Tax-smart Donations

Impact of 2018 Tax Reform

Prior to the 2018 tax year, about 50% of taxpayers filed the long-form, meaning they itemized deductions. But tax professionals estimate that two parts of the 2018 Tax Reform package will reduce the number of itemizers to less than half that number for two reasons:

• It limits the combination of real and personal property taxes, state and local income taxes, sales taxes, and mortgage interest deductions to $10,000 for a couple filing jointly (in 2018). Previously there was no limit at all on these items.

• It raises the standard deduction to $24,000 for the same couple, $26,500 if both are 65 years or older.

So valuable charitable giving strategies from the past won't work at all for many people. So I've rewritten this webpage.

Simple Donation Strategies

Give cash or equivalents

This works only in a year when you itemize deductions. Otherwise, it's useless.

“Equivalents” include writing a check, using a credit/debit card, or setting up an auto-pay from a bank account. You get a tax deduction for the donation - meaning that if you give it to a legitimate charity such as a 501(c)(3) then you can deduct the full value of the donation from your taxable income. In effect, you are giving “pretax dollars.”

Even though there are more tax-efficient donation strategies, this one is perfectly reasonable in many situations. It is best for small or medium-sized gifts. And for some Christians, the act of bringing a physical offering each week to the worship service is a meaningful part of their experience. After all, in the Old Testament worshipers brought lambs and birds to sacrifice at the altar. The modern equivalent is to bring cash or a check and deposit it in the offering.

Another place for cash/equivalents is political donations, such as to candidates and organizations that lobby the government. Such donations generally are not tax-deductible. For more click here.

Timing: This is the simplest option; it’s virtually instantaneous.

Donate Appreciated Stock

This works only in a year when you itemize deductions. Otherwise, it's useless.

Donating stock shares with substantial long-term gains is twice as efficient as giving cash/equivalents. You can give stock by instructing your broker to transfer shares from your account to the charity’s account.

It is important to not sell the shares and later give the money. From a tax point of view, this is the same as giving cash. Instead, donate the shares directly to the charity. Regardless of when the charity sells the shares, your donation date for tax purposes is the transfer date of the shares. And the deductible donation amount is the total value of the shares. And, you do not report this transaction as capital gains on your tax forms. So you receive a tax deduction for the full market value of the shares on the date of the transfer, even though you never reported the income.

Here’s an example. Suppose...

• You want to give $1,000 to charity.

• You own some shares of stock that you bought for $1 over a year ago.

• Today that share is worth $1,000 (so you have nearly $1,000 of long-term capital gains).

• At your normal Adjusted Gross Income (on your 1040 tax return) every additional dollar you receive is taxed at a pretty high rate. If your typical income is above $85,000 in the year, your federal tax rate on any additional long-term capital gains is about 20%, and your state taxes may run another 10% (in California, they do!).

Let's compare two scenarios:

The low-efficiency scenario works like this: You sell the shares, increasing your taxable income by $1,000 of long-term capital gains; then you write a donation check for $1,000 to the charity. At tax time, you claim $1000 as a charitable contribution on your tax forms, subtracting it from your taxable income.

So the stock shares exited your portfolio, the charity got $1,000 in buying power, the government received no net tax money from you from this transaction.

The high-efficiency strategy works like this: You directly transfer the shares to the charity. You do not report the increased income as a charitable donation on your tax forms. At tax time, you still claim $1,000 as a charitable deduction, reducing your Adjusted Gross Income by $1,000. You receive a tax refund of $300.

So this time the stock shares exited your portfolio, the charity got $1,000 in buying power, and the government gave you a tax refund of about $300! So you could have donated more shares for the same reduction in net worth, or you could write another $300 check to charity and still come out even!

It’s a double tax deduction because you deduct the donation from your income so that you gave the gift tax-free, and you get to do this WITHOUT reporting it as income.

This strategy applies when donating any item with long-term capital gains (including real estate). You can even use this technique to give to a Donor Advised Fund (see the next section).

For more on the details, see Stock Donations, which provides information about

• Shares from employee stock grant and stock options

• Detail about the mechanics for donors and for a church or non-profit that is unfamiliar with receiving stock donations.

