By Dr. James M. Dahle, WCI Founder
Guess what? The IRS (and thus Congress, the government, and Americans) wants you to give to charity. It knows (like you should) that you will come out behind financially for making those charitable contributions, but it also wants to lessen the financial pain a bit to encourage you to do more for humanity and the planet. Here are the seven tax breaks the IRS provides for those who participate in charitable giving.
#1 Charitable Donations Are Tax-Deductible
This is the one that most people know about. If you write a check to charity, you can take the amount of that charitable contribution as an itemized deduction on Schedule A. Of course, if you take the standard deduction ($12,550 and $25,100 married for 2021, and $12,950 and $25,900 married for 2022), that donation isn't going to reduce your taxes one lick. But if you do itemize and you have at least $12,550/$25,100 [2021] of other itemized deductions, such as taxes and mortgage interest, the charitable donation should be completely deductible.
If your marginal tax rate is 37% and you donate $10,000, that should reduce your tax bill by $3,700. Note that paying $10,000 to reduce your taxes by $3,700 is not a winning strategy. But if you're going to give the money anyway, it's nice to do it with pre-tax dollars. This helps you have $3,700 to spend somewhere else, or thought of another way, it helps you give an extra $3,700 to charity that you would not have been able to give otherwise.
In addition to cash, you can also donate stuff. If it is stuff that you don't really use, it's like free money. You do have to keep careful records of what is donated, to which charity (it can't be your brother-in-law), and on what date. This has a great side effect of decluttering your house. It usually works better than a garage sale, too. Rather than selling one-quarter of the stuff you want to get rid of for 10% of its value, you get to dump all of that junk for 30%-40% of its value, more than you'll usually get at a garage sale anyway. Plus, you don't have to spend your Saturday sitting in the driveway.
But wait, there's more. If you serve in a charity, you can deduct all of the expenses associated with your service. For example, if you drive the scouts to scout camp four hours away, you might be able to deduct 500 miles worth of travel at 14 cents per mile [2021] for a deduction of $70 ($26 off your tax bill if your marginal rate is 37%.) Granted, that's not even going to cover the gas, but it's better than a kick in the teeth. Unfortunately, you cannot deduct the cost (i.e., opportunity cost) of your time, nor can you deduct the value of charity care delivered in your office.
I've taken this deduction every year since at least residency, except in 2018 when I bunched my deductions into 2017 and took the standard deduction for 2018.
#2 Charitable Contributions Offset Capital Gains
This is a fun one that I do from time to time. Instead of giving cash to the charity, why not give them appreciated mutual fund shares from your taxable account? You get your usual charitable deduction, and neither you nor the charity has to pay the long-term capital gains taxes. Be sure you've owned the shares for at least one year. If you combine this tactic with tax-loss harvesting and smart fund selection, you can invest VERY tax-efficiently in a taxable account.
#3 Donor-Advised Funds Allow You to Save and Invest
This option is popular among finance bloggers. They like saving money on their taxes and they like investing. Like a 401(k), with a Donor-Advised Fund (DAF) you get to do both. Of course, you don't get to do any spending, but finance bloggers don't like that anyway. They prefer knowing they can spend to actually spending. With a DAF, they get to know they can give without actually giving. That's because you get the tax break (and start getting tax-free growth on the investments) when you put the money into the account, not when the charity actually gets the money. In fact, you can get the tax break and then leave the money in the account for decades without making any charitable distributions if you like. Kind of a jerk move, but I don't make the rules.
The other downside of a DAF is that there is usually another layer of fees. Even at low-cost mutual fund giant Vanguard, that's a substantial cost of 0.60% per year on the first $500,000 in the account (those fees get lower the more you contribute to the DAF).
So, why do people (who aren't jerks) actually use a DAF? Well, there are three main reasons.
The first is simply that a tax break now might be much more useful than a tax break later. This is Physician on FIRE's excuse for being a jerk front-loading his DAF in preparation for future giving. When I originally wrote this post in 2018, he was in his peak earnings years (in 2019, he retired from medicine at 43). He planned to have a dramatically lower taxable income for years and years afterward while taking the standard deduction, and he wanted to make sure he got the tax break so he could give as much as possible to his favorite charities. Plenty of others used a DAF at the end of 2017 to take advantage of the changes in tax brackets and the standard deduction going into 2018. Let's be honest. There are some reasons to make the contribution to the DAF now and distribute it to charity later (not sure which charity, charity can't handle it all at once, tax play for money you're not yet ready to give, using the giving to teach children throughout life etc.).
