Most of us have seen the Salvation Army's red kettle in front of major retailers and heard the ringing of their bell as they request donations.
Whatever your reason for giving, it’s important to consider simple ways to make your existing donations go further. And the fact is, giving is most effective when it is planned in advance and coordinated with other areas of your financial life.
Failing to consider your options can cause gifts of cash - or giving with your checkbook - to unintentionally become the most expensive way to support your favorite charitable causes. A few simple changes would allow you to give those same dollars to the same organizations while creating tax benefits for both you and your chosen charity. In the end, more dollars should be available for everyone.
First, Do Your Research
Maximize your charitable impact by selecting reputable and transparent organizations. A qualified charity like the Salvation Army will have a 501(c)(3) status and a tax identification number indicating its status as a federally recognized non-profit organization.
Websites like Charity Navigator, Charity Watch, and Give Well offer unbiased, independent ratings and evaluations of charitable organizations. These sites can be useful in finding and vetting organizations to support and offer important insights into how donated money is distributed.
If you’re considering making a sizeable donation, it may be helpful to speak directly with the chosen charity to discuss how the gift will be utilized.
The Old Way of Giving - Tracking Each Donation
Give to others when and how you decide. Giving is a personal decision, as we shared here: We Make A Life In What We Give.
The U.S. government encourages charitable giving by offering a tax deduction for qualifying charitable gifts. To qualify, a few conditions must be met.
Tracking: Each gift must be tracked throughout the year and reported in the next. The IRS will want to know a few important details such as the name of the charity, the gifted amount, and the date of your gift.
Reporting Evidence: Gifts may or may not come with accompanying evidence. If the charity does not have such a form handy (and some do not), you may be able to use other forms of proof including, receipts, credit or debit card statements, and bank statements.
Exceeding the Standard Deduction: After tracking and reporting each donation, one more hurdle appears: do your accumulated gifts (plus other itemized deductions) exceed the Standard Deduction? If not, although your charitable gifts are deductible, you might choose not to deduct your qualifying gifts.
With close to 90% of taxpayers taking the Standard Deduction, it appears likely that a vast amount of charitable giving is not being claimed as a tax deduction!
What is the standard deduction?
A portion of each person's income is not subjected to income taxes each year. This "freebie" portion of untaxed income is called your "Standard Deduction ". The 2022-year Standard Deduction is $25,900 for joint filers, $19,400 for heads of household, and $12,950 for single filers and those married filing separately.
Instead of accepting the Standard Deduction, some taxpayers choose to keep a list of individual deductions. These individual deductions are called "itemized deductions" and can include gifts to qualified charities, certain medical expenses, qualifying mortgage interest, a portion of state/local taxes, and other various items.
If you add all of your individual deductions up and they exceed your Standard Deduction, a lower tax bill could be yours by claiming your itemized deductions instead of claiming your Standard Deduction.
Charitable gifts are one popular itemized deduction. But, if your itemized deductions don't exceed your "freebie" Standard Deduction, you will likely take the Standard Deduction. Claiming the Standard Deduction requires you to ignore your itemized deductions, including itemized gifts to charity. To deduct the charitable gift would require itemizing, which would lead to a higher overall tax bill. That's how a vast amount of charitable giving is not being claimed as a tax deduction, even though it is tax deductible!
Note: You're required to fill out your tax return accurately; you're not required to pay the lowest tax bill possible. You can choose to claim an itemized deduction, even if it leads to a higher tax bill. Most taxpayers choose the result that leads to a lower tax bill without necessarily realizing the tradeoffs they are making, including the potential to ignore their itemized charitable gifts.
The New Way of Giving - Bunching Your Donations
Since the freebie "Standard Deduction" amount increases each year, including a doubling in 2018, donating to charity each and every year makes less sense from a tax perspective. In fact, for many taxpayers, it makes more tax-sense to donate every other year, or every few years in larger amounts (while donating nothing in other years).
To achieve the full tax benefit of charitable giving, one popular giving strategy is called “bunching.” With a bunching strategy, you would contribute multiple years’ worth of your charitable giving in one year. Bunching these gifts together in one year helps to surpass the itemization threshold. In off-years, you could then take the Standard Deduction.