Timing: Assuming the charity has experience receiving such contributions, this strategy may take a week or two. If it's the charity's first stock gift, it may take them a while to get permission from their board and to set up an account to receive the shares. To help with that, give them the link in the previous paragraph. And if your shares are in certificate form, it may take an extra couple of weeks. (This, too, is covered in the link.)

Create a Donor Advised Fund

Pay close attention to this one. A Donor Advised Fund coupled with a bunching strategy works. First I'll describe the Donor Advised Fund, then explain how to use it with bunching.

DAF’s are extremely valuable and tax-efficient, especially in years where you have an income or capital gains windfall. Examples: when you sell a lot of shares of stock, or sell a business, or receive a big bonus, or sell your house, and so on.

Suppose your typical Adjusted Gross Income is $85,000 a year. Then one year you get a $200,000 bonus! At federal and state income tax rates, you’ll owe $40,000 to $60,000 to the U.S. and your state's income tax system!

Now, suppose you want to donate $25,000 of the bonus to charity so you can get the tax deduction in the current year. But you need more time to decide which charity (or charities) to support. Or suppose you want to fund your ongoing charitable donations for the next several years, but you want to claim the entire deduction for those future contributions in the current year. These are perfect scenarios for creating a DAF.

You can easily set up a DAF and put the $25,000 into it. In this same year, you can take the $25,000 tax deduction, even if not one penny gets to a charity this year. Then, over the next several years you can trigger donations from the DAF to any charity. Once you put money into the DAF, you can never get it back - one way or another it must go to charity. That’s what makes it tax-deductible. But as long as there's money in the DAF you control how it is invested - in much the same way that you manage the money in a 401k.

There are several companies and organizations where you can set up a DAF. Here are the general categories of DAFs:

• National providers, such as Vanguard Charitable ($25,000 min) or Fidelity ($5,000 min). These are the most cause-neutral, meaning you can donate to any legitimate charity.

• Affinity groups help you support their cause, such as a religious tradition, medical research for cancer or heart, your favorite hospitals, mission programs, compassionate needs such as Feed the Children organizations, and so on.

• Educational institution providers help you support their university or private school.

• Community providers are available in some neighborhoods and towns. These help you support a list of local causes, like a homeless shelter, a food pantry, an arts commission, parks, and so on.

For more on this see Benjamin Pierce’s Vanguard Charitable article: Understanding the differences among donor-advised funds.

You can donate appreciated stock to a DAF and get the double tax break. (see above: Donate Appreciated Stock). And you can assign someone to manage the remainder of the fund in the event of your death.

Caution: you cannot move RMD money to a Donor Advised Fund without reporting it as income for tax purposes.

Timing: Setting up one of these with a Vanguard Charitable, Fidelity, or equivalent takes 1-2 weeks.

Bunching strategy. Suppose you knew that you intend to donate $25,000 in each of the next three years. You could put $75,000 into a DAF this year. And suppose you can max out the $10,000 limit for state and local taxes, property taxes, and mortgage interest. That would give you $85,000 in deductions. Since that's far more than the $25,000 standard deduction, you're way ahead to file the long-form this year. Then you can feed the donations monthly, quarterly, or at any flow rate to charities over the next three years.

You may wonder why not just give the whole amount to the charities this year and let them stretch it over 3 years. If you're confident the charities are sophisticated enough to manage this flow of money, great! Give it to them up-front.

Donate from retirement RMD

This work in the past and it works the same way now. Why? Because it's not a deduction. It works because these dollars never get added to your income in the first place!

In the tax year when you reach 70.5 years old, you must start taking an annual Required Minimum Distribution (RMD) from traditional IRAs, 401k, and 403b accounts. A federal government formula determines the amount, which changes every year. As soon as you pass your 70.5 "birthday" you can transfer up to $100,000 directly to a charity. This is called a Qualified Charitable Contribution (QCD) and it counts against your Required Minimum Distribution (RMD) for that year, but you do not report it as income for tax purposes. However, the donor cannot also take a tax deduction for it. This annual provision became permanent in December 2015.

