As the end of each year approaches, conversations with many of our wealth management clients turn to strategies for lowering their tax bill.
This type of tax planning often includes taking a look at their income, seeing if itemizing deductions could be a helpful strategy, and of course considering how charitable giving can make an impact—both on their favorite charities and on the donor’s tax return.
If you are considering making charitable gifts as the year draws to a close, there are several strategies to consider.
Common Forms of Charitable Gifting
Beyond the usual cash donation, which is simple, straightforward, and arguable the most common way to give to qualified charitable organizations, there are several other ways to make non-cash donations to lower your tax liability:
-
Publicly Traded Securities: Gifts of long-term appreciated stock receive a contribution at fair market value without realizing capital gain.
-
IRA Qualified Charitable Distributions (QCDs): IRA owners who are required to take Required Minimum Distributions (RMDs) may gift up to $100,000 per year to charity from IRA assets. This counts toward the RMD and is excluded from income.
-
Donor Advised Funds: These accounts allow donors to contribute cash, stock, and other assets for future distribution to charity. The charitable deduction is available upon contribution rather than ultimate distribution to charity.
-
Real Estate: Gifts of appreciated investment real estate held longer than one year generally follow the same rules as gifts of stock.
-
Personal Property: This can include collectibles such as art, stamp/coin collections, automobiles, boats, etc. The gift value is generally limited to the cost basis unless there is a related use by the charity.
-
Closely Held Business Interests: These may provide the ability to liquidate highly appreciated stock at a reduced tax cost, retain an income interest, and gift to family at a reduced estate tax cost while providing for charity.
-
Charitable Trusts and Other Planned Giving Methods: These include Charitable Remainder Trusts, Charitable Lead Trusts, Charitable Gift Annuities, and Pooled Income Funds.
Charitable Gifting Considerations for Donors
It may feel selfish to consider the potential tax savings the IRS will grant when a substantial charitable donation is made, but rest assured: even the most generous donors consider tax deductions an important consideration when strategizing on ways to make a positive impact on a non-profit organization in need.
The tax benefits from charitable gifting can be significant, but the rules to ensure a full charitable contribution deduction can be complex. Let’s cover a few of the key considerations to plan for with your financial advisor or wealth manager:
Ability to Itemize Deductions
Taxpayers can choose between claiming the standard deduction or itemizing deductions. The standard deduction is a predetermined amount based on tax filing status and is indexed annually for inflation.
Itemizing deductions allows taxpayers to deduct certain payments when the total exceeds the standard deduction. Common itemized deductions include state and local taxes, mortgage interest, and charitable contributions.
The Tax Cuts and Jobs Act, effective beginning in 2018, nearly doubled the standard deduction for most taxpayers. Since itemized charitable deductions will only reduce income taxes if the deduction amount, combined with other itemized deductions such as state taxes and/or mortgage interest paid, exceeds the standard deduction amount, this means that some generous donors do not receive an additional tax benefit from their charitable giving.
Donor advised funds can be a powerful tool to enable “bunch” charitable giving into a single tax year and maximize the deductible value while still maintaining the preferred charitable distributions cadence to the ultimate charity.
Value of Charitable Deduction
When a charitable gift is made, the deduction is generally based on either the fair market value or the cost basis (if lower) of the assets.
When the assets have appreciated, a fair market value deduction can be particularly valuable since the donor is not required to recognize the unrealized gain. Fair market value deductions typically apply, but are not limited to, the following asset types:
-
Cash
-
Long-term, appreciated public company stock
-
Long-term, appreciated private company stock to a public charity
-
Real estate
-
Art, if charity will use in a related-use
For other asset types, the deduction will be based on the lower of the cost basis or its fair market value. These asset types generally include:
-
Short-term stock (either public or private)
-
Long-term, appreciated private company stock to a private foundation
-
Art, if charity will not use in a related-use
-
Most other tangible personal property including auto, boats, household goods, etc.
It is imperative for donors to understand the value of the deduction before the gift is made to avoid unpleasant surprises.
Adjusted Gross Income (AGI) Deduction Limitations
Donors are generally unable to offset all of their taxable income with charitable gifts; rather they are subject to limitations based on their Adjusted Gross Income (AGI). These limitations vary depending on the type of asset gifted and the recipient of the charitable gift.
For example, cash gifts to public charities are currently subject to a 60% AGI limitation, while gifts of long-term appreciated stock to a public charity are subject to a 30% AGI limitation.
If a taxpayer’s gifts exceed this adjusted gross income limitation in any given year, a five-year carryforward is available so that the disallowed deduction may be used to offset income in future years.
Again, gifting to a donor advised fund during high income years can be a powerful tactic to both maximize the value of a charitable deduction as well as the amount of the deduction.
For example, often an employee may find themself with a high income in the year of retirement due to restricted stock vestings, payouts from deferred retirement plans and other bonus features of their compensation package.
For those who are charitably inclined, establishing and funding a donor advised fund in that retirement year can be a strategic tool to fund future charitable gifting while taking advantage of the current higher tax rate and adjusted gross income threshold.
Estate Tax Considerations
In addition to providing an income tax benefit, high-net-worth donors can also utilize charitable gifts to reduce estate tax due to the gift and estate tax charitable deduction.
Donors can include charitable gifts in their will or trust document to be made at death, or they can accelerate the gift to receive enhanced income and estate tax benefits.
Another strategy to consider is utilizing charitable trusts to provide for both a retained interest for themselves and their family as well as providing for charity and still receiving a tax benefit.
Substantiating Charitable Contributions
Both donors and charitable organizations must understand their responsibilities in substantiating gifts. Donors must obtain a written acknowledgment from the charitable organization before filing their tax return for the year of contribution.
The acknowledgment must include the name of the organization, the amount of a cash contribution, a description of non-cash contributions, and a statement regarding any goods or services provided in return for the contribution.
Final Thoughts
Charitable gifting is a powerful tool for donors to support causes they care about while also benefiting from tax advantages. By understanding the various considerations and best practices, both donors and charitable organizations can maximize the impact of their charitable contributions.
If you work for a charitable organization, there are several best practice to consider when it comes to receiving donations and managing funds. Our Institutional Asset Management team is ready to help.
