It’s an amazing feeling to give to those in need through organizations you are passionate about. Many donors assume that giving to a charity automatically gets them a tax deduction, but this is not always the case. If you’re looking to give and feel the tax benefits, choose a tax-efficient way to give. This blog gives a brief outline of how much donors can deduct on their tax return and outlines three giving methods to achieve a tax reduction.
How much of my charitable donations are deductible?
If you itemize deductions on your tax return, you can deduct charitable contributions made to qualified organizations. The sum of a year’s charitable donations are deductible up to the following ceilings:
- In 2022, cash donations can be deducted up to 60% of adjusted gross income (AGI)
- Long-term capital gain property (ex. highly appreciated stocks) can be deducted up to 30% of adjusted gross income (AGI)
If you give more than the applicable percentage of your AGI, these deductions can be carried-forward for five years. For example, if you gave 100% of your AGI this tax year, you can deduct up to 60% this year and deduct the leftover 40% over the next five tax years.
How do I make sure my donation reduces my taxes?
Here, we outline three ways to give that can lower your tax liability.
- Contribute to a donor advised fund (DAF)
- Give via qualified charitable distribution (QCD)
- Donate highly appreciated assets
Contribute to a Donor Advised Fund (DAF)
A donor advised fund (DAF) is an investment account that is bookmarked for charitable giving. Since this money is irrevocably designated for charity, contributions to this account are generally eligible for an immediate tax deduction for the donor. Funds in the DAF are invested, grow tax-free, and are eventually granted to a qualified charity.
For example, if a donor were to open a DAF and contribute $50,000, that amount would be eligible for a tax deduction this year, even if the funds were not yet granted from the DAF to a charity. Since $50,000 is higher than the standard deduction, this would allow the donor to use this below the line deduction to itemize deductions for this tax year. Once the DAF is opened, the donor can recommend funds directly to any qualified public charity when whenever they determine.
Is a donor advised fund right for me?
Donor advised funds are often used as a strategy to lower taxable income in an unusually high tax year. FAI advisors explore this strategy with clients who have an influx of income, like selling an investment property or having a larger-than-usual business distribution. For example, one client front-loaded five years of their regular church giving to their DAF and were able to use that entire donation to lower their taxable income for the year.
What are some other benefits of a donor advised fund?
Donor advised funds are a giving vehicle that makes it easier to donate non-cash assets. These assets include:
- Publicly traded stock and mutual funds
- Cryptocurrencies, such as Bitcoin
- Private equity interests
- Restricted stock
By giving to charity through a donor advised fund, donors have more flexibility in how they designate distributions to an organization. Some donors use DAFs to give to charity anonymously or in memory of a loved one. The DAF custodian (like Charles Schwab) can send grants to the charity from “Anonymous Donor” or “in honor of” a different person. Donor advised funds give the donor some of the control they would find in a private foundation, but do not require separate tax filing.
Keep in mind that DAF grants cannot be used for personal benefit to the donor, just like any tax-deductible donation. For example, donors can grant funds to a general scholarship fund, but cannot grant tuition for their child or grandchild.
Give via Qualified Charitable Distribution (QCD)
A Qualified Charitable Distribution (QCD) is a tax-free charitable donation that is directly transferred from an IRA to a qualified charity. Since IRA account holders over the age of 72 are required to take an annual Required Minimum Distribution (RMD) which is subject to ordinary income tax, QCDs can help reduce this income. When you choose to give through QCDs, these tax-free donations count towards the RMD for that year, which ultimately decreases taxable income for the year – an above the line deduction.
Here are more details to keep in mind.
- Account holders can begin making QCDs after the age of 70 ½.
- Up to $100,000 can be donated through QCDs per year, per person.
- While QCDs usually are donated from traditional IRAs, those with inactive SEP or SIMPLE IRAs can also participate.
QCD checks must be received and cashed by the charity before December 31st to count toward that tax year. While most charitable giving happens at the end of the year, FAI Wealth Management encourages clients to send out their QCD checks by the end of October. Since the postal service, charities, and banks can fall behind around year-end, it’s important to give extra time so QCD checks can be processed by December 31st.
How can FAI help me make a QCD?
The FAI team can coordinate gifting directly from your retirement account to your charity (or charities) of choice. We handle all the paperwork for annual donations – just let your advisor know the amount of money you want to give to each charitable organization by October 31st.
Donate Highly Appreciated Investments
While most donors write a check to their favorite charity, tax-savvy donors may choose to donate stock instead. When the value of stock has grown to much more than it was originally purchased for, it is considered a highly appreciated investment. When investors sell stocks that they have owned for more than a year, they must pay capital gains tax on the difference between the purchase price and the fair market value at the time of the sale. But when this stock is donated, the donor avoids capital gains tax, and the charity will never have to pay tax on those funds. With capital gains rates as high as 20%, donors could be giving 20% more by donating the stock directly to the charity instead of selling that stock and giving cash.
Which investments should I donate?
Here are a few strategies FAI considers when advising clients that want to donate investment assets.
- Give the most appreciated stock for the largest tax benefits (by avoiding the most capital gains).
- Donating can be an opportunity to examine a portfolio and bring it back into balance. Owning a large concentration of a single company is risky to any diversified portfolio. Investors often benefit from donating pieces of large positions that they may have inherited or earned through their employer.
- If the stock is in a loss position (i.e. worth less than the original purchase price), it is more beneficial for the investor to sell the stock and donate the cash directly. This allows the investor to take a loss on their tax return.
- While it is most common to give stock, donors can give a variety of highly appreciated investment assets. This includes bonds, mutual funds, and ETFs.
If you are interested in making a charitable donation that reduces your tax liability, a financial advisor can help. FAI’s financial advisors can evaluate your tax situation and determine how charitable giving can fit into your greater financial plan. Give us a call or reach out to your advisor to schedule a planning meeting today.
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