How Charitable Giving Can Lower Your Income Taxes: 4 Smart Ways To Give Tax-Efficiently!
How To Lower Your Income Taxes With Strategic Charitable Giving!
Presented by Irvine based Financial Advisor JP Geisbauer,CPA, CFP®, of Centerpoint Financial Management.
***Transcript***
(Edited for grammar and clarity.)
Donating to charities can provide two critical benefits: it allows you to support causes close to your heart, and it can provide significant income tax benefits. However, it doesn't always work out this way. Without proper planning, the income tax deduction associated with your charitable giving could be limited or, worse yet, eliminated. In this video, I'll discuss four ways to structure charitable giving to maximize the related income tax benefits. So, if you want to avoid wasting income tax deductions, watch this video.
Hi, my name is JP Geisbauer, Founder of Centerpoint Financial Management. I'm a Certified Financial Planner Professional (CFP®), a Certified Public Accountant, and this channel is dedicated to helping diligent savers maximize their lives and minimize taxes as they transition into retirement.
Before we dive into the four specific strategies, I wanted to briefly discuss how charitable donations are deductible for income tax purposes.
I don't need to tell you this, but taxes are complicated. And I'll be painting with some broad strokes here. So don't consider this individual income tax advice. But this is important information you may want to learn and incorporate into your income tax planning.
When calculating their taxable income, US taxpayers can use either the standard deduction or itemize their deductions. The three most common itemized deductions are state and local income tax (typically property or state income tax), mortgage interest deduction, and charitable giving. In 2024, the standard deduction for a married filing jointly couple is about thirty thousand dollars. This means that to qualify for itemizing your deductions, you would need over thirty thousand dollars of itemized deductions.
Now, it used to be easier to itemize. However, as part of the 2017 Tax Cuts and Jobs Act, the standard deduction was raised, and the state and local income tax deduction was capped at $10,000. This shift has made it much harder for taxpayers to itemize their deductions.
Let's go through an example. (The video includes exhibits to help illustrate the example. If the following text is unclear, please watch the video.) In this example, we'll take a married filing jointly couple that has taxable income of three hundred thousand dollars per year. As a result of that taxable income, they have state income tax of twenty-seven thousand dollars per year. They own a home worth about one point five million dollars and pay property taxes of twelve thousand dollars a year. They also have a mortgage on which they paid fifteen thousand dollars of mortgage interest last year—so adding the state and local income tax, they've paid thirty-nine thousand dollars. However, because the salt cap is at ten thousand dollars, they will only get a ten thousand dollars deduction for that amount. Add that to their mortgage interest of fifteen thousand dollars, and they have total itemized deductions of twenty-five thousand. This couple also donates six thousand dollars to a local charity, bringing their total itemized deductions to thirty-one thousand dollars. So, if they had contributed six thousand dollars to charity, they would have received the thirty thousand dollars standard deduction because they didn't have enough deductions to itemize. But the six thousand dollars in donations brings it to thirty-one thousand dollars, which increases their deductions from the standard deduction by one thousand dollars.
So, let's highlight that. They gave six thousand dollars to charity but only received a one-thousand-dollar deduction. That almost doesn't feel fair, right? But let's try something a little different.
Let's say we have the exact same year, two years in a row. Now, limits, tax rates, and things like that will change from year to year incrementally, but for the purpose of keeping this very simple, let's just say we have the exact same two years. But rather than donating six thousand dollars each year, we decided to take twelve thousand dollars in charitable donations in one year and used a standard deduction in year two. So the twelve thousand dollars plus the twenty-five gets us to thirty-seven thousand dollars in itemized deductions. Then, in the following year, we won't use any of the charitable contributions and just take the standard deduction of thirty thousand dollars.
So, remember what happened in our first example. We donated six thousand dollars but only received one thousand dollars of incremental tax deduction. So, by bunching those donations together, we got a seven-thousand-dollar deduction. However, if we took each six thousand dollars a year independently, we would only have a two-thousand-dollar deduction. This illustrates strategy number one, bunching your deductions.
1: How To Maximize The Tax Benefit Of Charitable Giving? Bunching Deductions
If you plan on giving a certain amount over the next few years, it may make sense to see if grouping or bunching those deductions within one year will provide a bigger tax benefit than paying those out over several years. As our example showed, bunching deductions can be a very powerful way to ensure that you're getting the tax deduction for your charitable contributions.
2: How To Maximize The Tax Benefit Of Charitable Giving? Use a Donor-Advised Fund
A donor-advised fund is like a charitable investment fund. In the year you contribute to a donor-advised fund, you can take the income tax deduction. Then, you can use the proceeds within that fund to donate to charities over multiple years. While the funds are in the account waiting to be donated to charities, they can be invested and grow. This growth will hopefully allow you to donate even more to charities down the line.
