Did you know that 41% of charitable giving occurs in December? I like to think people are motivated by the season, but the fact that the tax year is coming to end probably has something to do with it as well, as evidenced by the fact that 10% of giving occurs on December 30th or 31st! Whatever your motivation, I applaud you for supporting charitable causes. I have given a significant percentage of my income toward charitable causes for years, and I think the act of giving not only helps others but helps me to be a better person. If you don't currently have a habit of giving to charities you support, I suggest you develop one, no matter what your income, debt, or net worth. Following are a few ideas for maximizing tax benefits for charitable purposes:
Tax Benefits for Charitable Donations
1. You Can Deduct Your Charitable Contribution on Schedule A
Although only 10% of Americans itemize, the percentage of doctors who itemize is far higher. At least once you get past the standard deduction, your donation will be completely tax-deductible. That means that for a physician with a 38% marginal tax rate (33% federal plus 5% state), a donation of $10,000 to a qualified charity will save her $3800 in income taxes. It is possible that these savings could be even higher if you are currently in a phase-out range. Obviously, this isn't a method of making money (since you're giving away more than you're getting back) but it does make it possible for you to donate more to a cause you support than you would otherwise be able to.
2. You Can Donate an Appreciated Investment Without Having to Pay Capital Gains Taxes
For example, if your $10,000 donation was composed of shares of a mutual fund for which you paid $5000, you would save $750-$1190 in capital gains taxes by transferring the appreciated shares to the charity, rather than selling them and donating cash. Note that if you have not owned the investment for at least one year, you only get to the basis amount as your charitable deduction, not the full value of what you donated.
3. You Can Avoid Estate Taxes
For 2021, if you have an estate larger than $11.7 Million ($23.4 Million married), or as little as $675,000 in some states, a donation to charity either prior to or at your death decreases the size of your estate. It is possible that you could save as much as 40% in federal estate tax and 20% in state estate tax. Combining the deduction for the charitable donation, the avoidance of capital gains taxes, and the avoidance of estate taxes, donating $10,000 could be the equivalent of spending just $2004 in a worst-case scenario!
Tax Benefits for Other Charitable Giving
1. Donor-Advised Charity FundVanguard and Fidelity, have donor-advised charity funds. With these funds, you transfer your appreciated assets into the fund, then “recommend” to the fund which charities the fund should donate to. You get your tax deduction, dispose of capital gains, and reduce the size of your estate upon making the donation. You can then choose to invest in any of their funds, growing the money tax-free until such a time as you choose to recommend a donation to a charity of your choice. The fund then liquidates the investment and sends the money to your charity of choice. This provides convenience in planning your taxes and in making your donations. In addition, many charities, especially small ones, aren't set up to receive donations in kind, so this allows you a method to avoid capital gains taxes and still give cash to the charity.
There are three downsides to using a donor-advised charitable fund. The first is that you can only recommend donations to qualified 501(c)(3) charities. You can't just give money to the poor lady down the street or provide a scholarship to a deserving fellow. A private charitable foundation, not to mention a private individual, has a little more freedom in the charities it can give to. The second downside is that investments are a bit limited. Vanguard's offering, for instance, is composed essentially of Admiral shares of its popular index funds—Total Stock Market, Total Bond Market, Total International (and its components), Short Term Bond, Money Market Fund, and a few Fund of Funds made up of various asset allocations of these funds. Expense ratios range from 0.06% to 0.20%. The investments available at Fidelity are almost exactly the same, using their Spartan Index Funds. The third downside is the additional fee the donor-advised fund charges, 0.6% for the first $500,000 you have in the fund at either investment company.
2. Private Foundation
Another option is to start your own private charitable foundation. This requires a much larger donation ($500,000 is often suggested) to make it worth the additional costs and hassle of running a foundation. In return, you get more flexibility in your investments and in who can receive donations, such as individuals, businesses, and overseas organizations.
3. Charitable Remainder Trust
One way to combine a charitable impulse with an estate planning tool is to use a charitable remainder trust (CRT). With this type of trust, you put in a lump sum and take a tax deduction on it. This deduction will be less than the amount you donated as it must be discounted to its present value due to the fact that the charity won't get the money for a few years. You (or your spouse or a charity of your choice) then receive fully taxable income from the trust for a specified number of years or until you die, then the charity gets the “remainder”.
One estate planning reason that people choose to use a CRT is if they have a highly appreciated asset that produces no income, and they want some income. It is especially useful if estate taxes are an issue. For example, consider someone who owns a $10 Million property that he bought for $1 Million decades ago. If he sells it, he may owe as much as $2.14 Million in capital gains taxes. If he donates it to charity, and it is discounted down to a present value of $5 Million, then he gets a $5 Million tax deduction. The trust then sells the investment tax-free, invests in a reasonable portfolio, then provides the grantor an income of perhaps 5% a year ($500K) until his death. Keep in mind that the higher your desired income, the less of a current tax deduction you will get (and the less the charity will receive). There are a lot of other ways to structure a charitable trust. For instance, a charitable income trust (or charitable lead trust) pays the income to a charity until a specified date (such as your death) and then gives the remainder to your heir. If a trust is a consideration for you, then consult with a qualified estate planning attorney in your state.
What do you think? Do you donate money to charity? Do you do so directly, using a donor-advised fund, using a private foundation, or with a trust? Comment below!