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Everyone loves a win-win situation. And that's the case with charitable giving and its tax benefits — you can do good for others while also doing good for yourself.
When giving to charity, you can lock in tax deductions and save money for your heirs. Consider the following charitable giving tax strategies to help minimize your tax burden now and in the future while boosting a cause or improving your community.
» Interested in more tax savings? Explore other tax-efficient investing ideas
Giving during your lifetime
Taxwise, you can score two benefits when being philanthropic during your lifetime: tax deductions and estate reduction. You also have the opportunity to witness the impact made by your generosity.
Consolidate donations into high income years
There are many times when philanthropy may come to mind — when Giving Tuesday rolls around or as we head into the year-end period. Depending upon your situation, in some years you may produce more income than in others; for example, if you receive a big bonus or happen to sell a business. Instead of doling out smaller annual donations, consider combining a few years’ worth of donations to generate one larger donation and deduction during those high-income years.
The higher standard deduction brought about by the Tax Cuts and Jobs Act means that many taxpayers may not itemize deductions every year. By grouping donations, you can itemize deductions during the high-income year and use the standard deduction during other years. The maximum deduction for charitable contributions is 60% of your adjusted gross income each year, but in some cases lower limits might apply.
Estimating your income for the year and comparing it to what you think you’ll earn in other years can help you better direct your giving strategy and maximize your tax break.
Donate highly appreciated assets
If you have assets that have appreciated a great deal over time, such as securities or real estate, selling them will generate a capital gains tax liability. Donating these assets to a qualified charitable organization is one way to circumvent capital gains taxes. At the same time, you can lock in an income tax deduction for the fair market value of the asset. The charity receiving the donation will not be responsible for paying capital gains tax and will benefit from the fair market value of your gift as well.
Another perk of giving highly appreciated assets is reducing the size of your overall taxable estate. Estate tax planning is important because if your estate is subject to estate tax, the tax consequences could reach up to 40%. Removing high-growth assets from your estate can help constrain how large your taxable estate becomes over time.
Use a donor-advised fund
Another way to maximize your tax deduction during a high-income year, while avoiding capital gains tax and possibly estate tax down the road, is to give through a charitable vehicle, such as a donor-advised fund. Many brokerage firms or local community foundations can establish a DAF for you.
You can donate cash or other assets, such as appreciated securities, to the fund and receive an immediate tax deduction in the year of contribution. The fund grows tax-free and you can recommend fund disbursements over time to the causes and organizations you care about. This way, you can deliberately time your contribution to a DAF to coincide with a high-income year to benefit from a large tax deduction.
Roll donations over to charity
Retirees with traditional IRA accounts must take required minimum distributions after age 72. Some individuals may find themselves in the unfortunate position of being in a higher tax bracket after satisfying their RMD requirement.
Those who don’t need their RMD distribution to fund their lifestyle can consider applying the qualified charitable deduction or charitable rollover strategy, after age 70½. QCDs allow you to roll your RMD directly over to a qualified charity (up to $100,000 each year) and reduce your taxable income by excluding the amount gifted.
Leaving behind your legacy
Making philanthropic gifts through your will or trust is a common way to give and make an impact. Though you won’t receive the double tax benefits of gifting during your lifetime, a major benefit of a charitable bequest is that you can ensure your personal financial needs are covered before giving assets away to others.
Give your retirement plan to charity
A tax-advantageous way to give upon your death is by naming a qualified charitable organization as the beneficiary of your tax-deferred retirement plan.
Naming heirs as the beneficiaries of your plan means they will be subject to income tax and potentially estate tax on withdrawals, depending upon the size of your taxable estate.
Additionally, the SECURE Act recently changed the rules surrounding inherited IRAs, making them less attractive for heirs. Beneficiaries can stretch distributions only up to 10 years before full distribution and tax payments are required, and this 10-year time frame also reduces the tax-deferred growth potential of inherited IRAs.
Charities are exempt from taxes, so leaving non-Roth retirement assets to a qualified charitable organization and other assets to your heirs can help reduce your heirs' tax bill. Even leaving a portion of your retirement plan to charity can help secure some tax benefits for your heirs.
Blending lifetime and legacy giving
Charitable trusts can help you make an impact both during your lifetime and afterward. Depending upon your situation, there are several options to choose from. Two of the most commonly used are charitable remainder trusts and charitable lead trusts.
Charitable remainder trusts
A charitable remainder trust, or CRT, is a type of irrevocable trust that allows the grantor, or owner of the trust, to transform highly appreciated assets into an income stream. The grantor receives a tax deduction upon the asset transfer, avoids capital gains taxes when the asset is sold and can help curtail estate taxes in the future. Once the grantor (or the grantor’s chosen non-charitable heirs) dies or the term of the income stream is over, the remaining trust assets go to the qualified charitable organization(s) selected by the grantor.
Charitable lead trusts
A charitable lead trust is an irrevocable trust that is the opposite of a charitable remainder trust. A CLT pays an income stream out to a qualified charitable organization for a set period of time, and when that term is up, hands the remaining trust assets over to the grantor’s heirs. The grantor receives a tax deduction for the present value of the income stream donated to charity, and can remove highly appreciated assets from the estate and transfer assets to heirs without any gift or estate tax consequences.
Working with an advisor
While all of these charitable giving tax strategies have benefits, it may not be easy for you to recognize the best time to employ them or decide upon which strategies work best in your situation. Working with trusted financial, tax and estate planning professionals can help you craft the optimal giving strategy to maximize your philanthropic goals and tax savings during your lifetime and beyond.
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This article is meant to provide background information and should not be considered legal guidance.