The second reason is for convenience. Although a DAF doesn't really work for tiny deductions (Vanguard has a $500 minimum for a gift from the DAF to a charity), it's a whole lot easier to keep track of one big donation to a DAF than dozens of smaller donations throughout the year. It is also pretty darn convenient for Vanguard, the charity, and you to gift appreciated shares to the DAF and then distribute cash to the charity instead of going through the rigamarole of donating appreciated shares directly.
The third reason is anonymity. With a DAF, you still get to control what charity gets the money (by “advising” the fund manager to make distributions). But the best part is that the charity doesn't get to know who sent the money. Some people really like that because it makes the contribution feel more “pure” to them. I like it because it prevents my mailbox from being filled with “charity porn.” Not only is it annoying and planet-destroying to have to transfer all that paper from my mailbox to my trash can, but it means more of the money I donated is going toward marketing and fundraising rather than the charitable cause I'm trying to support! If you immediately distribute money from the DAF, you get to avoid “pulling a jerk move” and you also avoid paying that additional layer of fees for long—all while getting the twin benefits of convenience and anonymity.
#4 Qualified Charitable Distributions Are Easier Than You Think
What is a Qualified Charitable Distribution (QCD)? It's actually my favorite way to donate money to charity. Unfortunately, I can't do it because I'm too young; you have to be 70 1/2 to do it. This is when, instead of taking a Required Minimum Distribution (RMD) from your IRA or 401(k), you instead have the IRA provider send all or part of the distribution to your favorite charity. This fulfills the RMD requirement (and prevents that nasty 50% penalty for not taking an RMD) and makes it so you don't have to pay taxes on the RMD (which begins when you turn 72). A QCD essentially allows a retiree to take the standard deduction and still get a deduction for the charitable contribution. I predict they will become more and more popular as people realize the effects of the new higher standard deduction on the value of itemizing.
Giving enriches both the giver and the receiver
I helped my parents do this in 2018 and 2019, and I couldn't believe how easy it was. At Vanguard, you simply go into the RMD screen, choose “sell the fund,” choose “send me a check,” type in the name of the charity, and hit enter. Then Vanguard sends you the check and you can forward it to the charity. Be sure the check is in the charity's name, not yours. The only way Vanguard could make this easier would be to send the check directly to the charity. (Hint, hint Vanguard.)
#5 Private Charitable Foundations Have Benefits
This is like the rich man's DAF. DAFs generally have relatively low minimum initial and ongoing contribution limits. Those limits at Vanguard are actually relatively high at $25,000 and $5,000, respectively, compared to other DAFs. At those sorts of amounts, a private charitable foundation doesn't make much sense. But at larger amounts, the benefits of a private charitable foundation start outweighing the additional expense and hassle.
There are two types of private foundations. An operating foundation operates the charity itself. A non-operating foundation makes donations to various charities, as the Bill and Melinda Gates Foundation does. Either way, the foundation has a board of directors who determine how it is run, and it is subject to stringent IRS rules.
The big benefits of a foundation over a DAF are that it can employ your children (or you) as members of the board, it can accept a wider variety of assets (like a family-owned business), and it can give money to organizations and people that are not IRS-qualified public charities.
The big downsides are the much larger administrative hassle, a 1%-2% excise tax on earnings, less anonymity, and a potentially more limited tax deduction. The deduction for a DAF donation is limited to 60% of AGI for cash donations and 30% for appreciated assets. For a private foundation, those numbers are 30% and 20%, respectively.
Most doctors aren't going to be forming a private charitable foundation, but it can make sense for some entrepreneurs, especially at the time of sale of their business.
#6 Charitable Lead Trust Can Reduce Estate Taxes
There are two types of trusts worth discussing here. The first is a charitable lead trust. With this, you donate money (or appreciated assets) to an irrevocable trust. The trust then makes payments to a charity for a period of time (such as the rest of your life), and upon your death, the remaining assets in the trust are distributed to your heirs. You can tweak the numbers around a bit, but the general rule is that the more that goes to the charity, the larger your initial deduction.
Note that unlike a DAF, which pays no taxes on the earnings in the account, or a private foundation, which pays very little, a trust pays taxes on earnings at a fairly high rate. A classic use for this sort of trust is an entrepreneur selling a business with some charitable desires. That person gives the business to the trust, gets a tax break for doing so, supports a charity for a few years, and then passes the rest on to their kids (or even back to themself). It doesn't make sense without a charitable desire, but coupled with one, it can be a slick way to reduce some capital gains, income, and estate taxes.
