Tax Break Charitable

In Retirement, Get a Bigger Tax Break From Your Charitable Donations

As you transition to your retirement years, it’s a big mistake not to strategically think about “how” you are going to make donations.

The first strategy is available to anyone who has appreciated investments held outside of IRAs.

The second strategy is only available once you have reached age 70 ½, regardless of whether you are subject to a Required Minimum Distribution from your IRA.

Strategy #1: Donating Shares vs. Cash

As we have discussed on many occasions, any gain realized when selling shares of an investment held outside of IRAs is subject to capital gains taxes.

However, when you donate shares of these appreciated investments, as opposed to donating cash, you can avoid these capital gains and potentially make a bigger charitable donation.

Without thinking strategically, you would simply sell shares of an appreciated investment, pay the capital gains tax, and then donate the proceeds to charity.

A more effective method is to donate the shares directly to the charity prior to selling them.

Let’s walk through a quick example of someone in the 32% federal tax bracket making a $10,000 donation.

Sell Your Shares and Donate the Proceeds

Let’s assume the investment you purchased years ago for $4,000 is now worth $10,000.  If you sold it, $6,000 would be subject to capital gains tax.

At a combined federal and state capital gains tax rate of 25%, you would owe $1,500 in taxes, thus netting you out at $8,500 after taxes.

Assuming you then donated the $8,500 proceeds to charity, the charity would receive $8,500, and your federal income tax savings on your donation would be $2,720 (32% bracket).

Donate Your Shares Instead of Cash

As an alternative, if you donated the full market value of your shares to charity directly, $10,000, your tax savings on your donation would be $3,200 (32% tax bracket).

And, your charity would receive $10,000 instead of $8,500.

The key component of this is your charity of choice does not pay capital gains tax when they sell your shares because charities don’t pay taxes.

Mechanics of Donating Shares of Stock

The mechanics of this are actually quite simple.  You have two options:

  1. Ask your charity of choice for their gifting instructions for donating securities (Account custodian, Account number, DTC number, etc.). All sizable charitable organizations have brokerage accounts which receive charitable donations of shares.

    Provide these written instructions to your account custodian, i.e. Charles Schwab, and designate the holding you wish to donate and the number of shares.

    You would then receive a receipt indicating the fair market value of the donated shares to use for income tax return preparation.

  1. The second option, which I have personally implemented and use annually, is to donate these appreciated shares to a charitable fund. Once you donate your appreciated shares to this separately designated fund, you qualify for the charitable deduction.

    From there, the charitable fund sells your appreciated holdings and you instruct the charitable fund custodian to make your desired donations.  The account custodian sends a check to your charity(s) of choice.

    The importance of this method is two-fold:

  • First, it simplifies the process because you only have to donate shares to one fund instead of multiple charities.
  • The second key component is it allows you to donate amounts larger than you are planning to donate in a given year, qualify for the larger itemized deduction, and then make donations on your timetable.

    ** This is very important with the current tax law because of the larger $25,900 standard deduction most Americans filing jointly now qualify for ($28,900 for those age 65 and older), thus potentially eliminating the added tax benefits of making charitable donations because you already qualify for the higher deduction without the charitable donation.

If you would like to explore this in greater detail in your own unique situation, let us know and we can evaluate all options and implement the best strategy for your unique tax situation.

Strategy #2: Qualified Charitable Distributions

Another tax effective avenue for you to pursue if you have charitable intentions is Strategy #2: Qualified Charitable Distribution (QCD), i.e. making donations directly from your IRA!

The QCD strategy is available to you if you have reached age 70 ½.

When the Secure Act of 20200moved out the timetable for annual Required Minimum Distributions (RMD) from IRAs from age 70 ½ to 72, the timetable for making Qualified Charitable Distributions (QCDs) as a way to reduce your taxes on your RMD did not move with it.  What this means is you can still use the QCD strategy I’m about to reveal to you in the year in which you turn 70 ½ and beyond.

There are two important tax concepts at work to clarify here:

  1. RMD and QCD: Once you reach age 70 ½, the IRS mandates that you withdraw a certain amount from your IRA each year and pay income taxes on the amount withdrawn.

    As with Strategy #1, where most Americans donate cash or write a check to a charity after they have paid capital gains in order to free up the cash, many also do so after paying taxes on their IRA Required Minimum Distribution.

    With a Qualified Charitable Distribution (QCD), you make charitable donations directly from your IRA to the charity of your choice thus bypassing the multiple step transaction of making your required IRA withdrawal, paying income taxes, making a charitable contribution with the net amount, and then claiming the donation as a tax-deductible contribution.

  1. Itemized vs. Standard Deduction: If you already make charitable donations, what makes the QCD strategy so important is the change in 2018 tax law regarding itemized vs. standard deductions.  This doubled the standard deduction to $25,900 for couples and $12,950 for individual filers in 2022, and $28,900 and $14,150 respectively for those over 65 years of age in 2022.

    Couple this with the itemized deduction limit for state and property taxes of $10,000, and it’s more and more likely that you will be using the standard deduction because your itemized deductions may not exceed that $25,900 (pre-65) / $28,900 limit (post-65).

    While this is generally good news because filing is much simpler, it may mean that your charitable donations offer you no greater tax benefits because donations are itemized deductions.

    The huge benefit of the Qualified Charitable Distribution (QCD) in this case is you may still receive the tax saving benefits from a charitable contribution even though you file using a standard deduction.

    For example, if your itemized deductions, which include your charitable donations, total $25,000, you would file using the standard deduction and your charitable donations would not have provided any additional tax benefits.

    However, if you donate directly from your IRA to the charity, you are able to deduct the contribution even if you file using the standard deduction and reap tax benefits.

The mechanics of this are quite simple.  You simply provide the custodian of your IRA with the name of the charity and the amount you wish to donate, sign the appropriate form, and the custodian withdraws funds from your IRA and makes the donation in your name.

If your IRA Required Minimum Distribution for the year was $50,000, and you made a Qualified Charitable Distribution of $5,000 from your IRA, you would only pay income taxes on $45,000 instead of $50,000.

Intentional and Strategic

The key with each of these strategies is to always be intentional and strategic with everything you do financially, even making charitable donations.

While making charitable donations is a very noble thing to do, taking a few minutes to explore your options not only increases your tax benefits, but the organization you donate to receives more benefits too.

If you would like to explore any of these in greater detail in your own unique situation, simply let us know.

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