For those who are charitably inclined, changes to the tax code that went into effect in 2018 may require adjustments to your previous strategy to receive financial benefits from your planned giving. A near-doubling of the standard deduction and sweeping changes to the limits on itemized deductions will make it harder for many taxpayers to benefit from donations of cash or goods to charity. Luckily, there are other charitable giving strategies to consider which could offer multiple tax benefits, such as donating appreciated securities or cash directly from an IRA.
Planned giving: cash isn't always king
Depending on your financial situation and planned giving objectives, there may be a few different ways to reach your goals. Three common ways individuals can make a charitable donation are as follows:
- Giving cash
- Donating appreciated securities
- Taking a qualified charitable distribution from an IRA
Note: more advanced planned giving techniques, such as setting up a private foundation or a charitable lead/remainder trust are outside the scope of this article. To discuss your personal situation, we suggest you contact your financial advisor and estate planning attorney.
Giving cash or non-cash goods may be top-of-mind, but cash isn't necessarily the most effective way to donate - for either the charity or the donor. Cash gifts to charity appear on schedule A of the tax return, which is where itemized deductions are listed. So if a taxpayer doesn't itemize their deductions, they won't receive a financial benefit for their donation.
The new tax code (which took effect in 2018), effectively doubled the standard deduction and spurred other changes and limitations to itemized deductions. The result: only about 12% of households are projected to itemize their deductions in 2018, down from 31% in 2017 (source: Tax Foundation). In 2019, the standard deduction is $12,200 for single filers and $24,400 for married couples, filing jointly. In 2020, the standard deduction will be $12,400 for single filers and $24,800 for married couples, filing jointly.
This amount increases for married couples over age 65 by $1,300 per taxpayer or $1,650 for unmarried individuals. Using a 50-year-old married couple as an example, the pair needs itemized deductions in excess of $24,800 in 2020 or they would be better off claiming the standard deduction.
The most common itemized deductions include:
- Mortgage interest. Generally for mortgages before 2018, interest may be deducted on loans up to $1,000,000. For loans after 2017, the loan amount is reduced to $750,000. Interest on HELOCs may no longer be deductible unless certain conditions are met
- State and local taxes (SALT). Deductions for all state income tax, property tax, sales tax, and local taxes are capped at $10,000
- Qualified medical expenses. Medical expenses in excess of 10% of adjusted gross income (AGI) can qualify as an itemized deduction
- Charitable giving. Cash donations to qualified public charities are limited to 60% of AGI, but any unused deduction can be carried forward for 5 years.
As a result of these changes, you may want to consider a new strategy to maximize the tax benefits from your generosity.
'Bunching' cash donations
A strategy called 'bunching' can help ensure some donors don't miss out on a meaningful tax deduction for their charitable endeavors. Bunching, or clumping, donations would mean instead of making annual cash gifts to charity, a taxpayer would group two or more years together, for less frequent but larger gifts. In gift-years, the donor would itemize their deductions, and in other years, claim the standard deduction.
Also Read: 5 Ways to Minimize Tax on Your Investments
Here's a very simplified example of how this would work:
A couple with no mortgage lives in a state without income taxes. They have no state or local taxes, and their property taxes are $12,000 per year (which would be capped at $10,000). They also donate $10,000 annually to their favorite public charity. Their itemizable deductions are $20,000, which is less than the $24,800 standard deduction in 2020. If the couple 'bunched' their charitable deduction instead, making their 2020 and 2021 donation in 2020, they could take $30,000 of itemized deductions in the current tax year. In 2021, they would then opt for the standard deduction.
Donating appreciated securities instead of cash can be a very efficient way to maximize the support for your chosen charity and your financial benefit from the donation, assuming you can itemize your deductions. Since the securities are donated directly to the public charity, the taxpayer does not incur long-term capital gains taxes as they would if the security was sold to raise cash for the donation. Work with your financial advisor and CPA to identify whether any securities in your portfolio may be candidates for this strategy and to understand the potential tax impacts.
Donating appreciated securities
Giving appreciated stocks, bonds, or mutual/index funds, can also be a way to maximize your gift to charity and your financial benefit. Unlike cash donations, (which are made with after-tax dollars and may reduce your income tax liability if you itemize your deductions), when you give an appreciated stock, you avoid incurring the capital gains taxes that would otherwise have been incurred if the security was sold to raise cash for the donation.
In addition, if you itemize your deductions, you may also take a charitable deduction for the fair market value of the asset when it was donated, up to of 30% of your AGI. As with cash donations, there is a five-year carry forward for unused deductions. Therefore, the bunching strategy (discussed above), should also be considered when donating appreciated securities. Keep in mind, only long-term securities are eligible, so positions must be held for more than one year to qualify.
The benefits of this strategy really depend on how much the asset has appreciated relative to your cost basis, because without meaningful capital gains savings, this method looks rather similar to cash donations. For positions with losses, it is more advantageous to sell the security and realize the loss to offset other gains and then donate cash. Publicly traded and non-publicly traded assets can be donated, the latter requiring an independent valuation, which increases the cost of giving.
Using a donor-advised fund to give appreciated assets to charity
A donor-advised fund is perhaps the most streamlined way to donate appreciated securities. Donor-advised funds can be set up easily at some of the major institutions (e.g. TD Ameritrade, Fidelity) or with the help of your financial advisor. When you make an irrevocable donation to your DAF, you will receive an immediate charitable deduction for the fair market value of the asset as an itemized deduction. You will also not have to pay capital gains tax on the appreciation.
When a security is donated to your donor-advised fund it's sold, and the fund receives cash which can be re-invested in the market at your direction. Donors have full control as to the timing and charitable recipient of funds, if it's an IRS-qualified public charity. As explained previously, for taxpayers who itemize deductions, an immediate income tax deduction of up to 30% of adjusted gross income may be taken for donations of long-term appreciated securities.
