Charitable Gifting to Lower Your Taxes

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As we head towards the end of the year, many consider charitable gifting to support their favorite organizations around the holidays. These meaningful gifts can also provide the donor with tax benefits in the forms of reduced taxable income or increased itemized deductions, ultimately lowering their tax expenses.

Direct Gifting Provision

Under the Tax Cuts and Jobs Act of 2017, the standard deduction was increased to $12,000 for Single tax filers and $24,000 for Married Filing Jointly couples. As a result, many who elected to take the standard deduction were no longer able to claim a deduction for charitable contributions. The Coronavirus Aid, Relief, and Economic Security Act or CARES Act of 2020 now permits standard deduction filers to claim a limited deduction on their 2021 federal income tax return for cash contributions made to qualifying charitable organizations. The CARES Act included a direct gifting provision that allowed standard deduction filers to deduct up to $300 of cash gifts, per household, as an above-the-line deduction, meaning a direct reduction of taxable income. Due to COVID, this direct gifting provision was extended through the end of 2021. However, the 2021 direct gifting provision was amended to be $300 for Single tax filers and $600 for Married Filing Jointly tax filers. The IRS allows very few above-the-line tax deductions and this great opportunity will likely disappear in 2022. To take advantage of this tax benefit, ensure you are donating cash (not appreciated assets like stock), and keep a record of your donation for your CPA to reduce your taxable income on your 2021 tax return. This is a simple and effective gifting provision anyone can do before year-end!

Qualified Charitable Distributions (QCDs)

People with pre-tax retirement accounts such as 401(k)s, 403(b)s, Individual Retirement Accounts (IRAs) and so forth, are required by the IRS to take a Required Minimum Distribution (RMD) once they reach age 72. The RMD is taxed to the account owner as earned income for the year and can create a tax burden for the account holder in retirement. For those who are charitably inclined, they can fulfill the IRS mandated RMD and lower their taxable income at the same time, utilizing a Qualified Charitable Distribution (QCD). A QCD is a direct transfer of pre-tax retirement assets to a qualified charitable organization of your choice. The donation fulfills your RMD and the distribution is not taxed to you as ordinary income since you donated the funds. The non-profit organization who receives your donation doesn’t have to pay taxes on the gift either, allowing you to skip a whole layer of taxation and stretch your pre-tax dollars! In other words, if you are in the 25% tax bracket, a $100 after-tax gift might only cost you $75 in pre-tax dollars. QCDs offer a great deal of flexibility also. You don’t need to donate your entire RMD, you can give whatever portion you’d like to donate. Further, you can donate to as many organizations as you like, so long as they are qualified 501(c)3 organizations.

In an odd quirk of law, IRA owners can take advantage of the QCD provision once they reach age 70½ even though they are not required to take RMDs until they reach age 72. Therefore for retirees who are looking to reduce the taxable income that may be due on RMDs in the future, upon reaching age 70 ½, you can donate as much as $100,000 per year directly to a charity as a tax strategy to reduce the amount of RMDs and related income taxation in the future.

Roth Conversions & Charitable Gifts

Given the level of current U.S. national deficit, the increased funding needs for programs like Social Security, and the fact that we are in a record low tax environment (as a percentage of GDP) for the history of the U.S., many believe higher taxation is on the horizon. President Biden’s original Build Back Better plan outlined higher taxes for Corporations and high income earners (currently removed). Additionally, the House of Representatives recently introduced a provision called the Social Security Enhancement and Protection Act that proposes to increase the payroll taxes on wages above $142,800 as well as increase the payroll tax rate from 6.2% to 6.5%. For those who believe higher taxation is inevitable, it may be desirable to convert pre-tax retirement assets into after-tax Roth IRA accounts at today’s “lower tax rates.” Converting a pre-tax IRA to an after-tax Roth IRA is a taxable event, and the transfer amount is taxed at ordinary income rates. A popular strategy to offset the increased tax liability due to the Roth IRA conversion, is to coordinate a large charitable gift in the same year as the Roth IRA conversion, to offset the taxes due on transactions.

Donor Advised Funds (DAF)

A Donor Advised Fund is a charitable gifting investment account, managed by a third party on behalf of a family, individual or an organization. You can gift various kinds of assets into a DAF, such as appreciated stocks, or less liquid assets like Real Estate Investment Trusts (REITs). Inside of the DAF, these investments continue to grow in value, tax-free to you. You can gift from the DAF to several different non-profit organizations over your lifetime. The biggest benefit to utilizing a DAF is that you get the tax benefit up-front in the year you donate the asset to the DAF. However, the asset can continue to grow inside the DAF for many years and possibly extending your gifting power if the asset within the DAF appreciates. The downside of a DAF is the necessary administrative assistance and fees to manage the investment.

There are many charitable gifting options that may fulfill you gifting intentions or tax deduction needs. If these are of interest to you, plan early by reaching out to your Certified Financial Planner™ or CPA now so you can complete these transactions before year-end.

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