As we approach the end of 2020, many individuals and families are thinking about their year-end giving to help support their favorite charities and initiatives. 2020 has been a very challenging year, and many charities are in need of support now more than ever.
This article provides a general overview of three gifting strategies that can be used to help maximize charitable giving while potentially reducing taxes. Before selecting any specific strategy, it is important to first clearly identify your charitable intents and goals. Once your charitable goals have been identified, an appropriate strategy or combination of strategies can be designed to accomplish those goals in the most tax-efficient manner.
Please be aware that the following strategies, including gifts of appreciated assets, can involve complicated tax analysis and require advanced planning. This article is only intended to be a general overview of gifting strategies and is not intended to provide tax or legal guidance. Consult your tax, financial or legal advisor.
Strategy #1: Gifting Appreciated Securities
Gifting appreciated securities, such as stocks or mutual funds that have risen in value, can be one of the most tax advantageous strategies available to investors, especially those that itemize deductions. In addition to the itemized charitable deduction, donating appreciated securities avoids the capital gains tax on the gifted security as long as the security has been held for more than one year.
There are two tax benefits when gifting appreciated securities:
- Reduce taxable income due to the itemized charitable deduction
- Avoid capital gains tax on the donated security
Avoiding the capital gains tax on the donated security is a significant benefit as the current federal tax rate for long-term capital gains can be as high as 23.8% (20% Federal Capital Gains Tax + 3.8% Net Investment Income Tax).
The tax benefit only increases when considering any applicable state tax on capital gains. In a win-win situation, the charity also ultimately ends up receiving more proceeds than if the stock was sold and the net proceeds (gross proceeds less capital gain tax) were contributed to the charity.
This strategy is most beneficial when gifting assets that have appreciated in value and have been held for one year or longer. The security should be gifted directly to the charity (or a donor advised fund); do not sell the security and then gift the cash proceeds. Additionally, it is generally not appropriate to gift securities that are in a loss position.
The IRS does mandate some limitations. Deductions for appreciated securities are limited to up to 30% of adjusted gross income (AGI) in the year of the donation when gifted to a qualified public charity, with a five-year carry-forward for unused deductions.
Planning Note: This strategy is not always the right approach. Sometimes it is better to leave appreciated securities to heirs due to the step-up in basis that occurs at death (based on current tax law).
Strategy #2: Charitable Bunching and Donor Advised Funds
Charitable bunching is a multi-year strategy that can be used to increase tax savings. The basic premise of the bunching strategy is to maximize itemized deductions in the current year by accelerating multiple years of charitable giving into a single year.
For example, instead of giving $10,000 per year to charity, a family may accelerate five years of giving by donating $50,000 in the current year. This significantly increases itemized deductions and reduces the family’s tax liability in the current year. When used appropriately, this strategy can result in a greater tax savings over the entire “bunched” period, even if claiming the standard deduction in the remaining years.
This strategy may be especially attractive for:
- Taxpayers who have total itemized deductions that are very close to the standard deduction limit (either just below the limit and claiming the standard deduction or just above the limit and claiming itemized deductions)
- Charitably-minded taxpayers who have an unusually large income year and are looking for ways to offset income and reduce taxes
Donor Advised Funds (DAFs)
A common concern raised to the bunching strategy is that many donors prefer to give to their charities on a regular and recurring basis, rather than giving larger amounts on a much less frequent basis. Or perhaps the charities prefer to receive the gifts on an ongoing basis instead of receiving infrequent, lump sum contributions. Donor Advised Funds (DAFs) provide a great solution to this issue.
Due to their structure and benefits, DAFs are often used with the bunching strategy to capture the tax benefits of the bunching strategy while maintaining the flexibility to identify and spread charitable donations over time.
A DAF essentially serves as a holding tank (designated account) for charitable contributions. Donors claim a charitable deduction in the year they contribute to the DAF, but they are not required to name a specific charity at the time of the contribution. The funds remain in the DAF account until the donor directs a charitable distribution to a specific charity at some point in the future, which can be many years in the future if desired. While the funds are in the DAF, the donor normally has options concerning how the money is invested.
Planning Note: It may be appropriate and advantageous to combine charitable gifting strategies. For example, using the charitable bunching strategy to gift appreciated securities to a Donor Advised Fund can be an excellent tax-advantaged approach to help maximize your charitable goals.
Strategy #3: Qualified Charitable Distributions – Donate Directly to Charity From Your IRA
Individuals age 70 ½ or older can use Qualified Charitable Distributions (QCDs) to give directly to qualified charities out of their IRAs. While certain rules must be met, there are several benefits of using QCDs from your IRA to fund your charitable donations:
- QCDs can be counted towards satisfying the annual Required Minimum Distribution (RMD) from an IRA.
- The amount donated via the QCD is excluded from your income, which is unlike regular withdrawals from a traditional IRA. Not only does this help to lower taxes, but it potentially provides other cost savings and benefits related to Social Security and Medicare.
- Taxpayers do not have to itemize deductions to take advantage of the QCD strategy. This allows taxpayers who use the standard deduction to receive a tax benefit from their charitable giving.
This strategy may be especially attractive for:
- Individuals age 70 ½ or older who give to qualified charities but claim the standard deduction on their tax returns;
- Charitably minded donors who do not financially need their RMDs to fund living or other expenses; and
- Donors age 70 ½ or older who do not have other funding sources and must use their IRA for their charitable giving.
It is important to note that since the amount of the QCD is excluded from income, the taxpayer is not allowed to itemize a charitable deduction for the amount gifted via the QCD.
Planning notes for 2020:
- The SECURE Act recently changed the required starting age for RMDs from age 70 ½ to age 72 for individuals who reach age 70 ½ after December 31, 2019. However, QCDs can still be made from an IRA once age 70 ½ is reached, even if RMDs are not required until age 72.
- The CARES Act eliminated the requirement to take RMDs in 2020. While you are not required to take an IRA distribution in 2020, the QCD gifting strategy is still allowed this year.
Which Strategy is Right for You?
As you might expect, there is no one-size-fits-all approach to picking the best charitable giving strategy. Your unique goals and circumstances must be considered when evaluating how to best support your favorite charities. Our advisors and financial planners at Waverly Advisors are experienced in helping clients navigate the multiple aspects of charitable giving and are ready to assist you in developing a tax-efficient strategy to achieve your charitable goals.
You should not assume that any information provided serves as the receipt of, or as a substitute for, personalized investment advice from Waverly Advisors. This article reflects information available at the time it was written and should be used as reference only. Talk to your Waverly Advisors, or a professional advisor of your choosing, for the most current information or for guidance specific to your situation.