By Matt Stephens, CFP®
What if you could continue to give the same amount to charity, but have more money at the end of the month? With efficient tax planning, you could.
Discover New Ways to Give
First, know that when planning your giving, the more intentional you are, the better. Donating to a charity can be personally fulfilling, but there are also tax benefits to be harnessed that financial planning can help you attain. For example, charitable giving is tax-deductible, but only if you itemize your deductions. We are able to deduct (or subtract) certain things from our income that we don't have to pay taxes on. These are called deductions.
Also written into the tax code is something called the standard deduction. This is a standard amount that every taxpayer can use to reduce taxable income, regardless of actual deductions. When you take the standard deduction, your charitable giving has no additional effect on your taxes. That being said, there are some creative ways to still make it count, so before simply writing a check to support your favorite charity, consider incorporating one of these giving strategies to maximize your generosity while reducing your tax bill.
Donor-Advised Funds (DAFs)
Donor-advised funds (DAF) are charitable giving programs that allow you to maximize the tax benefits of giving in a single year with the flexibility to support your favorite charities over time.
Contributions to a DAF provide a tax deduction in the current year, then the money is invested and granted out in the future. These programs allow you to contribute almost anything of value to them. Cash, stock and bond funds, crypto assets, real estate--you name it, you can probably donate it to a DAF and lower your tax bill. When the money leaves your account and arrives in the DAF, you get an immediate tax deduction for that year, but the donation can go to the charity at any point in the future.
Technically, you no longer have legal control over the assets but, you are still the decision-maker when it comes to how the funds are invested and when they are distributed to the charities you recommend. According to the legal setup of these accounts, the organization that holds your DAF isn’t required to follow your recommendation, but there’s an understanding that they will and I haven't seen any issues. The money can ultimately go to any 501(c)(3) organization that the donors want it to go.
The best way to utilize a DAF is with highly appreciated assets that have long term capital gains. When donating an asset that has risen in value, your deduction is for the full market value of the asset, not what you paid for it. This effectively eliminates any capital gains tax on that asset, which is more efficient than selling the asset, paying the capital gains tax, and donating cash. Utilizing a DAF in this way will reduce your lifetime tax burden and put more money in your pocket.
Qualified Charitable Distributions
Retirees love to hate required minimum distributions (RMDs)--especially when they don't need the money yet! Investors used to be required to remove a certain amount of money every year from their IRA accounts starting at age 70.5. That law changed in 2019 with the passage of the SECURE Act, pushing the RMD age back to 72. But, what if you still don't need that money for living expenses? If you are already giving to charity, and are over age 70.5, you can utilize something called a Qualified Charitable Distribution (QCD). This allows you to gift part (or all) of your RMD directly to a charity and pay no tax on the distribution.
This works particularly well if you take the standard deduction instead of itemizing. Most people take their RMD and then give money to charity from their bank account. They owe taxes on that income, but don't get any additional tax savings from the charitable gift because the standard deduction is so high. By doing a QCD instead and sending money directly to the charity from an IRA, that income satisfies the required minimum distribution, but never shows up on the tax return and is therefore never taxed.
Something to keep in mind when using this strategy is to make sure to tell your tax accountant how much was sent directly to charity from your IRA. The custodians (i.e. Fidelity, Schwab, etc.) don't itemize the IRA distributions, so you have to keep track of what is going where. Our clients can get a Charity Checkbook, which they can use to write checks to their favorite charities and helps us track the distributions to make sure they're getting full credit for the contributions.
When trying to itemize deductions instead of taking the standard deduction, the main categories include State and Local Taxes (like property tax), Mortgage Interest, and Charitable Contributions. Again, you can either take your actual deductions or the standard deduction, whichever is larger. Since the Tax Cuts and Jobs Act of 2017, something like 90% of taxpayers take the standard deduction.
For those who tithe on their full incomes or are otherwise charitably inclined, it's somewhat easier to get above the standard deduction. But, what if you're close, but don't quite have enough deductions? In that unfortunate situation, your charitable contributions simply aren't helping you reduce taxes. Deduction stacking can help. Here's the math.
For 2023, the standard deduction for a married couple is $27,700. Let's say your deductions add up to $24,000 ($10,000 of state and local taxes and $14,000 of charitable giving). If you add next year's charitable contributions to this year ("stacking" it on top of the deductions you already have), you'll end up with $10,000 + $14,000 + $14,000 or $38,000 worth of deductions and $10,300 less taxable income ($38,000 - $27,700 = $10,300). Next year, you'll still have the $27,700 standard deduction. Repeat this process every other year for ongoing tax savings.
But, what if your favorite charity is counting on consistent contributions every month? No problem. Let's bring the Donor Advised Fund back into the picture. By moving next year's contributions into a DAF (bonus if you use appreciated investments), you'll get the tax deduction all in this calendar year, but you won't have to grant the money back out to the charities until next year. Many of my clients who utilize this strategy continue giving every month, we're just navigating the tax code to their benefit.
Which Strategy Will You Use?
Everyone’s tax and charitable giving circumstances are unique, so rules of thumb and basic formulas just aren't effective. These strategies are complicated, so working with a financial advisor who understands the tax code and how it applies to you is important. If you have questions or want to discuss ways to save taxes with efficient charitable giving, our team at AdvicePoint would be happy to talk with you and review your specific situation. Schedule a 30-minute intro call here.
Matt Stephens is a financial advisor with AdvicePoint, a financial services firm based in Wilmington, North Carolina, specializing in retirement income planning, tax-reduction strategies, and charitable planning. Matt spends his days guiding clients as they make the leap from career to retirement. He loves simplifying complex financial issues and giving unbiased answers in plain English. His team goes beyond just professional investment management with their client-focused and high-touch approach, building plans as unique as each client.
Matt obtained degrees in Business Administration and Communication Studies from UNC-Wilmington, holds the Series 66 Investment Advisor and Insurance Licenses, Chartered Retirement Planning CounselorSM and CERTIFIED FINANCIAL PLANNERTM certifications, and was a recipient of the 2019 Wealth Management Thrive Award. Outside of work, Matt enjoys spending time with his wife, Brooke, and their two young children. They attend Port City Community Church, where Matt has volunteered since 1999. His favorite pastime is surfing. To learn more about Matt, connect with him on LinkedIn.