There are two types of lead trusts: a Charitable Lead Annuity Trust (CLAT) provides a fixed income stream to the charity, and a Charitable Lead UniTrust (CLUT) provides a variable stream.
#7 Charitable Remainder Trust Earnings Are Tax-Exempt
The other type of trust, often considered the “inverse” of a charitable lead trust, is a charitable remainder trust. In this case, you donate cash (or more likely an appreciated business) to the trust, get an upfront deduction, and collect annuity payments for the rest of your life (or designate them to go to one of your heirs for the rest of their life). Upon the death of you (or your heir), your designated charity gets whatever is left in the trust. Again, you can mess with the figures a bit, but in general, the more that goes to the charity, the larger your upfront deduction. Unlike the charitable lead trust, the earnings in a CRT are tax-exempt. The income stream, of course, is fully taxable to its recipient. A Charitable Remainder Annuity Trust (CRAT) provides a fixed income stream, and a Charitable Remainder UniTrust (CRUT) provides a variable stream.
As you can see, there are a lot of different ways to make charitable contributions while reducing your tax burden at the same time. Whether you prefer the simplicity of a check or the unique benefits of a complex foundation or trust, there should be an option that will work for you.
What do you think? Do you give to charity? How? Why? Comment below!
[This updated post was originally published in 2018.]
This puts me in the holiday spirit! Except for the part where you make us sound like Scrooges! The “knowing they can give without giving” is a bit harsh.
When people send money to the DAF, they cannot get it back. It is gone. It will all go to charity. When I established mine I wasn’t sure which charities I wanted to support. Now with more stock growth and time to research charities, I can continue giving a lot more and over a long time.
I actually do enjoy giving and I give large amounts of money every year. PoF and the others do too. In fact, it is one of the main reasons I keep working and investing past FI.
If you don’t want to look like a Scrooge, get busy on that researching thing and start making distributions from the DAF. How’s that stock growth going right now? The charity would have been better off to have gotten the cash a month ago than a smaller donation now.
Scrooge and jerks detest giving to others. I feel the opposite way.
Actually, I did donate four $500 grants a month ago. The fund is doing fine. I think I have a longer perspective. Stocks are a lot higher than when I started this particular fund in 2003. It has been both growing and giving annual gifts for over 15 years.
It acts like an endowment. Are you saying all foundations (Ford Foundation) should just give all money away today and never grow and give more in the future? Are you familiar with Ben Franklin’s fund that gave out grants for two hundred years per his instructions?
You get half credit for putting it in the foundation/DAF/endowment. You can have the other half when you distribute it! 🙂
Thanks for highlighting an important topic in the finance community! Giving to others in need is an important aspect of personal finance.
The DAF sounds intriguing. I first heard about it from POF. It will be a math game for us (making sure our charitable contributions plus our other deductions like our mortgage interest and SALT deductions add up to well past the standard deduction, etc). Last year it wouldn’t have made a lot of sense even if we had the large taxable account to do it. Going forward that might change, though.
I really like the idea of anonymity with giving for lots of reasons, including that my right hand shouldn’t know what my left hand is doing when I am giving to someone in need.
TPP
The DAF has nothing to do with itemized deductions. You either give enough to charity to itemize or you don’t. The purpose of the DAF (perhaps aside from facilitating the gift and keeping it anonymous) is allow you to get a tax deduction now without actually giving anything to the charity. It’s a tax timing play, not a charity play.
Right. I guess I couldn’t justify not giving now in order to give later for my benefit. Maybe I am starting to see why you called it a “jerk” move 🙂
I’m going to have to disagree. With the new larger standard deduction, occasional, large grants to a DAF make a lot more sense than giving enough to just over the $24,000 hump with itemized deductions each year (married filing jointly).
For us, the first $14,000 donated is not rewarded by the IRS each year. So unless you’re going way over that annually with charitable giving (which you are but few do), a DAF has everything to do with itemized deductions.
Best,
-PoF
Not really. All you’re talking about is bunching deductions. You can bunch deductions with or without a DAF. I bunched just fine last year without one, giving for both 2017 and 2018 in December 2017. The main point of a DAF is to get your deduction now but not give the money to charity yet. The convenience and anonymity are minor features.
With the recent changes in the tax law, a lot of people opened up DAFs in order to bunch several years’ worth of donations into one big contribution to the DAF so they can itemize at regular intervals. Give 2 years’s worth of donations to the DAF in year 1 and itemize, then pay out half of the contribution to charities; in year 2 take the standard deduction while paying out the rest of year 1’s contribution. Lather, rinse, and repeat.