Here's why this makes sense: A typical retiree pays her bills using money from some combination of Social Security income, defined benefit retirement money, withdrawals from tax-advantaged retirement accounts, plus dividends and capital gains from investments in the taxable accounts.

Now suppose she wants to donate $6,000 to her church for the year. If she cashes in money from any of the sources and writes a personal check to the church, that money adds to her adjusted gross income and gets taxed as ordinary income. But if she donates the $6,000 directly from her tax-deferred retirement account to the charity, it counts against her RMD for the year, but it does not add to her adjusted gross income. Note that this is not a tax deduction; the money never adds to her income in the first place. So the amount is better than a tax deduction because it works whether she itemizes it or not. For retirees with sufficient money to pay all their bills and also contribute to charity, the smartest strategy is to first donate the RMD dollars. Note that the $100k limit per year is larger than most peoples' RMD, so she can donate more if she wants to.

I did this through Vanguard and the process was simple, requiring a 15-minute phone call. My representative triggered a check written to the charity, in care of me, and sent the check to my mailing address. I delivered it to the charity. Some investment companies require the charity to cash the check before year-end, so check with your investment company. The Vanguard representative coded the transaction as a Qualified Charitable Distribution for my year-end 1099. This website explains the details: IRA FAQs - Distributions. Especially see the last section, "Qualified charitable deductions."

As noted above: you cannot move RMD money to a Donor Advised Fund without reporting it as income for tax purposes.

For more on this, including the details of how to make the transfer directly from your retirement account, check out this Kiplinger article.

A more complicated strategy

The method in this section is more complex, so you need to see a finance professional (such as a Certified Financial Planner) before getting too far into one of these.

Fund a Charitable Gift Annuity

In an annuity, you transfer a lump sum to an insurance company that pools your money with the money from many other people. The insurance company invests this pool, promising to provide a monthly (or annual) stream of payments for a prescribed number of years, or until you die. If you die early in the payment stream, the company keeps your money and uses it to fund the payment streams of other people in the pool who live longer than expected. It is not an investment; it is an insurance policy. The security of this income stream is only as good as the insurance company’s ability to manage the pool.

Social Security is a form of annuity. But many people need/want a bigger money stream than it provides. So people use some of their investment money to purchase a commercial annuity (or two). The best time to buy an annuity s when interest rates are high.

A Charitable Gift Annuity is where you donate a lump sum (or stock or property) to a charitable organization (instead of an insurance company) that promises to pay a steady stream until you die. The remainder goes to that charity.

When you purchase a CGA, the charity calculates how much longer you are expected to live to determine how much of your lump sum is needed to pay for the stream of payments they pay back to you. The remainder is your tax deduction for the year you purchase the CGA. These annuities are considered a general obligation of the charity - meaning the income stream is as secure as the charity.

So if you have a history of donating to a church, or university, or the Cancer Society, or if you have already included one of these in your estate plan, then you can check to see if they offer Charitable Gift Annuities.

Timing: Any charity that is set up to offer these can probably walk you through it in 2-4 weeks maximum.

The most complicated strategies

If you want to donate really big dollars and you want a lot of control over how the money is spent now and after you die, then it's time to consider more complicated strategies. Implementation requires a good investment professional and probably a lawyer. Such strategies are beyond the scope of this post (and my expertise), but here's a general understanding.

Split-Interest Trusts

These involve two types of ownership: 1) an income interest, and 2) a remainder interest.

In a Charitable Lead Trust, you put money into a trust, which generates an annuitized income stream to the charity for a fixed number of years. After that, the remainder goes to whomever you designate (yourself, family members, etc.). The size of the tax deduction is the net present value of the income stream to the charitable organization.

A Charitable Remainder Trust works just the opposite: the annuitized income stream goes first to you (or your beneficiaries), and eventually, the remainder goes to the charity.

Create a private foundation

These apply to very wealthy people who are able to give away several million dollars and want to set something up that can greatly control forever. Giving advice on this strategy is "above my pay grade." So see a certified financial planner and/or a lawyer.

For more material on donations check out: The joy of charitable giving: Strategies and opportunities, and Tithes and Offerings.

All the best, Tim