Consider this example:
John, who files his taxes as single, donates $10,000 each year to a qualifying charity. In the past, his $10,000 donation has put him over the itemization threshold, and he has deducted the amount from his income as a charitable tax deduction. See "John's Old Strategy" below.
Starting in 2018, his $10,000 donation will no longer surpass the Standard Deduction, which was set at $12,000 in 2018 for single filers. However, if he “bunches” two years of donations into one year, he will be able to itemize and receive the full tax benefit of his charitable giving. See "John's New Strategy" below.
John's lowest tax bill comes from itemizing deductions in years he donates to charity, and taking the Standard Deduction in years he doesn't donate to charity.
This strategy works well in theory but can fail in real life.
Most people don't give large amounts to charity one year and none the next. Plus, the tax benefit of giving should be an extra bonus, not a rule that restricts your yearly giving.
Here is a better idea:
Supercharge your giving with a "Donor-Advised Fund"
Also known as a gift fund or as a giving account, a donor-advised fund allows you to support the same charities you do now, plus give freely to any charity in any year you choose. It also helps to ensure the full tax deductibility of your gifts.
Using your online access or by telephone, you direct gifts to charity in the same way you now use cash, check, or your credit card, but the money would come instead from your donor-advised fund. You have the remainder of your life to give those same funds to a qualifying charity.
No tracking, no additional reporting: Since the donor-advised fund provider shares evidence of your initial contribution with you, you'll have just one tax receipt to claim your full income tax deduction upfront in one year. You don't need to track nor report gifts from your donor-advised fund ever again.
Ease of Use: While you don't need to track or report gifts to the IRS, the account provider still keeps a history of your gifts. This can be useful for remembering the details of your favorite charity. It also allows you to give to specific charities again with the click of a button. You'll drastically reduce the time it takes to look up a charity's contact information or tax ID, and if you know one piece of information about the charity, most other details tend to be linked together.
Give Automatically: A donor-advised fund allows you to set up automatic recurring gifts on a monthly, or yearly basis.
Give Anonymously: Have you ever given to a charity and then felt stuck on their mailing list? A donor-advised fund allows you to give anonymously to any U.S. charity.
Potential for tax-free growth: The contribution to your donor-advised fund can be invested with the ability to grow for current or future charitable use. All growth would be tax-free.
Generational planning benefits: A beneficiary can be named for your donor-advised fund. You can name one charity or multiple charities to receive the funds in your absence. Or, you could name one or multiple people to distribute the funds in your absence. A human, non-charitable beneficiary is free to direct gifts to charity as they choose, or you could mention the historical giving record within your account, or you could add specific directions in your estate documents.
Estate planning benefits: Speaking of estate documents, although you control the donor-advised fund, the funds exist outside of and separate from your estate. This can be helpful for families concerned by the estate tax limit.
Lower costs: Open Window does not charge clients for assets held in a donor-advised fund, and although the donor-account-provider would (e.g., Fidelity, Vanguard, Schwab, etc.) our clients with donor-advised funds tend to see their total percentage costs decline.
Easily exceed the Standard Deduction with a donor-advised fund.
Continuing our example above, John “bunches” six years of donations into one year. He contributes $60,000 this year to his donor-advised fund. His $60,000 contribution far exceeds the itemization threshold, and he deducts the full $60,000 from his income as one itemized charitable tax deduction. He receives the full tax benefit of his charitable giving in that same year.* He then takes the "freebie" Standard Deduction every year thereafter.
*Subject to limits on his income. For example, deductions are limited to 30% or 50% of income before the excess charitable deduction is stored for use within the next five years.
John still has the remainder of his life to give the $60,000 to a qualifying charity, perhaps choosing to follow his previous plan of donating $10,000 yearly for the next six years.
Unlike his previous plans, he has the potential for a lower yearly tax bill by taking the higher Standard Deduction amount for the foreseeable future.
Unlike before, his donor-advised fund also can be invested and his $60,000 contribution has the potential to achieve tax-free growth.