Minor clarification: The way Vanguard does it, after you check, “Send Me a Check”, they’ll give you the option of checking a box, “Qualified Charitable Deduction”. If that box is checked, then will they ask for the charity name. If you don’t do this, they’ll send you the check in your name.
That’s exactly right.
Another advantage of a Qualified Charitable Deduction is that it reduces your adjusted gross income, which may significantly reduce what you pay for Medicare. Schwab has an elaborate form that must be filled out to make the QCD, but it can all be done on line, and the check can be sent by Schwab directly to the charity.
Good point, obviously only applicable below an income of $85K ($170K married). But that includes lots of retired docs.
Actually, the Medicare part B and D “income-related monthly adjustment amounts” (IRMAA) are graduated, beginning at $170,000, with progressive increases at annual incomes of $214,000, $267,000, $320,000, and $750,000 for a married couple. If you can use the Qualified Charitable Deduction to move you to a lower (IRMAA) level, a married couple can save close to $2000 in 2019 Part B premiums and $500 in Part D premiums.
Even more reason why it is my favorite way for a retiree to give to charity
You’re right; once you open a DAF we’re never going to let you live it down! 😉
You probably already know this, but donations from a DAF aren’t automatically anonymous; you have to specifically request that when you make the donation. You can swing the other way, too, and have the DAF include your name and address on the check (as well as the name of your DAF account) if you want the charity to know who made the donation. It’s nice and flexible that way.
When you set up your DAF account, you’ll be asked to give your account a name. To be 100% sure your donation will be anonymous, I’d suggest not including any part of your name in your fund name. I made the mistake of naming my Schwab Charitable account The Artemis Charitable Fund; now I wish I’d gone with a more cryptic name like The Prairie Star Charitable Fund. That would have given me three donation options (completely anonymous, semi-anonymous with fund name only included in the letter, or fully transparent with fund name plus my name and address included in the letter) Instead of only two (either anonymous or not anonymous).
Good tips, thanks.
I’m contemplating opening a second DAF with Fidelity specifically for the blog for this reason. The Physicianonfire.com Fund. I can give via name only and the recipient will know where it came from, but cannot easily find an address to send their marketing materials to.
Glad to see PoF finally won the DAF battle, haha.
Merry Christmas!
Didn’t realize there was a battle. As I recall, my position was always that I would use a DAF as soon as I saw an advantage for me in it and that it’s a bit of a jerk move to get a tax deduction for giving to charity without actually giving to charity. The advantage for me is to decrease the charity porn in my mailbox which I thought I could avoid just by giving to them anonymously. Doesn’t work though if you actually want a receipt. They still send you the charity porn.
You didn’t realize there was a battle? I took the Pro/Con as one, but I was using literary license.
The best Pro/Cons are the ones where you could argue either side.
Seriously though, my main problem with a DAF is giving yourself a pat on the back when you put the money into the DAF instead of when you take it out.
Expect to continue receiving charity porn in your mailbox for a few years after your switch to using a DAF. The charities you’ve previously donated to by check/credit card will still keep your name and address on their mailing lists for a while, because they will be hoping to win you back. It’s easier to win back a previously active donor than to try to convince someone who has never opened their wallet for their cause to start giving. (Obviously the charities won’t know you’re still donating, just anonymously via your DAF.)
Excellent article, as always. Note, though, that qualified charitable distributions can come only from IRAs, not from 401(k)s or other employer retirement plans (except for inactive SEP or SIMPLE IRAs).
Excellent point, although I see little reason to not roll 401(k)s into IRAs after age 70. Maybe if you were still working.
Excellent Post! Here are a few more ways the IRS incentivizes charitable giving:
Charitable Gift Annuity: A contract between a donor and a charity, where the donor receives a partial tax deduction and a lifetime stream of income, in return for an irrevocable donation. A typical minimum donation is $10,000 to $20,000. It is generally possible to donate appreciated assets, avoiding cap gains tax. The annuity payment is a mix of taxable income and return of principle, until reaching statistical lifespan, then the entire payment is income. The minimum annuitant age is typically 50-65. The immediate tax deduction is a function of annuitant age, amount donated, current rates, etc. Provides some of the features of a CRT, at a lower donation commitment and lower administration costs.