A wide range of assets can be donated to a donor-advised fund, from publicly traded stocks, bonds, and mutual funds, to real estate and shares in a closely-held business. For individuals with a significant amount of stock options or equity-based compensation from their employer, a donor-advised fund may be a great opportunity to accomplish charitable goals. Typically, shares from vested restricted stock units (RSUs), restricted stock awards, or shares from an exercise of non-qualified stock options (NSOs) held for over one year provide the greatest tax benefits when donated to charity over other forms of equity compensation.
Gifting your required minimum distribution
The Secure Act, which was passed at the end of 2019, changed the age some retirees will need to begin distributions from tax-deferred retirement accounts. Individuals born on or before June 30th,1949 will need to start required minimum distributions at age 70 1/2 while investors who are born on or after July 1st 1949 will be required to take RMDs starting at age 72. The first RMD can be deferred until April 1st of the year following the year you turn age 70 1/2 or 72. Subsequent RMDs must be taken by 12/31 for every year thereafter, and if you choose to defer the first RMD until April, you will need to take another RMD by 12/31.
What many retirees don't know is that they can donate all, or a portion of, their required minimum distribution (RMD) directly to charity, through a qualified charitable distribution, or QCD. Charitable distributions directly from an IRA can also be made before RMDs begin - the Secure Act raised the RMD age for some taxpayers but did not change the age in which QCDs could be made, which remains unchanged at age 70 1/2.
Particularly with a sizable IRA, satisfying the annual RMD may create an unfavorable tax situation in four main ways:
- RMDs are included in the taxpayer's ordinary taxable income, meaning the taxable portion of the disbursement will be taxed at the higher rates for regular income (versus capital gains), and can also push some retirees into a higher marginal tax bracket
- Required minimum distributions also increase the taxpayer's modified adjusted gross income, or MAGI, which could trigger the 3.8% Medicare surtax. The surtax applies to the lesser of net investment income or MAGI in excess of $200,000 for individuals or $250,000 for married couples filing jointly
- Even modest withdrawals from a retirement account can cause Social Security benefits to become taxable, up to 85% for single filers with income above $34,000 annually or married couples with income above $44,000
- Medicare Part B and D premiums are also calculated using a taxpayer's MAGI, so large RMDs can cause sharp increases to your Medicare costs, with the wealthiest taxpayers shouldering up to 80% of the cost
For wealthy retirees who are charitably inclined and are over age 70 1/2, a qualified charitable distribution is likely worth considering.
Qualified charitable distributions
As discussed, a QCD can be a very financially-effective way to support a cause. However, as with any financial and tax strategy, it's important to first understand the details and limitations. It's very important to note that a qualified charitable distribution does not provide a charitable deduction for taxpayers - regardless of whether the individual itemizes their deductions.
Instead, a disbursement directly to charity enables the donor to exclude the sum from their taxable income, the benefits of which (as explained in the four reasons above), can cascade into other areas of their financial situation. Eliminating the hurdle to itemize tax deductions to realize the full monetary benefits can be very advantageous when considering the standard deduction is even higher for taxpayers over age 65.
QCDs are perhaps best utilized when an individual does need the income from their entire required minimum distribution. Since the IRS will first satisfy the RMD with any withdrawals throughout the year, it's important to plan ahead, especially if taking monthly distributions.
For example, suppose a required minimum distribution is $100,000 (taken in equal monthly installments), and the goal is to donate $40,000 to charity. If the individual later realizes they haven't made their QCD until they take the September distribution, their remaining RMD for the year is $25,000, $15,000 short of their goal. Although the taxpayer could withdraw $115,000 that year to reach the full $40,000 gift, the oversight has increased his or her taxable income by 25%, and triggered an unnecessary $15,000 drawdown of their investment portfolio.
Each retirement account owner can donate up to $100,000 annually through a qualified charitable distribution, even if it exceeds their required minimum distribution. For the purpose of calculating Medicare premiums, there's a 2-year lookback, meaning 2020 premiums are devised using the 2018 tax return. Donations must also go directly to the qualified public charity. Careful tax and financial planning is advised when considering a planned giving strategy.
Is it more advantageous for retirees to donate appreciated securities in taxable accounts or give using a qualified charitable distribution? Unfortunately, the answer will really be specific to each individual's financial and tax situation, as factors such as marginal tax bracket, ability to itemize deductions, and even legacy goals can influence the advice.
For retirees looking to leave an inheritance to a spouse or family members, it may be better to pursue a qualified charitable distribution, as appreciated assets in a taxable brokerage account will receive a favorable 'step-up' in basis to the fair market value of the security at the date of death. Although the timing and amount of RMDs will likely change, assets inherited in an IRA will receive the same tax treatment when passed to a spouse, child, or relative, though non-spouse beneficiaries can no longer 'stretch' the distributions over their lifetime by taking required minimum distributions.
Starting in 2020, beneficiaries who inherit a retirement account from a non-spouse (e.g. a parent or relative) will be forced to take the funds in 10 years. Again, given the step-up in cost basis and no withdrawal requirements for inherited brokerage accounts, this type of investment vehicle may become even more popular in legacy planning.
Final note on advanced giving strategies
For those who are charitably inclined with substantial financial resources, there are likely a wealth of charitable strategies available to you in addition to the methods discussed in this article. Before diving into the complex giving realm of charitable trusts and private foundations, take a moment to assess and prioritize your objectives. While advanced planned giving techniques can be valuable tools, the administrative costs (measured in time and dollars) must be properly weighed as well. This is particularly true for some private foundations, which essentially operate with the same needs as a business.