One of the best tax planning options you have is around charitable giving, yet most do not do it in an optimized way.
At its core, charitable giving should be about helping others not about taxes, but when you can combine the two there is no reason not to.
Most people do not benefit tax wise from giving to charity.
Why?
Because they take the standard deduction. The average person thinks that mortgage interest, charity, etc. benefit them tax wise, but they don’t unless you itemize your taxes. If all of your deductions total to be less than the standard deduction, then of course you are going to take the standard deduction. And for most people who do get above the standard, they barely benefit due to the standard deduction being so high today.
So how do you best benefit from charity moving forward?
There are 2 main strategies to consider:
1) Lumping charitable giving into 1 year
Lumping charitable giving into 1 year is all about maximizing deductions. Let’s say you are someone that gives $10k per year and most years before charity you are at about $18k in deductions (well below the standard deduction). This means if you keep doing what you are doing over 4 years you would just take the standard deduction each time and get a total of $116,800 in deductions.
However, if you start lumping charitable giving, you can become more tax efficient. This could look like year 1 instead of giving the $10k, you save the $10k. Then the next year in January you give all that $10k and you go back to giving monthly. This means you would give $0 in year 1, $20k in year 2, $0 in year 3, $20k in year 4. Here’s the impact:
This means you got $17,600 in added deductions. At the 37% tax bracket, you would save over $6,500 on taxes just by optimizing when you give.
2) Donor advised funds
Donor advised funds are charitable investment accounts. You can set them up a most major custodians like fidelity charity, schwab charity, etc. They allow you to give cash, stocks, crypto (or even part of your business) to the donor advised fund and get the charitable deduction in that year. You however, do not need to distribute to any charity at any time. You can wait as long as you want, you can grow the dollars, etc. This allows you to be able to give without knowing where or when you want to give. It is a pretty great tool.
You can combine lumping charitable giving and donor advised funds pretty well. In the example above, you could just do the $20k to a donor advised fund and then wait years till you want to distribute. You could even invest those funds and grow them
But… for most wealthy people, they should only be donating stock and here’s why. When you donate cash, you only get a deduction against your income, but when you donate stock you can avoid the capital gain and get a deduction against your income.
Let’s look at an example. Let’s say you are a high net worth individual and want to donate $50,000 this year to reduce your tax liability. You can either donate $50,000 of cash which assuming you are above the standard deduction would lead to $50,000 x .37% = $18,500 in tax savings.
Or the other option is you could donate stock.
Let’s say you have $50,000 of Apple stock that you bought for $10,000. With a donor advised fund, as long as you donate the stock first and it is at long term capital gains rates, you would get the $50,000 deduction against your income. But you also would avoid the $40,000 capital gain as well. This means you would save at least 23.8% (long term cap gains + Net investment tax) on the $40,000 capital gain = $9,250. Then you can buy back that stock with the cash you have and raise your cost basis.
By using the donor advised fund you get the deduction against you income AND the capital gains avoidance. This means you save an added $9,520 of taxes and get to raise your cost basis with that investment by buying it back with cash. Donor advised funds are one of the most powerful tools out there. We have a ton of clients at year end doing this to free up more room for Roth conversions as well since it lowers your taxable income and frees up more room in your bracket.
Year end is the best time to look at your investments and get ahead of your charitable giving when the stock market has performed well!
Hopefully this helps you understand how to optimize your charitable giving.
Financial Advisor