Three techniques to provide a tax benefit from your charitable donations
The Tax Cuts and Jobs Act (TCJA) of 2017 made major changes in tax filing, including increasing the amount of the standard deduction, removing personal exemptions, dropping income tax rates and limiting the amount of state and local income tax (SALT) that an itemizing taxpayer can deduct to $10,000.
This limits the tax incentives for charitable giving for many taxpayers who no longer itemize. Let’s take a look at three techniques that provide a tax benefit to support a person’s desire to give charitably.
1. BUNCHING CHARITABLE CONTRIBUTIONS
A technique that is seeing renewed interest is bunching charitable contributions every other year or even less frequently. In the year that you bunch your charitable contributions, you would plan that your total itemized deductions, including charitable contributions, exceed the standard deduction. In other years, you would take the standard deduction and not make any charitable contributions.
This technique works well from an income tax planning standpoint but may make it difficult for the charities you support to budget and maintain appropriate cash flow each year. Additionally, this technique requires that you create a monitoring system for yourself to track the years you plan to itemize and match that to the years that you make your charitable gifts.
In Scenario #2, the couple accelerates charitable giving into a single year (2022) to maximize itemized deductions and takes the standard deduction in subsequent years (2023-2025). The composition of itemized deductions is the same under both scenarios, yet Scenario #2 produces a greater tax deduction of $20,700 over the four-year period.
2. DONOR-ADVISED FUNDS
Another version of bunching is to use a donor-advised fund (DAF) offered by your local community foundation or other providers. Using the DAF method, you would contribute the equivalent amount of money of your normal charitable giving over a number of years and instruct the fund to spread that amount over a period of years to specific charities. You would itemize deductions in the year that you use the DAF and use the standard deduction in other years.
The advantage of this approach over bunching is that your selected charities continue to receive monies each year. Rather than you making a direct contribution, the DAF makes the annual distribution on your behalf. See tax benefit illustration for tax savings impact.
For those who are charitably inclined, these techniques can assist you in gaining an income tax benefit. Contact your Trust Point advisor to learn more about what options are best for you.
3. CHARITABLE IRA DISTRIBUTIONS
Charitable IRA distributions actually predate the TCJA. If a taxpayer meets the requirements, this is an excellent way to receive a tax benefit for those who are charitably inclined, regardless of whether they itemize.
The regulations allow an IRA holder to make a distribution from their IRA directly to a qualified charitable organization.
- The IRA holder must be age 70 1/2 or older when the charitable IRA distribution is processed.
- The charitable IRA distribution must be distributed directly from the IRA by the custodian/trustee to the IRA holder’s charity of choice.
- The maximum annual charitable IRA distribution (in total) is $100,000.
- In the case of a married couple, if both spouses meet the requirements for a charitable IRA distribution, they can each use the technique, which increases the maximum allowed charitable IRA distribution to $200,000 for the household.
Benefits of charitable IRA distributions include:
- The distribution is not federally taxable (Note: Both WI and MN have also adopted charitable IRA distributions; for residents of those states, the distribution is also not state taxable).
- The distribution counts toward the IRA holder’s required minimum distribution (RMD). NOTE: The SECURE ACT changed starting age for RMD calculations effective 1/1/2020 to 72; Did
not change age requirement for Charitable IRA Distributions – remains at 70½.
- Distributing all or part of your RMD as a charitable IRA distribution reduces your adjusted gross income (AGI).
- AGI is used to determine social security taxability; lowering AGI may lead to reduced taxable social security benefits.
- AGI is also used to determine Medicare premiums; lowering AGI may lead to reduced Medicare premiums.
Reach out to a financial professional if you have questions
The team at Trust Point is here to answer the questions you may have regarding increasing your tax benefits from your charitable contributions. Reach out and we are more than happy to help.