A majority of Americans donate to charities, and many donate cash. However, using cash is the least tax-efficient method to make a gift. Here are three ways to enhance your giving.
If you have a brokerage account and own shares of appreciated stock or mutual funds in the account, transferring shares in-kind to the charity may be ideal. As long as the investment has been held for more than a year, you can deduct the shares’ full market value and avoid paying capital gains taxes. With capital gains being taxed as much as 23.8% federally plus state taxes, this can yield substantial savings from both the charitable deduction and avoiding capital gains taxes.
From an investment perspective, cherry-picking highly appreciated shares may also help you bring your portfolio back in balance while avoiding a tax bite. Or if you want to continue to hold the position, donate the shares, and then use cash to rebuy the position, established with a new and higher cost basis.
Rather than donating stock directly to a charity, you can instead establish and donate it to a donor-advised fund. There are several advantages. The first is operational ease. After establishment, using the fund is like using your bank’s online bill pay. You can set up recurring payments or send a one-off check to multiple charities in a matter of seconds. Contrast this with sending a transfer form for each charity each time you want to donate stock.
A distinct tax advantage the fund has over direct stock donations are related to bunching. The standard deduction is $24,800 in 2020 if married filing joint and higher if over age 65. This and the fact that no more than $10,000 in state, local, and property taxes (SALT) can be deducted causes many not to itemize.
Suppose you have $10,000 in SALT taxes and no other deductions. The next $14,800 of charitable deductions equals the standard deduction and thus no incremental tax benefit.
Instead, you could use a bunching strategy to donate enough stock to the fund to meet the next several years of your planned giving. You itemize in the year of the contribution and go back to the standard deduction next year. You still avoid capital gains taxes on the appreciation and can dole out the money from the fund over the following years. The initial contribution is an irrevocable gift, but as trustee of the fund, you control the distribution’s timing.
The bunching strategy can be particularly effective during the last few years of work when you may be in a higher tax bracket than your early retirement years.
Use IRA Money
If you are age 70 and a half or better, Qualified Charitable Distributions (QCDs) represent one of the most tax-efficient ways of giving to charity. QCDs allow IRA owners to transfer up to $100,000 per year from their IRA or inherited IRA accounts directly to charities with the QCD amount being excluded from income, despite being sent from your pre-tax IRA.
Since QCDs are excluded from income, there are a few distinct advantages. They do not have to be itemized and thus avoid the higher standard deduction issue. They also benefit from avoiding federal and state income taxes since most states do not allow charitable deductions.
The exclusion may allow you to avoid higher Medicare premiums, which start at $174,000 of adjusted gross income if married or $87,000 if single or married filing separately in 2020. And lastly, if your adjusted gross income is above $200,000, QCDs may help you avoid an additional 3.8% tax on your taxable investment income.
While QCDs are often the optimal tax-efficient gifting solution, you or your advisors need to be sure to carefully track and report QCDs on your tax return to realize the tax benefits. Account custodians report QCDs on IRS Form 1099-R similar to any other IRA distribution and do not indicate them as QCD distributions.
There are many details that go into the above strategies and other strategies to consider. If you need help making the most of your charitable gifts, talking to a knowledgeable and experienced financial and tax advisor is an excellent first step.