Donating to charity is a way to contribute to causes bigger than ourselves. For some, it can be motivated by available tax advantages, while for others, the act of giving is completely personal. Regardless of your intent, having a plan for your philanthropic endeavors can help you make the most of your ability to support the causes you care about, while also taking full advantage of potential tax benefits.
Identifying Tax-Efficient Opportunities
Appreciated Securities
Donors who use this strategy can generally eliminate capital gains they would otherwise incur if they sold the assets first and donated the proceeds. Depending on your income level, this can increase the amount available for charities up to 20% (highest capital gains tax rate).
“Bunching” Donations
Bunching is a strategy to maximize tax savings. Charitable contributions for multiple years can be grouped into a single year so that a donor can itemize tax deductions in one year and take the standard deduction in other years.
Look for this opportunity when you have a major increase to your taxable income, such as a large bonus, stock sale, or business liquidity event. Bunching also presents an opportunity for those close to retirement. Bunching while still working allows you to build a charitable checkbook and get tax benefits of a large donation rather than receive no benefits from smaller annual donations in the years you take the standard deduction.
Donor-Advised Funds
A donor-advised fund is a charitable investment account that provides simple, flexible, and efficient ways to support the charitable organizations you care about.
A donor and their family can donate appreciated assets and/or cash, receive an immediate tax deduction, avoid capital gains taxes on the appreciated securities, allow the charitable funds to grow, and make donations at the donor’s discretion. Essentially, this vehicle allows the donor to capture the benefits of donating highly appreciated securities and “bunching” while adding flexibility to the donation schedule.
The structure of a donor-advised fund can ease the pressures associated with determining ultimate charities and creates an opportunity for donors to build a charitable legacy within their families.
Building a Charitable Legacy
Charitable Remainder Trusts – Retain Income
Many individuals plan to give their wealth to charity at the end of their lives. However, this mindset can cause us to overlook tax-efficient giving strategies during one’s life. Many want to ensure their financial needs are taken care of before making a large gift.
Charitable remainder trusts allow donors to make a donation of assets and receive a tax deduction in the year of the donation. The donor will receive lifetime income, and, at the termination of the trust, the remaining assets will pass to charity. If you would like to build a legacy and ease the pressures associated with selecting charities to receive the funds, you can work with your estate planning attorney to name your donor-advised fund as the charitable beneficiary of the trust. This will allow your family members to carry on your legacy set out in your shared vision of your philanthropic giving plan.
Charitable Lead Trusts – Donate Income
Charitable lead trusts are often referred to as the “reverse” of a charitable remainder trust because the trust makes annual payments to a qualified charity or charities for a specified term, then distributes the remainder to the donor, the donor’s family, or other designees. Depending on how the trust is structured, the donor receives a current charitable tax deduction on the donated assets. In summary, a charitable lead trust allows you to provide annual gifts to your favorite charity or charities during your life, while transferring assets to yourself or your heirs in the future, at a reduced or even zero estate or gift tax cost.
Like a charitable remainder trust, you can work with your estate planning attorney to name your donor-advised fund as the charitable beneficiary of the trust. This provides flexibility to either donate the full annual income amount or retain assets within the donor-advised fund. This allows you to look for the right giving opportunity while the assets remain invested or build a source of funds available to your children to support their philanthropic endeavors in the future.
Minimizing Required Minimum Distributions (RMDs)
Roth Conversions
Roth conversions before your RMDs1 begin can help reduce the forced income you will have to recognize in retirement and provide a source of tax-free inheritance for your beneficiaries. However, individuals must pay ordinary income tax on the conversion amount.
Coordinating your annual charitable contributions into years of a Roth conversion can help mitigate the taxes associated with the conversion by using the charitable deductions to offset the realized income.
Qualified Charitable Distributions
If you were not able to reduce your RMDs to your desired level, you still have the chance to reduce them through a qualified charitable distribution. While you do not receive a charitable income deduction, you do reduce your income, and ultimately your tax bill, and potentially your Medicare premiums.
Since there is no charitable income deduction, donors can gift more assets if they already have exceeded 60%/30% adjusted gross income (AGI) limitations and still receive tax benefits in a high-income year. It is important to note that the 60% cash AGI limitation will drop back to 50% in 2026 if the TCJA sunsets. Make a note and update a year from now if needed.
Next Steps
Having family conversations around wealth can be difficult. Before discussing wealth transfers within the family, it may be beneficial to establish a family governance system for philanthropic giving. A D.A. Davidson financial professional can help facilitate the process and provide ongoing support to adapt your individualized giving plan to meet your changing values, interests, and relationships.
1 Required minimum distributions (RMDs) are the minimum amounts you must withdraw from your retirement accounts each year. You generally must start taking withdrawals from your traditional IRA, SEP IRA, SIMPLE IRA, and retirement plan accounts when you reach age 72 (73 if you reach age 72 after Dec. 31, 2022). Source: IRS.gov
This material is being provided for educational and informational purposes only. D.A. Davidson & Co. is a registered broker-dealer and registered investment adviser that does not provide tax or legal advice. Information contained herein has been obtained by sources we consider reliable but is not guaranteed and we are not soliciting any action based upon it. Any opinions expressed are based on our interpretation of the data available to us at the time of the original article. These opinions are subject to change at any time without notice. Copyright D.A. Davidson & Co., 2024. All rights reserved. Member FINRA and SIPC.