charity “in the lead”. In other words, you make a large donation to a CLT, and annual donations are made from the CLT to a charity (or charities) or your choice during a certain period (typically, the rest of your life). Once this time is reached, the remaining funds in the trust are paid to beneficiaries.
Things are flipped with a CRT. Instead of paying a charity income during your lifetime, the trust pays you, and the charity gets the remainder upon your death. Charitable remainder trusts are great planning tools for avoiding large income tax hits in a single year (such as upon the sale of a business), but still allow you to use your windfall for retirement income or lifetime gifts to family members.
Charitable trusts aren’t typically used unless there are opportunities to fund them upfront, generally in the form of transferring highly appreciated property to the trust. Such a strategy has the same tax benefits as donating to charity outright, but the trust structure allows you more control over the funds during or after your lifetime.
3. Donor advised funds
Think of a Donor Advised Fund (DAF) as a brokerage account for a charity. You contribute cash or highly appreciated securities to the DAF and invest the funds within the DAF into a mix of stocks, bonds, mutual funds, ETFs, etc. Depending on where the DAF is held, the type of property that can be donated to a DAF can be wide ranging. Many DAFs accept closely held stock, real estate, and personal property.
The greatest thing about DAFs is their flexibility. Your initial donation is deductible in the year you make it, but your actual donations can be made whenever you’d like. For example, if you encounter a large windfall and want to set some of it aside for charity, you can make a large donation to the DAF, realize the entire deduction today, and then make donations to charity from the DAF at your own discretion over the rest of your life.
Finally, DAFs are simple and easy to set up, administer, and operate. Unlike the trusts mentioned above, they accept contributions throughout their lifetime and don’t require an attorney to draft.
4. Bunching charitable contributions
This is one of my favorite strategies to teach new clients who give to charity. In short, “bunching” charitable contributions is nothing more than making two years’ worth of charitable donations in a single year, effectively doubling your charitable deduction every other year.
The reason that this is so powerful is because charitable donations are itemized deductions, so they must first, in combination with other itemized deductions, exceed the standard deduction before they help you on your taxes. For example, the standard deduction is currently about $30,000, which means that the first $30,000 of itemized deductions does nothing to reduce taxes. Every dollar of itemized deductions after $30,000, however, will reduce taxes by your marginal tax rate.
Therefore, by bunching charitable contributions, more of your itemized deductions will be applied above the threshold set by the standard deduction, meaning more of them will be used to reduce your taxes. In the year after you bunch, you can just take the standard deduction or, if your other itemized deductions exceed the standard deduction, claim them.
Finally, if you don’t like the idea of charities you support receiving your donations unevenly and would prefer to donate on an annual basis, then you can use this strategy in conjunction with a donor advised fund which was discussed above. Simply bunch your contributions to the DAF and distribute annually from there.
5. Qualified Charitable Distributions
Qualified charitable distributions (QCDs) are effectively a way to make a tax-free distribution from your Traditional IRA. They also, in essence, allow you to claim a charitable deduction without having to itemize your taxes.
A QCD is a distribution made from your IRA in the name of a charity. The IRA distribution must be made directly to the charity. It cannot go to a bank account or be distributed as a check in the name of an individual.
The only requirement for a QCD is that the IRA owner must be 70½ or older in age. Finally, QCDs cannot exceed $100,000 per IRA owner in a single year.
Conclusion
While any single one of these strategies can make a big difference around tax time, they are most powerful when used in conjunction with one another. Donating highly appreciated stock to a Donor Advised Fund and bunching these donations, for example, can be very powerful. And using qualified charitable distributions to keep gross income low can also help you avoid the dreaded social security tax torpedo!
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