As we head into the holiday season of giving, let’s consider charitable giving strategies that maximize the amount you save. The tax reform law enacted some significant changes, such as: eliminated personal exemptions, limited state and local income tax deductions to $10,000, including property taxes, and increased the standard deduction, which may affect the benefit received from a charitable gift. Taxpayers must identify the optimal timing and methods of donations to ensure maximum tax savings for their charitable giving.
Below are some strategies to keep in mind as we enter the season of giving:
Qualified Charitable Distributions (QCD) from IRA:
When planning your charitable gifts strategy, you may want to consider making charitable donations through a QCD via your Individual Retirement Account (IRA). A QCD is a direct transfer of funds from your IRA custodian, payable to a qualified charity. QCDs can be counted toward satisfying your required minimum distributions (RMDs) for the year, as long as certain rules are met. This allows you to kill two birds with one stone.
In addition to the benefits of giving to charity, a QCD excludes the amount donated from taxable income, which is unlike regular withdrawals from an IRA. Keeping your taxable income lower may reduce the impact to certain tax credits, and deductions, including Social Security and Medicare.
Also, QCDs don’t require that you itemize, which due to the recent tax law changes, means you can take advantage of the higher standard deduction, and still receive a benefit from a charitable contribution.
Who can make a QCD?
While many IRAs are eligible for QCDs – Traditional, Rollover, Inherited, SEP (inactive plans only), and SIMPLE (inactive plans only) – there are requirements:
- You must be 70 ½ or older to be eligible to make a QCD
- QCDs are limited to the amount that would otherwise be taxed as ordinary income. This excludes non-deductible contributions
- The maximum annual amount that can qualify for a QCD is $100,000. This applies to the sum of QCDs made to one or more charities in a calendar year. (If, however, you file taxes jointly, your spouse can also make a QCD from his or her own IRA within the same tax year for up to $100,000.)
- For a QCD to count towards your current year’s RMD, the funds must come out of your IRA by your RMD deadline, generally December 31.
What kind of charities qualify?
The charity must be a 501(c)(3) organization, eligible to receive tax-deductible contributions.
Some charities do not qualify for QCD:
- Private foundations
- Supporting organizations: i.e., charities carrying out exempt purposes by supporting other exempt organizations, usually other public Charities
- Donor-advised funds, which public charities manage on behalf of organizations, families, or individuals.
Considering the possible tax benefit from charitable giving, the regulations are fairly straightforward. Giving with a QCD allows you to donate your money to a cause or organization that’s close to your heart, while reducing your tax liability.
Giving in Bunches:
Prepaying charitable contributions using an alternating, or every few years, basis (also known as the bunching method) allows taxpayers to itemize deductions in the year contributions are made and use the standard deduction in years featuring little or no donations. Future donations are repeated according to the established timetable.
Donor Advised Fund (DAF):
One may give outright to a charity during this time of year or consider donating to a DAF. A DAF is a giving vehicle that is maintained and operated by a section 501(c)(3) organization. Each account is composed of contributions made by individual donors. Once the donor makes the contribution, the organization has legal control over it. However, the donor, retains control of the distribution of funds and the investment of assets in the account.
DAFs may be used in tandem with the bunching method. Here an explanation of how the method works: a taxpayer funds a DAF in year one with a large donation and claims the itemized deduction. In the subsequent years, the taxpayer directs the amounts and timing of distributions from the DAF to favorite charities and takes the standard deduction. Timing plays a major role with this method, so be sure to develop a plan with us to execute DAF donations in years with larger projected tax liabilities. This provides tax savings at times when marginal tax rates may be higher.
Donation of Appreciated Assets:
Once appreciated, assets like common stocks, mutual funds or ETFs can be donated. This may further enhance the tax savings by shifting the unrealized capital gain to a charity or DAF with no tax liability on the sale of those securities. Additionally, DAF can avoid capital gains and donors can get a deduction in the amount donated.
A Note for Business Owners
If you’re a small business owner, there is another deduction which may be affected by charitable giving. The Tax Cuts and Jobs Act introduced the Qualified Business Income deduction (QBI), that offers a 20-percent deduction for qualified business income for pass-through entities, which includes Sole proprietorships, S corporations, Partnerships, and Limited liability companies. Up to 20 percent of your QBI can be deducted, reducing your tax footprint even more for the year.
Keep in mind here, that if you’re making more than $315,000 that year (for a married couple) or $157,500 for all others, your QBI deduction will be subject to certain restrictions, which complicates things. Using the bunching and QCD solutions mentioned above may help you stay below that income threshold and get the QBI deduction free and clear.
Give and Save at the Same Time
As you celebrate by giving this year, keep in mind that choosing the right strategy may help you maximize your tax deductibility.
At JSK we believe you should chart the course of your own journey. Our mission is to make financial planning, investments, and taxes work together to help you reach your goals. Make an appointment today, and let’s start the process.