Want to contribute to your favorite church or charity? If done correctly, your donations can save you significant taxes. Here are some strategies to consider, but make sure to discuss them with your tax advisor to make sure they are appropriate for you.
If you donate a stock that has appreciated, you can save taxes in two ways. First, you won’t be taxed on the appreciation of the stock, and second, you might be able to deduct the full value of the stock (if you itemize deductions on your tax return).
Example: Ten years ago, Mary inherited 1,000 shares of stock in XYZ Company from her mom. At that time, the stock was valued at $75 per share. Today, the stock is valued at $200 per share. Mary wants to donate $10,000 to her favorite charity and use the stock. If she sells the stock then donates the proceeds, she will realize capital gains and may owe capital gains taxes. A better idea would be for Mary to donate the 50 shares of XYZ Company stock directly to the charity. In this way, she will not realize any capital gains, and can still get a tax deduction of up to $10,000 (if she itemizes). The charity can then sell the stock with no tax consequences.
The Tax Cuts and Jobs Act of 2017 (TCJA) dramatically increased the standard deduction amount. Because of this, most taxpayers are better off taking the standard deduction instead of itemizing their deductions. This makes their tax preparation easier, but they lose any tax benefits from making charitable contributions if they don’t itemize. By grouping your charitable contributions every other year, taxpayers might be able to itemize (and save taxes) every other year.
EXAMPLE: John and Diane are married, so their standard deduction for 2019 is $24,400. Their deductible mortgage interest and property tax total $19,300. They want to donate $5,000 to their church. Combined, the mortgage interest, property tax, and church contribution add up to $24,300, so they are still better off taking the standard deduction of $24,400. The $5,000 donation to their church does not save them any taxes. John and Mary decide that instead of donating $5,000 a year to their church, they will donate $10,000 to their church every other year. The $10,000 donation allows them to itemize their deductions every other year since they exceed the standard deduction amount in those years. Then they take the standard deduction in alternate years when they make no donation.
Taxpayers who have reached the age of 70½ must begin taking Required Minimum Distributions (RMDs) from their Individual Retirement Accounts (IRAs). These distributions are taxable, and must be taken even if the taxpayer does not need the money to live on. One way to reduce or eliminate the taxes is to make a Qualified Charitable Distribution (QCD) from your IRA directly to your church or charity. The QCDs are not taxable and can satisfy part or all of the annual RMD requirement.
Example: Fred and Barbara are both age 75 and must take RMDs from their IRAs in 2019. Fred has to take a $11,500 RMD, and Barbara has to take a $14,500 RMD, so their RMDs total $26,000. Fred and Barbara also have a pension and Social Security, and don’t need the RMDs to live on. They want to donate $14,500 to their favorite charity this year. Barbara requests that her IRA custodian (Fidelity) issue a QCD check from her IRA made payable to her favorite charity. The check is mailed to Barbara and she gives it to the charity. This reduces Fred and Barbara’s taxable income by $14,500 in 2019.
High income taxpayers who want to contribute significant amounts to their church or charity may want to consider a donor-advised fund. A donor-advised fund allows the taxpayer to make a large deductible contribution one year so they can itemize that year. They can then instruct the donor-advised fund to pay out a certain amount to their church or charities in future years.
Example: Hugh and Laurie have adjusted gross income of $300,000 per year, and want to give $10,000 per year total to their church over the next 10 years. Unfortunately, they don’t have enough deductions to itemize, so they get no tax benefit from the $10,000 per year donation. Instead, they decide to donate $100,000 to a donor-advised fund this year. Since the $100,000 is greater than the standard deduction, they get to deduct most of the $100,000 this year. They can then direct the donor-advised fund to send their church $10,000 per year over the next 10 years.
Talk to your tax advisor to see if any of these strategies make sense for you.
Story by Jim Kerr, CFP®, EA, CLU®
Wealth Management Team, Austin Asset