One of the most common tax mistakes our wealth management firm consistently witnesses can be traced back to poor choices surrounding charitable giving. Many people will make out checks to their favorite charities and then report this information when it comes to tax time. Unfortunately, this simplistic approach can leave tax savings on the table. Today I am going to share two strategies designed to help you.
Donate Appreciated Investments
Many people choose to donate to their favorite charities by simply writing out checks from their bank account. If you can itemize deductions on your tax return, this may provide you with a tax deduction. However, other methods can provide additional tax savings.
If you own an appreciated investment, you may be able to donate it directly to your charity. By donating an appreciated investment, you can still receive the same tax deduction as if you had written a check, plus you avoid future capital gains taxes on the appreciated investment. Charities do not pay taxes, so they will be able to use 100% of the proceeds from the appreciated investment donation. By implementing this strategy, the charity gets the same amount when compared to receiving a check. You avoid capital gains tax and deduct the donation if you’re able to itemize deductions.
Many people who donate to charity take the standard deduction when filing their tax returns because they do not have enough deductions to itemize their deductions. Examples of costs that can count towards itemized deductions may include mortgage interest, personal property taxes, charitable donations, and various other items. A household would only itemize deductions if the collective total of all of their itemized deductions were greater than their standard deduction. Unfortunately for many people, this does not occur, and they do not receive any tax savings for their charitable donations.
The solution to this problem includes increasing your itemized deductions. One way to increase your itemized deductions could include prepaying your charitable donations into something called a donor-advised fund. A donor-advised fund is like a charitable investment account that allows you to contribute money that will be donated in future years while receiving an immediate tax deduction. Combining several years’ worth of donations into one year can increase a household’s itemized deductions above the standard deduction amount, thereby providing an additional tax deduction that would otherwise not be realized. Our firm calls this strategy “Charitable Stacking” as you stack multiple years of donations into one year.
The money that is contributed to a donor-advised fund can be diversified into a variety of different investment options while you are waiting to donate the money in the future. Each year you will be able to contact your donor-advised fund team and let them know the amount and names of the charities you would like to donate to for that year.
To amplify the benefits of the charitable stacking strategy, one could combine it with the donating appreciate assets strategy. This can be accomplished by funding multiple years’ worth of charitable donations into a donor-advised fund with an appreciated investment instead of simply writing out a check to the donor-advised fund. The benefits of combining both strategies are twofold, not only do you avoid paying taxes on the appreciated investment, but you also get to deduct the amount on your tax return. For the best results, consider implementing this strategy in years where your tax bracket is elevated, making the deduction from the strategy more valuable.
To illustrate the power of implementing these strategies, I will use a hypothetical example:
- Darin and Kristie typically donate $4,000 per year by sending checks to various charities.
- They have been unable to receive any tax benefit for their annual donations because their itemized deductions do not exceed their standard deduction.
- Darin and Kristie own a stock that has appreciated significantly from $100 to $20,000.
- Total taxable income equals $150,000, which places them in the 24% tax bracket.
- Darin and Kristie are just below the threshold for being able to itemize their deductions.
- We will assume that there is no special legislation that allows for additional charitable deductions like we have presently due to the COVID stimulus bill.
Tax Savings Strategy
Darin and Kristie decide to make their usual $4,000 worth of donations and also choose to contribute an additional four years’ worth of donations totaling $16,000 into a donor-advised fund. Instead of writing checks out for their charities and the donor-advised fund, they decide to use their appreciated stock.
Since Darin and Kristie were on the cusp of itemizing their deductions previously, the additional $16,000 deduction this year could save them from paying 24% tax on the entire $16,000 contributed to the donor-advised fund for a total tax savings of $3,840. In addition to the tax saving from the deduction, they would also avoid future capital gains tax on the appreciation of their stock, which could save them $2,985 at today’s capital gains tax rates. So collectively, between the $3,840 from the additional tax deductions and the $2,985 in capital gains tax savings, the total tax savings would be $6,825. If Darin and Kristie continued donating the way they were previously, they would have continued to receive no tax savings.
If you donate to charities annually, several strategies can be implemented to provide you with more significant tax savings. The onus to implement these strategies is somewhat dependent on you, even if you have a CPA that you work with. The onus is on you because your CPA might not collect information on the types of investments that you own, which prevents the CPA from knowing the most beneficial assets to donate. I hope the strategies shared with you provide you with the foundation needed to implement your charitable tax savings strategy.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Great Valley Advisor Group, a registered investment advisor. Great Valley Advisor Group and Bernicke Wealth Management are separate entities from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.