Giving back to those in need is a common practice among Americans. In fact, for tax year 2016 (which were filed in 2017), 36.95 million tax returns included a deduction for charitable giving, averaging about $5,508 among them, according to IRS data. But why do we give? Psychologists generally breakdown the motivation for people give into two categories: altruistic givers and warm-glow givers.
Altruistic givers are motivated by an unselfish concern for the benefit of others. It’s the output of the charity, and its positive effect on those in need, that moves them to donate. Warm-glow givers, on the other hand, give because it makes them feel good about themselves. Regardless of which type of motivation might drive the giver, charitable giving comes from the heart and helps improve the lives of our friends and neighbors in need. While that’s the most important aspect of giving, there is also a third motivation that helps spur generosity: the charitable contribution tax deduction.
Under the tax code you’re allowed to deduct up to 60% of your Adjusted Gross Income (AGI) if those gifts are made in cash and up to 30% of your AGI if you gift other assets (appreciated stocks, real estate, tangible goods, etc.). Gifts over these amounts are allowed to be carried forward for up to 5 years to be used as future deductions. The catch, however, is that in order to take advantage of the charitable gift you made you first have to be itemizing your deductions on your tax return. That means that when you add up all of your individual tax deductions (state and local taxes, mortgage interest, charitable gifting, qualifying medical expenses, etc.) the sum must be larger than the standard deduction, since the higher of the two is what’s used. Under the new Tax Cuts and Jobs Act the standard deduction has been nearly doubled to $12,000 for single filers, $24,000 for married couples filing jointly. In fact, the IRS estimates that only about 5% of taxpayers will itemize in 2018, compared to about 30% in prior years. In other words, the bar to itemize, and therefore get a benefit on your tax return after a charitable gift, has gotten higher while at the same time limits and reductions to those types of expenses that are itemizable deductions have made it even harder to meet that threshold. There are, however, gifting strategies that can give a tax benefit to even if you don’t itemize.
1. Qualified Charitable Distributions
For those over the age of 70.5 years with traditional IRA balances, the tax code allows each person to direct up to $100,000 of their annual Required Minimum Distribution to a qualifying charity without having to add the amount to your taxable income for that year. That means that you don’t have to itemize your deductions to get credit for the donation, since the donated amount has already been excluded from your taxable income rather than being treated as an itemizable deduction. You’re also allowed to do partial gifts, in case you still need a portion of your required minimum distribution for living expenses or if you want to donate to multiple charities. The distribution check must be made payable to the charity, though it can be sent to the donor and passed on to the charity. Following that path ensures that you can get a receipt for your donation, which is important to keep with your tax records. You cannot, however, have the distribution paid to you and then turn around and gift it to the charity. In that scenario you would be back to having to use the itemized deduction to get the tax benefit. In order to be a qualifying charity the organization must be a 501(c)(3). Private Foundations and Donor-Advised Funds, unfortunately, are not eligible recipients.
2. Gifting Appreciated Securities
For many investors, rising markets over the years have led given them investments that are worth far more than they originally purchased them for. Be it stocks, bonds, mutual funds, ETFs or any other financial security that is held in a taxable investment account (i.e. not IRAs or 401(k)s), the difference between the higher current market value and the original purchase cost is called a capital gain and is taxable upon the sale of the security at rates determined by how long you’ve owned the security for. Herein lies another gifting opportunity. Rather than giving cash to your favorite charity(ies), instead consider gifting shares of these highly appreciated securities of an equivalent value. While this strategy doesn’t get you around the requirement to itemize your deductions to get a current tax year benefit, it does allow you to avoid paying the extra tax on the capital gain that you would have been liable for upon the liquidation of the security. Since qualified charities are tax exempt, they don’t have to pay any taxes on the gains when they liquidate the shares you’ve donated to fund operating expenses. Remember, though, that in order to qualify for this strategy the security(ies) you are donating must have been held in your account for more than a year. The value of the security(ies) you plan to donate must also be higher than their original purchase cost. If the positon has lost value over time then you’re better off selling the position yourself and donating the cash proceeds. Finally, remember that you can only deduct the value of donated securities up to 30% of your AGI in a given year.
3. Bunch Future Gifts into a Single Tax Year
One option to help you qualify for the itemized deduction is making less frequent but larger donations that are more likely to get you over the standard deduction hurdle. In other words, rather than giving $5,000 per year you could make a $15,000 donation every three years. You could gift directly to the charity(ies) of your choice as a lump sum, or you could use a Donor Advised Fund or Private Foundation to spread the donation out over time. Remember, however, that the donations made are still subject to the annual AGI limits for deductibility (60% for cash, 30% for appreciated assets). You are allowed the five year carry forward, however that only helps you if you itemize in future years. If you’re likely to revert back to the standard deduction in the years following your bunched contribution then the carry forward likely won’t help, so be sure to discuss that option with your tax advisor.
Giving is done best when it’s done for the right reasons. Find a cause and an organization that you’re passionate about, and then engage your professional advisor team to ensure that you structure your gift so that the organization and your family gets the maximum benefit. The tax code was designed to incentivize charitable giving, so don’t be bashful about taking them up on the offer!