Tax Management

How to Better Manage Taxes with Charitable Donations

Let’s be honest, paying taxes is not everyone’s favorite thing to do, but one strategy to minimize taxes afforded to us by the tax code is the deduction for charitable donations. In many cases, the tax deductibility of charitable donations was significantly reduced by the Tax Cut and Jobs Act of 2017 (TCJA) as the standard deduction was increased. In 2021, the most recent year the data is available, approximately 90% of filers elected the standard deduction – meaning if they donated to charity (cash or otherwise) they were unable to deduct this donation on their tax return. We’re going to review three different strategies that may be used in order for those charitably minded folks to save on their taxes. The first two are for those who are unable to itemize, and the final one is for those who may be on the cusp of itemizing or for whom a large tax is owed (say from the sale of long-held real estate or a business sale).

The first strategy is one we’ve touched on before – the qualified charitable distribution (QCD). As a refresher, a QCD is a distribution directly from an individual retirement account (IRA) (other than an active SEP or SIMPLE IRA) to a qualified charity. The tax laws allow for anyone who is age 70 ½ or older by the end of the year to make a QCD. For folks who are 73 or older, this distribution can help satisfy their required minimum distribution (RMD) requirement. The benefit for an individual is to exclude up to $105,000 (in 2024 and indexed for inflation in future years) from their gross income – and, for couples over 70 ½ who file jointly, this amount is effectively doubled, as each spouse can make a QCD from their respective IRA. The tax reporting for QCDs is a little complicated, as you’ll receive a 1099-R for the distributions, and the IRS requires you to also receive written acknowledgement of the donation from the charity (just as if you were itemizing).

The second strategy for those electing the standard deduction and wishing to donate to charity is to donate appreciated assets (stocks, bonds, crypto, etc.) to a qualified charity. In this donation scenario, you have assets worth substantially more than what you paid for them (your basis), and you have a charity in mind that is willing to accept this type of asset as a contribution. If you own stock worth $10,000 for which you paid only $1,000 and you wanted to donate $10,000 to a charity, you could sell the stock for $10,000 in cash and donate that $10,000 to a charity, but you will most likely owe tax on the gain ($9,000), and, effectively, you will have paid more than $10,000 to make that $10,000 donation. If instead you were able to donate that $10,000 stock directly to the charity, then you will have donated $10,000 to them and avoided the tax on the gain ($9,000) on the asset, making this a much more efficient means of donating to charity. One important item of note is the donation of cash is subject to a limit of 60% of adjusted gross income (AGI), and non-cash property is subject to a limit of 30% of AGI.

The last strategy to employ is often overlooked but highly effective for managing the tax liability on a substantial sale of asset(s) that results in large tax due in a given year – the donor-advised fund (DAF). For example, let’s assume you purchased a piece of real estate on which to build a warehouse many years ago and, with the recent run-up in real estate values, you are now in a position to reap a substantial profit. You have modest income and are typically not itemizing your deductions but have recently sold this property to generate a profit of $500,000. As a charitably minded individual, you may make modest donations annually and never reach a threshold for itemizing, but you can open and fund a DAF and receive an immediate tax deduction. The assets can be invested over a longer period of time, and donations can be made from the fund on a periodic basis to the charities you, the grantor, recommend to the fund. This large tax deduction can be an invaluable tool in mitigating the tax impact of a sale like this.

In conclusion, these are some examples of how people who are charitably minded can deploy these strategies, alone or in tandem to manage their taxable income in any given year. As always, it is imperative that you consult with your tax advisor alongside your financial advisor in order to make the most effective decision for your personal circumstances.