Pooled Income Fund: A trust created and managed by a charity. Assets from multiple donors are combined into a common pool for investment purposes, where donors have “units of participation”. Although different in structure, the benefits are similar to a charitable gift annuity or a CRT. Each donor receives a pro-rata share of the total rate of return of the pooled income fund, each tax year, with the charity retaining the balance upon the donors death.
Making a charity the beneficiary of a traditional IRA, 401K, 403b, HSA, etc.: Tax deferred accounts are not tax efficient for heirs, so if one has charitable intent, it is better to name a charity as the beneficiary of these instruments and have heirs inherit step-up-basis assets. Note that your DAF can be a beneficiary and then support several charities as a legacy.
By selecting beneficiaries in the most tax efficient manor, both heirs and charities will net more funds.
The annuity would have been a good one to include in the post, thanks!
The pooled income fund is just a variation on the themes.
I agree IRAs are the best account to leave to a charity instead of your kids.
I have a Schwab DAF and I love it. I have my investments with Schwab so its very easy to donate appreciated equities to my DAF. Its just a couple of clicks and I get the tax benefit.
It must be nice to have appreciated shares. I’m almost out of those.
An interesting charity deduction besides mileage for charitable activity is paying a babysitter during your charitable activities. Slightly controversial since IRS Pub 526 page 5 lists it as an example of a deduction that can’t be taken. However, it was adjudicated in an IRS tax Court case and was permitted. It’s also recommended by TurboTax
https://turbotax.intuit.com/tax-tips/fun-facts/9-things-you-didnt-know-were-tax-deductions/L6M1dynSH?cid=em_41580_6802_006b_2018
It’s probably not worth it for a night here or there but where it helps me is if I do a weekend mission trip or chaperone a high school trip and pay a babysitter a few hundred dollars for the weekend.
Interesting tactic. Definitely sounds a bit gray, but I like to call the gray areas in my favor. Tie goes to the runner. Not sure there’s any significant deduction there for me though.
I’ve done the calculations and concluded that if people would give 10% of income, most government welfare would be unneeded. It would be great if the first 10% of income given were a straight tax credit. I feel like private charities acting locally do a much better job of helping people than does the government.
That would be a huge increase in how much the government subsidizes/encourages charitable giving.
Great post about the nuances of charitable giving. I would simply highlight the role of Community Foundations in this regard. While the large institutions are an option for a DAF, locally based Community Foundations, like mine; https://cfncw.org/ , allow you to establish a DAF and give to any nonprofit anywhere, but also use a small % of interest from their amassed holdings to support non-profits locally. Support your community and neighbors while simultaneously keeping all your options open. Our Healthcare System has also partnered with our Community Foundation to run our institutional charitable giving campaign, so matched donations augment our local impact. Keep an eye out for your local Community Foundation.
Thanks for this article. My spouse and I have been trying to decide whether to start tithing to our church with appreciated stocks instead of cash. As far as I can figure, my current taxes would not be affected, but it may save me some capital gains taxes in retirement through unofficially stepping up my basis (donating old stocks and using the money planned for charity to buy new ones). Are there any downsides of giving to charity through shares that we should be thinking about?
Exactly.
Not really.
You still would get the same tax deduction as giving cash.
Thanks!
Can you explain what my net out of pocket cost for a charity gala/dinner is in this situation? Tickets = $1500, tax deductible = $1150 (stated by the organization). AGI >$100k. Is my net out of pocket cost ~$350?
Sounds like it.
“The fact is, if you’re a billionaire, you don’t need any income.”
Biggest quote of the century, I guess!
I actually found this article looking for your opinion on bunching vs giving each year to charity. Unfortunately I don’t see any comments about bunching donations other than you did it once in residency. Wondering your thought of bunching 2-3 years together vs giving each year. We give about 25k to our church each year and 10k to other charities. Have about 10k in state taxes (property and sales tax) we can deduct each year. 24% marginal tax bracket. In running this through fidelity’s bunching calculator, it indicates we would we would save 12k by bunching 2 years of giving and 20k by bunching 3 years. Seems like better ROI than investing and later donating appreciated shares each year. What are your thoughts and why did you only bunch donations once?
I appreciate your article. My wife and I have been debating whether to begin making tithes to our church out of appreciated equities rather than cash. As far as I can tell, my current taxes wouldn’t be impacted, but I might be able to avoid paying some capital gains taxes in retirement by raising up my basis clandestinely (donating old stocks and using the proceeds to purchase new ones). Are there any drawbacks to donating to charity via shares that we need to be aware of.
No.