Charitable gifting can be a great way to support non-profit organizations that you care about and save taxes at the same time. Tax qualified deductions may also be useful to reduce the tax liability related to high income, realized capital gains, or an income triggering event such as a Roth conversion.
In order to gift efficiently, you should first determine if you will take the standard deduction or itemize deductions on your 2022 tax return. Given the passage of the Tax Cuts and Jobs Act in 2017, the standard deduction is currently very high, at $12,950 for Single tax filers, and $25,900 for Married Filing Jointly couples. Because the current standard deduction limits are nearly double the 2017 amount, people who have traditionally itemized their tax deductions might find they are now subject to the standard deduction. In such case, standard deduction filers might not receive a tax deduction for traditional donations and may want to instead consider a qualified charitable gifting strategy. Here are a few opportunities for tax-smart investors to consider before the year is over.
Qualified Charitable Distributions (QCD)
Qualified Charitable Distributions are an above the line deduction for donations made from an IRA directly to a qualified non-profit organization. That is important for standard deduction filers, as they will still receive the benefit of reduced taxable income, even if they are not eligible to itemize their tax deductions. In order to make a QCD, the donor must be age 70 ½ or older, and the gift must not exceed $100,000 for the tax year.
Direct Gifts of Cash or Stock
Tax filers who are eligible to itemize deductions may record a tax deduction of up to 60% of their Adjusted Gross Income (AGI) on gifts of cash to a qualified charitable organization. Non-cash gifts (i.e. stock) may qualify for a tax deduction of up to 30% of Adjusted Gross Income (AGI) if the assets were held for more than one year. If you make a contribution in excess of these deduction limits, the unused benefit may be carried forward up to five subsequent tax years.
From a tax perspective, it is beneficial to gift appreciated stock to a charitable organization. People who gift stock can often eliminate the capital gains tax they would have normally paid if they sold the stock and donated the net of tax proceeds. This can be a tax savings of 15-20% in Federal taxes, plus State taxes (if applicable). Additionally, the receiving organization does not have to pay tax on the appreciated stock. This increases the amount you can gift by skipping a whole layer of taxation.
Diversify and Offset Capital Gains Tax
Additionally, gifters may utilize a part gift, part sale strategy to liquidate a concentrated stock position. Occasionally, investors might hold an appreciated stock position which they are reluctant to sell due to the capital gains tax that would be triggered. However, in a down market like we are currently experiencing, that stock gain might be temporarily reduced. Someone wishing to diversify their investment position may choose to sell the appreciated stock and simultaneously offset the capital gains tax on it by making a donation to eliminate or reduce the taxes they would have owed.
Given the current high standard deduction, some charitably inclined gifters may find that their normal annual gifting does not qualify for itemized deductions in 2022. However, if you aggregate or bunch a couple years of donations into a single year, you can overcome the itemization deduction hurdle, qualifying you for a higher tax deduction in the current year. Next year, you can resume taking the standard deduction. In addition to achieving a larger charitable gifting impact in 2022, you may benefit from a larger two-year aggregate tax savings, depending on your income level, tax filing status and amount gifted.
Offset Tax on a Roth IRA Conversion
With investment account balances down in 2022, many savvy investors have moved money from their pre-tax IRA to their after-tax Roth IRA. Doing this transfer allows the market recovery to occur in the tax-free Roth IRA and could provide substantial long-term tax savings, as all future gains in the Roth IRA may be tax-free (if holding period and age requirements are met). Additionally, original account owners do not have to take future RMDs on Roth IRAs, and beneficiaries can receive inherited Roth IRA assets tax-free. However, the initial transfer between your IRA and your Roth IRA is treated as a taxable event. To offset this income tax, those who itemize deductions may consider using charitable deductions to help offset the tax liability on the Roth IRA conversion. Keep in mind the tax deduction is limited based on the income and types of gifts, as noted above.
Donor Advised Funds (DAF)
A Donor Advised Fund may be a tax-smart way for you to accelerate all of your future lifetime gifting into the current year, when you may need the tax benefit the most. Gifts into a DAF create a tax benefit in the year the non-revocable gift is made. However, once you have donated into the DAF, you can donate as much or as little as you want from the DAF each year. For example, let’s say you sell an investment property, triggering a large taxable gain in the current year. You normally gift $5,000 per year, and hope to gift the same amount for the next 20 years. To offset the capital gains tax on the sale of the investment property, you can donate appreciated stock to the DAF, accelerating your tax benefit on the next 20 years of gifting to the current tax year, offsetting your realized capital gains tax liability. Once the DAF is established, you can gift from the DAF to the charity of your choice the planned gifts of $5,000 per year until the DAF balance is exhausted. Additionally, both you and the end-charity escape paying capital gains taxes on the appreciated stock. This is a strategic way of fast-tracking the tax benefits while leveraging your gifting power by avoiding unnecessary taxes.
Good charitable gifting can help you fulfill your donor intents and provide you tax savings at the same time. If you want to gift in 2022, start taking action now, as gifting strategies may take time to implement before year-end. If you need financial guidance, reach out to a Certified Financial Planner™ to determine which gifting strategy might be most appropriate for you. Also consult a CPA to confirm the tax benefits are applicable for your specific tax circumstances.