According to various sources, Americans are the most “giving” country in the world. Americans gave $427.71 billion to charities in 2018 (the latest year for which information is available), a 0.7% increase from 2017, even though tax law changes have made it more difficult for people to deduct their charitable contributions. We certainly have many choices when it comes to giving, as there are more than 1.5 million charitable organizations in the United States.
If you think most of the money given to charities comes from big foundations or corporations, think again. In 2018, over two-thirds (68%) came from individuals, while foundations provided 18%, bequests accounted for 9%, and corporations contributed 5%. You don’t have to be a big donor to make a difference – the average non-high net worth household gave about $2,500 in 2017 (1).
In this article, we discuss various ways to approach charitable giving, with particular attention to maximizing associated tax benefits. Please note that specific strategies used, primarily by ultra-high net worth individuals, are not covered here.
The Direct Approach
Probably the simplest way to donate to a charity is to go to the organization’s website and find a link that says “give” or “donate” or “support.” Fill in the amount you wish to donate, provide your credit card information, and that’s it. If you’re not comfortable giving online, this can be done by phone or by check. Please be aware that if it's a political donation, you will be required to provide your employment status and employer's name. Keep the digital or paper receipts from each charity even if the individual amounts are small. You could reduce your taxes if the total across all donations is large enough that it makes sense for you to itemize your deductions.
For many people, charitable donations no longer provide a tax benefit in a given year because their tax deductions, including donations to charity, are less than the standard deduction (therefore, they don’t itemize). However, there are other ways you can give that can preserve some tax deductions. For 2020 only, the CARES Act provides a $300 "above the line" deduction for all public charities, which means that you will be able to deduct the first $300 you donate to these charities on your 2020 tax return.
Donor-Advised Funds – A Popular and Flexible Approach to Giving
What if your combined charitable donations over a two or three-year period would be big enough so that your total deductions exceeded the standard deduction? Or, what if you know you want to give a certain amount in total to charities, but you haven’t yet decided which ones yet? Or, perhaps you are faced with an extraordinary tax-bill and would rather give some of the money to charity instead of giving all of it to the IRS. For people in these situations, a Donor Advised Fund (or DAF) is an excellent vehicle for charitable giving that has become increasingly popular over the past 10+ years.
A Donor Advised Fund (DAF) is a separate account established at a brokerage firm or bank. At GMW, we typically utilize Fidelity, the largest DAF program in the country. You decide how much money to put into the fund, and you choose when and how much of that money is distributed to the charities you want. Transferring money into a DAF is permanent, you cannot change your mind, because the IRS treats this as a charitable contribution the year you put the money into the DAF. This treatment makes it especially attractive if you have a considerable income year, perhaps from the sale of a business, while allowing you to spread out your donations to various causes over time.
There are various benefits to donating through a DAF. Here are three of the most popular:
“Bunching” donations – Consider this scenario: A married couple plans to donate $5,000 per year to charity. They pay about $12,000 in mortgage interest and $5,000 in property taxes. In a single year, these three deductions total $22,000, which is below the $24,800 standard deduction for a married couple in 2020. So, for tax purposes, they lose the benefit of their charitable contributions. However, if they combine two years of charitable contributions ($10,000) and put that money into a DAF this year, they deduct the entire amount this year. They don’t have to put the $10,000 into the DAF all at once. For example, they might put in $5,000 in January and $5,000 in December, or $833 per month throughout the year. “Bunching” two years of donations brings their total deductions to $27,000 for the year, which is $2,200 more than the standard deduction for 2020, thus preserving some tax benefit from their charitable giving. Then they can dole the money out from the DAF to their chosen charities over two years (or longer), but they would not contribute to the DAF in the second year.
Donating appreciated securities – Imagine you want to make charitable contributions of $4,000 this year. You can use cash, or you can donate highly appreciated securities, such as shares of stock, an ETF, or a mutual fund. This method helps you avoid paying capital gains taxes on the increase in the value of the donated securities. Let’s assume you purchased shares of XYZ fund some years ago, at $75 per share. Today, those shares are trading at $100 per share. If you sell forty shares to generate roughly $4,000, you would have to pay capital gains taxes (typically 15 or 20 percent) on the difference between $4,000 and the $3,000 you paid when you bought the shares. Instead, you could transfer the 40 shares to your DAF and pay zero capital gains taxes while simultaneously being able to itemize the full market value. You can even donate illiquid assets such as real estate or shares in a closely-held corporation. Your financial advisor can help you to identify the assets that would be most beneficial to transfer to a DAF given your situation, considering both tax advantages, your overall investment mix, and your other financial goals. If you are selling a business, consult your financial advisor before finalizing the transaction so that you can strategize the best way to make charitable donations, and resultant tax consequences.
Tax-free growth – When you contribute money or other assets to a DAF, any increase in value from the day you contribute until the day you have the money distributed is not taxed. Since you can take as long as you like to distribute the funds, there could be a substantial increase in value over that time that generates no tax liability for you and more money to give to charities.
Charitable Giving Using IRA Distributions
If you are over 72 years old or if you reached 70 ½ before January 1, 2020, you must take a Required Minimum Distribution (RMD) from your traditional (not Roth) IRAs each year. You can make charitable contributions directly from your IRA, the amount donated counts toward your RMD, and is excluded from their taxable income. Any QCDs must be made before the RMD is disbursed. This maneuver is officially called a Qualified Charitable Donation (QCD). Your 1099-R form will show the total amount of your RMD and any taxes withheld. It is up to you (or your CPA) to indicate on your tax return that some or all of that money was donated to charity. Keep in mind that all donations must be to legitimate charities, 501(c)3s, and that political organizations are excluded. Unfortunately, you cannot donate from an IRA to a donor-advised fund.
In 2020 only, because of the impact of the COVID-19 pandemic, Congress has waived everyone’s RMD for the year. This allows people to leave those funds in their IRAs, giving them longer to recover from recent losses. For those who typically make their charitable contributions directly from an IRA and who still want to make charitable contributions this year, it could make more sense to transfer securities from a non-retirement account into a Donor Advised Fund for 2020. Or, consider delaying contributions until January 2021. Then, you could double up on your QCDs in 2021, reducing your tax liability for that year.
Charitable Trusts
If you have substantial assets that you would like to donate to charity in the future, there are two types of charitable trusts you may want to consider, a Charitable Lead Trust (CLT) and a Charitable Remainder Trust (CRT).
With a CLT, you transfer assets into the trust and donate a stream of income from those assets to charity. Assets left in the trust at the end of a period you specify can be disbursed to other beneficiaries or held in the trust. You receive an immediate tax deduction based on the value of the income stream to be given to charity. This strategy can be an excellent way to transfer wealth to your heirs and to provide consistent cash flow to the charity of your choice.
A CRT is similar to a CLT, with one big difference. With a CRT, you or your designated beneficiaries are paid income from the trust first. Assets remaining in the trust after a specified period are given to the charity of your choice. This strategy can be a great solution for those with highly appreciated investments who want to generate income while still providing for charitable giving. Both CRTs and CLTs have annual administration requirements.
Giving money isn’t the only way to support the causes that are important to you. Approximately 77 million Americans, 30% of the adult population, volunteer their time and energy to various charities that would not be able to do what they do without those volunteers. Of course, money is also critical to those organizations, and one of the wonderful benefits of becoming financially secure and accumulating wealth is the ability to support the causes that you value most. We encourage you to work with your financial advisor to figure out the optimal way to do that.
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