Helping develop tax-efficient charitable giving strategies for our clients is an important part of our wealth management practice. In this blog, we will highlight the current tax environment and offer several insights to the types of strategies we are implementing for 2021.
In 2018, the Tax Cuts and Jobs Act was passed, with the goal of simplifying the tax code and providing for several tax incentives. This Act significantly enlarged the standard deduction, as an estimated 90% of US households no longer itemize their deductions on Schedule A. Right away, you’ll note that unless you have a significant level of charitable donations, making them no longer earns a reduction in your income tax. However, if you’re over 70 ½, there is still a way to contribute to a charity that directly reduces your Adjusted Gross Income, even if you use the standard deduction.
In 2021, the federal standard deduction is as follows:
- $12,550 for singles
- $18,650 for head of household
- $25,100 for married filing jointly
For those over 65, there is an incremental standard deduction of $1,300. The simplification means that unless your total of donations, medical expense, mortgage interest, and state and local taxes do not exceed the standard deduction, you no longer itemize. However, there are still several viable strategies for reducing taxes whether you itemize deductions or not.
Strategies for Those Who Still Itemize Deductions in 2021:
- Donate Appreciated Stock: Donating appreciated stock that has been held for one year and one day helps you in several ways. You avoid paying taxes on the gain, the charity gets the full value of the stock, and you will realize the full value of the stock on the day of transfer. In general, we advise to not gift stock in which you have a loss. Sell the stock and realize the loss first, which will provide you a tax-loss that can reduce your income tax. Once the loss is realized, you are then able to gift the proceeds to your charity.
- “Bunching” Donations: This strategy means that you might make group two or more years’ worth of a charitable contributions and gifting them in the same year, rather than giving each year. This will help you to exceed the standard deduction for that year of the gift and earn a potential reduction in income tax. You may want to communicate your intention to your charity, so that they understand the timing of your gift and can plan accordingly.
- Gifting Life Insurance: You may hold an old, cash-value life insurance policy that featured a modest death benefit that no longer makes a meaningful contribution to your estate plan. You may gift the policy to your charity and receive a charitable deduction that approximates the cash value of the policy. Please note that if you have taken any loans from the cash value, the loans must be repaid before making the gift. This could be combined in a “bunching” year.
- Use a Donor Advised Fund: If you have regular plans to give to a charity and have a particularly high year of income, using a Donor Advised Fund may be an excellent strategy. Donor Advised Funds are managed by a non-profit custodian and are designed to accept, hold, and administrate gifts to other charities on behalf of donors. The DAF might be named for your family (The Smith Family Fund) and can accept appreciated stock, appreciated mutual funds and even real estate. You can gift several years’ worth of donations to the DAF in one year and take the entire deduction for that return. You can then direct the DAF to grant the funds to a charity of your choice at a later time. The custodian will provide recordkeeping of the gifts and verify that the grant recipient is a qualified 501(c)3 charity. Grants may be set up for monthly, quarterly, or annual schedules and there are no requirements that grants be made in any particular year. There is generally a minimum dollar amount for a grant that the charity will accept and some administrative fees will apply. This is often seen as a favorable alternative to “bunching” contributions to a charity, since you can take the deduction in a given year but continue to administrate the gifts on a regular basis (monthly, annually, etc). Note that your DAF may also remain invested, giving your donations a chance to grow over time.
If You Take the Standard Deduction, and are Over the Age 70 1/2
- Gifting from Your Traditional IRA: If you are over 70 ½, you may contribute directly from your Traditional IRA to your charity. This is referred to as a Qualified Charitable Distribution. Why make a charitable contribution in this way? It directly reduces your Adjusted Gross Income, and therefore your income taxes. You can still use the Standard Deduction. In essence it allows you to have both the standard deduction, and a reduced income from your contributions. If you are taking Required Minimum Distributions (RMD), a Qualified Charitable Distribution will satisfy some or all of the RMD for that year. The charity must be an IRS approved 501(c)3 charity. It is necessary to alert your tax preparer that have made the gift and provide documentation. The preparer will know how to let the IRS know what you have done. Note that if your retirement savings are held in a 401(k), 457, or 403(b), the approach is not allowed. To take advantage of this technique, your will have to open an IRA, and transfer funds from the 401(k) (which is not a taxable event), and then proceed.
The Bottom Line
Contributing to a charity can be a way to help others and lower your tax bills. Taxes can be complicated, so we advise consulting with your CFP®, Financial Advisor, or CPA prior to taking action. As it relates to your financial planning needs or implementing the right strategy for you, please reach out to us if we can be of assistance.
The commentary is informational in nature and not intended to imply a specific strategy or course of action. Investment advice and recommendations are only provided according to each individual’s personal circumstances. Chancellor Wealth Management is an investment advisor firm registered pursuant to the laws of the state of Georgia. The firm is also registered to conduct business in the states of South Carolina and Texas. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright © 2021 Chancellor Wealth Management, All rights reserved.