One way to think of a donor advice fund is like a prepaid charity account. you earn the tax deduction in the year you fund the account, which gives you tremendous control over when you can recognize the income tax deduction. But then you can donate to charities out of that account anytime you wish to do so. But make no mistake about it: once you've put that money into that account, that amount is essentially gone. You recognize the donation on your income tax return, and the gift has been completed. You can only give those funds to charities in the future.
Now, just about every custodian with a household name has a charitable fund capability. But if you're interested in as much of the funds as possible going to charities, then you want to make sure that you understand the fee structure at both the fund level and the investment level within the fund. So, before selecting which custodian to use, make sure you understand the fee structure.
Donor-advised funds are great because they provide an immediate income tax deduction. They also provide flexibility in the timing of your donation and the specific charity you choose. And finally, while you're waiting to make those donations, the balance in the donor advice fund account can grow via the investments. So, donor-advised funds are a great tool to use to maximize your charitable deductions.
3: How To Maximize The Tax Benefit Of Charitable Giving? Donate Appreciated Stock
Donations of appreciated stock are a very tax-efficient way to give to charity. For example, let's say you purchased some shares of stock for five thousand dollars, and now that stock is worth one hundred thousand dollars. If you donated that entire position to charity, you could recognize a hundred-thousand-dollar charitable deduction without recognizing the related capital gain. So, that ninety-five-thousand-dollar capital gain essentially disappears when you donate that stock to charity.
There are certain taxable income limitations you must be under when donating appreciated stocks to a charity. So, make sure you familiarize yourself with those limits prior to using the strategy. But if you meet these rules, donating appreciated stock can help you do several things. It can maximize the value of your charitable donation. It can eliminate having to recognize the related capital gain on the sale of those securities. You can use this to rebalance your portfolio without having to recognize any taxable gains. Finally, this can be a very effective way of reducing concentration risk in any one particular security.
And if you wanted to supercharge your charitable giving, you could donate your highly appreciated stock to your donor-advised fund.
So, keep these strategies in mind.
4: How To Maximize The Tax Benefit Of Charitable Giving? Qualified Charitable Distributions (QDCs)
For individuals aged seventy and a half and older, QCDs offer a way to donate to charity directly from your Individual Retirement Account or IRA. In 2024, the limit is a hundred and five thousand dollars. And you can do this without recognizing the distribution as income.
This is different than taking a deduction on the income tax return. Rather, a taxpayer donates directly from their IRA to their charity. That donation will also help satisfy any Required Minimum Distribution or RMD that the taxpayer might have for that particular year. This means that if the QCD you donated to a charity was greater than your required minimum distribution, no additional required minimum distributions need to be taken.
The beauty of a QCD is that the taxpayer doesn't recognize income for the distribution. So, this can be a great way to help you navigate around the taxable income associated with required minimum distributions.
Now you might be saying to yourself, "JP, I subscribe to your channel, and I watch a lot of your videos, and I know that RMBs don't start till age seventy-three."
And yes, that is correct. But that is the beauty of the QCD eligibility age start at seventy and a half. You can get a head start with these charitable donations directly from your IRA and reduce the future RMDs. So, the benefits of this strategy are that they reduce your required minimum distributions, and they're not included in your taxable income. This can be particularly helpful for retirees when considering IIRMA surcharges or the taxability of your Social Security benefits.
But remember there are a couple limitations. You must be older than seventy and a half, and the ability to do this is limited to IRAs.
So those are the four strategies, bunching donations, using donor advised funds, donating appreciated stock and qualified charitable distributions. Now you don't necessarily need to use these in silos. As I pointed out earlier in the video, you could combine these to create even greater income tax benefits. So, if you're interested in using these strategies, talk with your CPA or CFP® about how they can be incorporated into your financial plan.
Any charitable giving strategy should be part of a comprehensive financial plan. I did a video on What Makes A Comprehensive Retirement Plan. Please click on link if you are interested in learning more.
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Thank you again for watching, and I'll see you next time.
About the presenter:
JP Geisbauer is a Certified Public Accountant, a Certified Financial Planner ®, and the founder of Centerpoint Financial Management, LLC, a financial planning, investment management, and income tax planning firm located in Irvine, CA. JP Geisbauer is dedicated to helping California-based business owners and executives transition into retirement. He has been quoted in many news outlets including Forbes, Newsweek, US News & World Report, MarketWatch, YahooFinance, CNN and NerdWallet.
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Disclaimer:
This article is for general information and educational purposes only. Nothing contained in this article constitutes individual financial, investment, tax, or legal advice. Before taking any action on any topic discussed in this article, consult with your own financial planner, investment advisor, tax professional, and/or attorney for advice on your specific situation.