Nancy Coumou, CFP®, Wealth Advisor of BlueSky explains the pros and cons of some charitable-giving strategies from a tax planning perspective.
You give to a charity to support its good work, not, foremost, to get a tax benefit; but the tax benefit is a nice bonus. With good financial planning, there are ways some donors can maximize the tax benefit of such gifts.
Let’s say you give $5,000 to a favorite qualified charity. They are happy! You are happy too because if you itemize at tax time, you will include this gift on Schedule A and think yeah, I supported the mission of a charity that is important to me and avoided tax on $5,000.
Let’s consider a few charitable-giving strategies that could further boost the tax-efficiency of a $5,000 gift.
Gifting highly appreciated shares – instead of making a cash donation, some tax-payers are in a good position to donate securities. For example, if you long ago purchased 10 shares of mutual fund X for $1,000 and these shares are now worth $5,000, you can give them to a qualified charity and deduct $5,000 on your Schedule A at tax time. What about the $4,000 capital gain? Poof, it’s gone! No one pays it. The charity sells the 10 shares of fund X you gave them and receives $5,000 in cash to do its good work.
- Completely avoid tax on capital gains
- Non-cash transaction so no impact on your cash flow
- Qualified charity must have a brokerage account in order to receive gifted securities
- Less convenient than cash (you must sign paperwork for each gift)
Gifting through Qualified Charitable Distributions (QCDs) – instead of donating from current cash reserves, Individual Retirement Account holders who are older than 70.5 may directly transfer part (or sometimes all) of their required minimum distribution (RMDs) amounts to an eligible charity.
How is this better than just sending a check and deducting the gift on Schedule A? The answer has to do with adjusted gross income (AGI). AGI is that number on the very bottom of page one of the 1040. Among many other things, AGI determines how much of your Social Security income is taxable. On Schedule A, AGI is also used to determine the deductibility of certain things including investment expenses and tax preparation fees. The lower your AGI the better. When you directly transfer your RMD to an eligible charity, you have essentially lowered your AGI by not recognizing this income in the first place.
- Charity receives cash.
- Tax-free gift.
- No impact on current cash flow as this income is never received.
- Lowers adjusted gross income (AGI) – for those who itemize on Schedule A, this lowers the ‘floor’ on certain deductions, thus making more of certain expenses deductible.
In other situations, reduced AGI may also have these positive impacts:
- It can potentially reduce the amount of Social Security that is taxable
- It can potentially lower Medicare premiums
- It can help some taxpayers avoid the net investment income tax surcharge
- Inconvenient (you must sign paperwork for each gift recipient)
- Reduced AGI may not appreciably ‘move the needle’
Gifting through a Donor Advised Fund (DAF) – rather than managing the administration of giving to individual charities, you can instead contribute to a Donor Advised Fund (DAF) such as Schwab Charitable or Fidelity Charitable. You receive a same-year tax deduction from such contributions and, regardless of the number of contributions you make to the fund in a calendar year, receive a single tax receipt. Your gift goes into a DAF giving account where it is invested according to the asset allocation of the investment pool you choose. You then decide which qualified charities will receive grants from the account.
DAFs are a terrific way to establish and maintain a schedule of charitable giving, even if you do not yet know which charities you’d like to support.
- Convenience and ongoing administrative ease.
- Charity receives cash.
- Allows for ‘in memoriam’ or anonymous gifts.
- Allows assets in your pooled giving account to grow tax-free so you can to give more to the charities that matter to you.
- Minimum deposit of $5,000 to open a new DAF.
- No tax benefit to capital gains in the giving account
BlueSky is here to help!
This primer has obviously omitted many details of gifting highly appreciated shares, using QCDs or using a DAF; each comes with caveats galore. While there’s no reason for you to keep the various gift-giving strategies straight (that’s our job!) it is helpful to know that such tax-saving opportunities exist. The planning professionals at BlueSky Wealth Advisors understand and recommend to our clients the tax-smart giving strategies that best suit their individual needs.