5 Charitable Giving Strategies to Give Back and Reduce Your Tax Liability
Charitable giving has gained a lot of steam in recent years as we look for ways to give back and find a few tax breaks along the way. When it comes to charitable giving, many make simple cash contributions. Still, there may be more strategic ways to give to your favorite causes, create a more significant impact, and reduce your tax liability even further.
To start, it is critical that all donations are made to a non-profit, 501(c)(3), to get the full tax benefits of these contributions. When it comes down to the gift itself, most charitable contribution strategies will only provide the largest tax benefits if you itemize deductions. Typically, this means you would need to give more than the standard deduction on an annual basis. Alternatively, you could have other deductions (in addition to your charitable donations) that add up to be greater than $12,950 for individuals or $25,900 for married filing jointly (the standard deduction). Additionally, there are significant estate tax benefits to charitable contributions that we will discuss, as well.
Here are the most common strategies around charitable giving:
Qualified Charitable Deductions (QCD)
Utilizing Qualified Charitable Deductions, or QCDs, is an often-overlooked strategy we frequently use with our clients. If you have saved significantly to retirement accounts and find that you have run into required minimum distributions (RMDs) which you do not need, you can give these directly to a charity through a QCD. Typically, an RMD would be fully taxable as ordinary income from every dollar taken out. By gifting these distributions directly to a charity, you allow the tax benefits of a charitable contribution to offset the income tax consequences of a distribution. The great thing about QCDs, and why this strategy is so helpful, is that it works whether you itemize or take the standard deduction.
I have a client that came to us a bit later in their retirement journey. They were 77 years old when we started working with them and had been forced to take distributions that were well over $100k/year and not needed for their lifestyle. On top of this, they were contributing about $70k/year to their favorite charity. We helped them see that by using QCDs, as opposed to cash contributions, they could allow themselves to donate the entire $100k/year to their favorite charity without any taxation PLUS contribute more for the same net impact, as these distributions were now tax-free. (And providing a much higher tax-equivalent value).
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Charitable Trusts (CLT and CRT)
Charitable Trusts allow you to minimize your estate and make charitable contributions to the organization of your choosing. The two types of trusts are Charitable Led Trust (CLT) and Charitable Remainder Trust (CRT). The difference is when the gift is made to the charity. For a CLT, the charity of your choosing will receive income from this asset until you pass away or a specified period. After this is satisfied, the remaining assets will transfer to a non-charitable beneficiary. For the CRT, you gift to a trust and a beneficiary receives the income from this asset until you pass away. Upon your passing, any funds remaining are sent to the charity you established.
Gifting appreciated assets
Gifting appreciated assets can create a HUGE tax benefit, especially after significant market appreciation, where we may be beneficiaries of a strong market. Rather than giving cash, you can explore gifting appreciated assets. Gifting these assets may allow you to avoid capital gains taxes on its appreciation while still receiving the charitable contribution benefits on the entire value at the time of the gift.
Think about it this way; if you were looking to give and had two assets, say $200k in cash and $200k in stock that had grown from an original investment of $20k, which would you rather give? Of course, the answer is a bit more complicated, but simply speaking, by giving the appreciated asset, you can avoid the tax on selling appreciated assets while still gifting the same value as you could with the cash balance.
Bunching charitable contributions
Bunching is a great strategy and is very commonly implemented, especially for those who may find their typical charitable contributions are below the standard deduction limits. Rather than giving a lower amount each year and not receiving any tax benefits, you can hold onto your donations and contribute a more significant amount less often. Overall, you may be making an equal contribution. Still, by bunching donations rather than spreading them out, if structured properly, you should be able to contribute in a way that allows you to also receive the tax benefits by itemizing these deductions in that particular year.
I have a client who has made annual gifts for over ten years. Since these contributions were spread out annually, the size of the “gift” did not suggest itemizing deductions, so they received a minimal tax benefit each year for these charitable contributions. We developed a strategy to allow them to bunch five years of gifts all at once to slow their annual contributions until the five-year period had ended. Bunching these gifts gave them the ability to itemize their taxes in this particular year, providing a much more significant tax benefit than the standard deduction while still allowing them to make the same impact on their favorite charity.
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Donor advised funds (DAFs)
Donor advised funds are charitable gifting accounts in which you do NOT have to specify the charity upfront. You can donate cash, stock, or many other assets to a donor advised fund, and these contributions will be deductible as charitable contributions for that year. You will experience tax-free growth on these funds as you figure out which organizations you may want to donate to, and then you can distribute (or grant) these funds to these charities when you are ready. It is critical to understand that any assets contributed to a donor advised fund are irrevocable. Irrevocable refers to the fact that once assets are given, the donor (you) cannot take assets back out of these funds. They must go to a qualified charity at some point.
Samantha Kennedy, an advisor on our team here at Mainsail, will sometimes suggest donor advised funds as a resource to clients looking to incorporate family into charitable giving. As an example, grandparents can “gift” children or grandchildren donations to a donor advised fund, and the child or grandchild can select a charity that they care about to be supported!
CARES Act Rule No Longer Applies
Unfortunately, the 2021 CARES Act rules are no longer available to donors. In 2021, the CARES Act allowed donors to deduct up to 100% of their AGI if they were to itemize deductions. This year, in 2022, the tax breaks have returned to a maximum percentage of AGI, depending on the type of gift with itemized deductions. For those taking the standard deduction, after the changes revert in 2022 and onwards, you will no longer recognize tax benefits for charitable giving.
If you have been able to put yourself in a position to give back, you likely feel very strongly about the organizations you would like to support. Gifting is a great way to make an impact on these organizations. You may even want to consider a combination of these strategies. For those looking to donate, utilizing QCDs, bunching, or a combination of methods can help to make the most of your contributions. With a bit of planning, you may not only be able to give more with the same net distribution from your assets but also help your long-term tax bill significantly by using one or more of the above strategies.
To chat about each of these strategies in more detail and learn about how they may benefit your specific situation, please schedule a call with a member of our team.