The pandemic and other disasters like the local floods in 2005 and 2011, Hurricane Katrina, 9-11, and more show how generous Americans can be. Most want to give regardless of the tax deduction- and yet the tax deduction can also make it more advantageous.
For 2021, we were able to claim a $300 charitable deduction for cash donations. That continues in 2022 – for those with a filing status of married filing joint, the amount will increase to $600. For all other filing statuses, the $300 amount will continue. What if you want a deduction for amounts over that? Given correctly, you can get a deduction for larger amounts.
For amounts over the above-the-line deductions of $300 and $600, or for non-cash contributions, you must be able to itemize. A single filer gets a standard deduction of $12,550; for a married filing joint status, that standard deduction amount is $25,100. Itemized deductions include mortgage interest and a maximum of $10,000 for income and property taxes along with charitable contributions. If your itemized deduction amount is greater than the standard deduction of $12,550 or $25,100, you can itemize and take those deductions.
One way to have enough to itemize and claim those charitable contributions is to take one year and put several years’ worth of charitable contributions into a donor-advised fund (DAF). You open a DAF with $10,000, $25,000, whatever amount you want, and claim that deduction in the current year. You can then distribute the funds over several years.
Consider, for example, that you usually give $3,000 a year to various charities. In 2021, you put $15,000 into a donor-advised fund. Your state income and property taxes are limited to $10,000. Adding in $6,500 of mortgage and home equity loan interest brings your total itemized deductions to $31,500. This exceeds your standard deduction of $25,100. This would allow you to get a tax deduction by itemizing on your tax return.
The $15,000 goes into a financial account registered as a DAF account. These funds can be invested into the stock market by opening an account where your other financial investments are located. Some banks will allow you to open this type of account and earn interest on the proceeds. Each time you want to contribute to a charity, you request that the institution send them a check. You can distribute over whatever period you want. You can choose whatever charities you want, continuously contributing to the same one or choosing a different one each time.
When you set up the DAF, you name a final charitable recipient. If there are any funds left in the account when you pass away, the balance would be distributed to that named recipient. You can change this recipient at any point before your death.
If you typically give your church $100 a week, that $5,200 may not currently be tax-deductible. What if you placed funds into a DAF instead of writing a check to the church once a quarter for $1,300? The church will get the same amount of funds. You would get a tax deduction when you put the funds into the DAF.
You can give that $1,300 quarterly to the church and give your annual $250 to WSKG, the $500 you give to your college alma mater and whomever else. The key – to get the charitable deduction means putting enough in the DAF upfront to exceed your standard deduction amount. Maybe you fund the DAF account every five years. You get the tax deduction in that 1st year and spend the funds for the next five years. The income earned in the DAF is not taxable to you, nor do you get a tax deduction for that income. You do get to distribute the earnings to the charity of your choice.
What if you do not have the cash to fund several years of charitable contributions? Consider funding the donor-advised fund with appreciated mutual funds, stocks, bonds, or other investments.
Consider, if you have 2,500 shares of IBM stock that you purchased over many years and are stuck with a very low-cost basis. You do not want to sell it and pay the tax on the appreciated gain. You could move 250 shares into a donor-advised fund. If on the day you move them into a DAF, the fair market value is $150 per share. Your tax deduction would be $37,500.
When you are ready to make a charitable contribution, a few shares would be sold, and the fund would donate to the charity of your choice. The dividends on the stocks would increase the available dollars in the DAF. If the stock price continues to increase, more funds are available to distribute to charities. The dividends and stock price increase would not be reportable as taxable income.
Another option for receiving a charitable donation by itemizing is funding a charitable remainder trust (CRT) or a charitable gift annuity (CGA). These accounts are set up directly with the charitable organization that you want to receive the donation. You place a dollar amount – either as cash or as securities into an account registered as a CRT or CGA. When you place the funds into the account, it is a tax-deductible contribution. With these options, you then receive income each year. The income that you receive is taxable when received. When you pass away, the remaining balance goes to the charity.
With a CGA, you will receive a fixed dollar amount based on your age and the value donated. Typically, the amount is around 5% of the donation. You can elect to defer payments until a later time, allowing for larger income payments or start receiving income immediately. If you do not need the income, you can elect to direct the income to someone else – a child, a grandchild, or anyone of your choosing.
With a CRT, you transfer assets to the charity of your choice. The charity retains the assets. They distribute the income from those assets to you, typically quarterly. When you pass away, the charity is free to use the assets as they wish. Because the income for the invested assets may vary, the income amount you receive can also vary.
One advantage of a CGA or CRT is that you can still receive income from the investment until you have passed away while getting the charitable deduction now. There is also the advantage of getting an asset out of your estate if you are concerned about estate taxes or potentially using all your assets for long-term care expenses. This could be an inheritance technique – allowing you to give income to a spendthrift child without providing them a lump sum. Instead, you would be giving them an annual income.
Another way to contribute to a charity and save tax dollars is using the qualified charitable distribution (QCD) rule. You must be over age 70 ½ to use the QCD. You can take any amount out of your IRA and have it sent directly to the charity of your choice. Whatever amount you take out of the IRA is not subject to income taxes. The maximum amount you can do as a QCD is $100,000 per year.
You can do a QCD with your required minimum distribution (RMD) from your IRA to avoid paying taxes on that amount. A QCD only works with IRAs. If you have funds in a 401(k), 403(b), or other types of employer retirement plan, you will need to move those funds to an IRA first to take advantage of the QCD option.
Take the example of having an RMD of $4,500. Each year you typically give five different charities $1,000 each. Instead of writing out checks for the $5,000, you direct your IRA custodian to send out the five checks. You have now met your RMD requirement and are not required to take anything more out of your IRA. You will get a 1099R at tax time for the $5,000. None of the $5,000 is taxable, and you should reflect a zero taxable amount. You have met your RMD requirement. Your cash flow will not change because you have the funds you usually would have sent to the charity to use. The adjusted gross income (AGI) on your tax return will not include the $5,000 distribution.
A lower AGI might save you even more taxes. It could reduce the amount of taxable Social Security. Maybe, allow you to claim a larger medical expense deduction. The amount of your Medicare premiums could be impacted if you are making an IRMA payment because of a higher AGI. It could allow you to qualify for other non-tax benefits like lower EPIC premiums, the enhanced STAR credit, and other income-based benefits.
Making charitable contributions can give you the satisfaction of helping an organization. Getting a tax deduction or reducing your taxable income can be a bonus if you are willing to go through some extra effort. Planning with Purpose can help set up donor-advised funds, a charitable gift annuity, a charitable remainder trust, or make sure that you correctly do a qualified charitable distribution. Contact us if you would like help.
