By Denise Downey
As the end of the year approaches, donation season is upon us. Not everyone associates charitable donations with tax law but these two areas have long been intertwined.
US Tax Law has two main goals. Most people only know about the first one: they understand that the goal of the IRS is to collect money through taxes.
But tax law is also meant to incentivize. The IRS is happy to allow you to pay less in taxes if you donate to charitable organizations.
This means that donating is a win-win. Charities receive their funding, and you may receive a break on your tax bill.
There are multiple ways to donate to charities. Here are some of the common and less common strategies.
The Traditional Model
Handing over a check or cash is the classic way to donate to a charitable organization.
Many people forget this: your donation is tax-deductible. This means that you can subtract that amount from your taxable income when reporting your taxes, which ultimately means you will pay less in taxes.
In 2021, you can deduct up to $300 ($600 for married couples) of cash donations. You can donate more than this amount but the tax benefits stop there unless you itemize your deductions.
If you have no idea whether you itemize your deductions or use the standard deduction, then you’re probably already doing the latter. Most accountants do not recommend itemizing your deductions unless your deductions exceed the “standard deduction” ($12,550 single filers / $25,500 joint filers for 2021).
This method is the easiest way to donate for most people, but with a little extra effort (and paperwork), you may get more bang for your buck.
In lieu of a check, you can donate stock.
Appreciated stock, i.e. stock whose value has grown while you’ve owned it, is a great way to give.
When you sell appreciated stock, ETF’s, or mutual funds in a taxable account (i.e. non-IRA or 401k), you pay capital gains tax. However, you can donate shares of your investment directly to a charity.
You won’t have to pay the capital gains tax and—bonus—the charity also does not have to pay capital gains tax. A win-win!
Allowing nonprofit organizations to receive assets tax-free is one of the ways the IRS incentivizes people into donating to them.
Charities are accustomed to receiving donations in the form of stock. If you need help figuring out how to do it, reach out to the organization you want to donate to and ask them. It will make their day.
Donor Advised Fund
A Donor Advised Fund, or DAF, is a giving account that can be set up at most financial institutions. You can donate money (cash or appreciated stock) to this account and claim the tax benefit in the year of the gift.
You receive the tax deduction in the year you make the deposit to the DAF. However, now you have the freedom to make donations to organizations now or later. You can save up funds over the course of a few years and provide one large check to a charity of your choice. Or you can send out multiple donations to a variety of organizations over several years.
This is a great option if you have a high-income year. Rather than paying extra in taxes for an unusually lucrative year, you can funnel the funds into your DAF and disperse it whenever you want to.
One thing to note is that there are fees and investment risk with these types of accounts. But overall, they’re a excellent long-term vehicle for holding your money. Just remember to spend it!
Qualified Charitable Distributions
If you’re reading this and you’re under 72, this next strategy won’t apply to you (though your parents may be interested).
People over 72 are subject to Required Minimum Distributions from tax-deferred retirement accounts. The IRS requires you to withdraw a small portion of your tax-deferred savings (traditional IRA, 401k, 403b) each year once you turn 72. These distributions add to your taxable income for the year, i.e. you pay taxes on the amount withdrawn.
The good news is that you can donate part or all of your Required Minimum Distribution (up to $100,000) directly to a charity. The money donated is not added to your taxable income.
Financial advisors often recommend saving as much money as possible through your career so that you’re not entirely dependent on social security checks once you’re in your 70s and 80’s. However, that means that once savers reach 72, they sometimes don’t need all the funds that they are required to distribute.
If that describes you, then reach out to your favorite organization for details on how you can send your RMD’s their way.
Tax law should not be the most exciting part of your holiday season but it can have a big impact on organizations you care about. Many charities collect their annual budget between Thanksgiving and Christmas. They’re happy to receiving funding any way you can provide.
And if this isn’t the year that you donate millions in accrued stock positions, that’s fine too. Donating your time and expertise goes a long way. You may not see the tax benefit, but the impact is just as real.