Designate 10 Years Of Gifts
How do you consider how much money to contribute to a donor-advised fund?
It helps to answer that question with another question: On average, what is a good estimate of your yearly charitable giving?
In the example above, John already planned to give $10,000 each year to a qualifying charity. He was comfortable looking out for six years, so $60,000 was a logical contribution (6 years times $10,000 per year).
Instead, let's say that you tend to give $6,000 yearly to various qualified charities. However, you're not sure what the next few years will bring. Some years you might exceed $6,000, other years you might give less, especially if life changes. Using a working estimate of $6,000 yearly, we suggest designating or pre-funding charitable gifts for the next 10 years. So, consider designating $60,000 to your donor-advised fund (10 years times $6,000 per year).
Contribute appreciated securities to a Donor-Advised Fund
Continuing our example above, would you have $60,000 cash ready to contribute? Even if you did, consider if you have other assets that would be better candidates with which to achieve your $60,000 goal.
When we think of charitable giving, we tend to think of gifts of cash. However, donor-advised funds accept cash and other non-cash donations, including stocks, bonds, real estate, and even private business interests. Contributing non-cash assets that have been held for more than one year and that have grown - called “long-term appreciated assets” - can be a tax-savvy move.
Since selling an appreciated asset and then giving that same cash to charity can lead to a taxable event (and less after-tax money), it can be wiser to transfer the appreciated security itself directly to your donor-advised fund (or directly to the charity). By donating stocks or other appreciated assets, the capital gains tax bill disappears. Your donor-advised fund receives the full value of your gift, and you receive the full value of your charitable deduction.
Done correctly, the transfer also offers a way to rebalance back to your target investment objective without incurring taxes.
Consider the Fidelity Charitable example1 below of a potential donor holding $450,000 of appreciated securities. If they were to sell those securities, they would pay $35,700 in capital gains taxes. If instead, they donated the same securities to a donor-advised fund, the capital gains tax bill would disappear and the full $450,000 would be available for use in their donor-advised fund.
The Most Expensive Way To Give? With A Checkbook.
Failing to consider your charitable giving options can unintentionally cause gifts of cash - giving with your checkbook - to become the most expensive way to support your favorite charitable causes.
Without a giving strategy, you're likely adding the burden of tracking gifts and excessive tax reporting. You also increase the risk of missing an income tax deduction or the inability to fully deduct your tax-deductible gifts.
Part of your giving could be funded through the forgiveness of capital gains taxes; money that would have gone to taxes can instead go to your preferred charitable causes.
A donor-advised fund can also allow your pre-funded designated gifts to be invested with the potential for growth; potentially allowing your existing funds to go further and to do more.
If the money you're giving to charity isn't designated in advance and coordinated with other areas of your financial life we can likely help you give more - with less time and less effort - to the causes you care about. A few simple changes would allow you to give those same dollars to the same organizations while creating tax benefits for both you and your chosen charity.
If you’re not sure how your finances match up with your yearly giving strategy, now is the time to make your list and check it twice. Organization and planning are two keys to maximizing the impact of your gifts.
Whatever your situation, getting competent advice from a trusted professional - preferably a Fee-Only Fiduciary like Open Window - can help you enhance your charitable giving strategy. If charitable giving is an important part of your financial life, it’s important to make sure you’re getting the most value out of each donation.
Contact us any time at (775) 827-0670 and www.openwindowFS.com/connection.
- This assumes all realized gains are subject to the maximum federal long-term capital gains tax rate of 20% and the Medicare surtax of 3.8%, and that the donor originally planned to sell the stock and contribute the net proceeds (less the capital gains tax and Medicare surtax) to charity.
- Total Cost Basis of Shares is the amount of money you have invested in the shares of a particular fund or individual security. It represents the basic dollar amount that, when compared to the price at which you sell your shares, tells you how much of a capital gain or loss you have realized.
- This assumes all realized gains are subject to the maximum federal long-term capital gains tax rate of 20% and the Medicare surtax of 3.8%. This does not take into account state or local taxes, if any.
- Amount of the proposed donation is the fair market value of the appreciated securities held more than one year that you are considering to donate.