There are more than 1.5 million charitable organizations in the U.S. They are established for the public benefit and all the money they raise has to go towards achieving their aims such as relieving poverty, or advancing the arts, culture, heritage or science. We are a giving society. Americans gave over $400 billion to charity in 2018 with 75% of that amount coming from individuals. 30% of the adult population volunteer their time, talents and energy to religious, cultural, and educational organizations to make a difference.
The U.S. income and estate tax regulations have historically supported charitable contributions by providing tax reductions for contributions. However, because of recent changes to the tax code, many charitable contributions now have no impact on your income taxes or eventual estate taxes. While donors many times would have made the gift without a tax benefit, we believe it is valuable to try to organize your philanthropy in a manner that will provide a tax benefit, if possible. That either makes the gift a little easier to fund or perhaps encourages you to give a little more.
The Tax Cuts and Jobs Act of 2017 increased the standard deduction (up to $24,800 in 2020 for married couples). It also capped the state and local tax deduction at $10,000 if the taxpayers were itemizing deductions. The result is that 90% of taxpayers now use the standard deduction. Couples with total itemized deductions less than the standard deduction receive no tax benefit from their charitable contributions. In addition, the lifetime exemption on payment of estate and gift taxes was increased at the same time and is now $11.6 million per person ($23 million per couple). Fewer estates are taxable. And, those estates that provide a specific bequest or percentage bequest to charity, get no tax benefit from their philanthropy.
Fortunately, there are a number of strategies that can help you get more “tax bang from your charity buck.”
Donor Advised Funds (“DAFs”). For charitable gifts, this simple, tax-smart investment solution has become a real favorite, particularly starting in 2018. The concept of DAFs is that taxpayers can contribute to an investment account now and get a current deduction yet determine in the future where and when the money will go.
Taxpayers can get a benefit by “bunching” their contributions using a DAF. For example, if a couple made annual charitable contributions of $10,000 per year, they could contribute $40,000 to the DAF in 2020, e.g., and certainly, in that case, their itemized deductions would exceed the standard. The $40,000 would be used as their charity funding source over the next four years. In this manner, they would receive the full $40,000 tax deduction in 2020 for the contribution to the account, though they will not receive a deduction in the years after for the “grants” you advise to be made from this account.
Now, what’s really great about a DAF is that if long-term appreciated securities are contributed to the DAF, you won’t have to pay capital gains taxes on them and the full fair market value (not cost) qualifies as an itemized deduction, up to 30% of your AGI. Why use after tax dollars for charity, when you can use appreciated securities? And, after a big equity value increase in 2019, this is an excellent tax strategy for rebalancing your portfolio.
Within the DAF, your fund grows tax-free. You or your wealth manager can manage the funds. The funds are not part of your estate. However, you advise your custodian, such as Schwab, the timing and amounts of the charitable donations. In general, your recommendations as donor will be accepted unless the payment is being made to fulfill an existing legal pledge liability or in a circumstance where you would receive benefit or value from the charity, such as a dinner, greens fees, etc.
Many taxpayers are using the DAF as part of their long-term charitable giving and estate planning strategy. They annually transfer long-term appreciated securities and/or cash to a DAF, get a nice tax deduction, allow the funds to grow tax-free (unlike Foundations which are expensive to administer and have a 5% minimum distribution, there are no minimum distributions for DAFs), remove these assets from their estate and then, before or after their passing, the charities they support receive the benefits. Some even provide that, on their passing, the funds will not be given outright, but instead their children will become the account holder(s) and determine future grants to charities providing a legacy of giving.
Qualified Charitable Distributions (“QCDs”). A QCD is a direct transfer of funds from your IRA to a qualified charity. These payments count towards satisfying your required minimum distribution (“RMD”) for the year. You must be 70 ½ years or older, you can give up to $100,000 ($200,000 for couples) regardless of the RMD required and the funds must come out of your IRA by December 31. You don’t get a tax deduction, but you make charitable contributions with pre-tax dollars. Each dollar in QCDs reduces the taxable portion of your RMD, up to your full RMD amount. Distributions in excess of your RMD are not deductible, but they do allow you to fund your charitable goals with pre-tax dollars and reduce the income tax on those assets for you or your heirs in the future. The DAF restrictions as to fulfilling pledges or receiving a small benefit from the charity do not apply to QCDs.
QCDs can help keep your Medicare Part B premiums down.In 2020, the minimum monthly premium for Part B is $144.60. This premium applies to couples with joint adjusted gross income of $174,000 or less. Premiums go up for larger incomes; to $492 per month for Part B for those with income above $750,000. The use of QCDs reduces your gross income and thereby helps to keep your Medicare Part B premiums low.
For taxpayers 70 ½ or older, their annual charitable contributions generally should be QCDs and if their gifting exceeds their RMDs, they can either do QCDs up to $100,000 annually or, instead of QCDs, fund a DAF with long-term appreciated securities and bunch the contributions to maximize the tax deduction.
Conclusion. Every situation is different. Your goals, assets and legacy plans are uniquely yours. If charitable giving is a one of your goals, as it is for many of our clients, we encourage you to look at your overall planning and find ways to use the tax benefits available. Reducing your taxes has the long-term effect of either providing more money to your family and/or more money to charity. Regardless, your legacy is enhanced.
We are charitable givers, both with funds and volunteer work. We applaud other givers and want to help you. We are happy to give our time without charge to reviewing your specific details and helping you identify ways in which Uncle Sam can reward you for your charitable giving. Just give us a call. All discussions will be kept strictly confidential.