Lower Your Taxes: Maximize Charitable Giving with the New Tax Law

It always amuses me what my kids come away learning or thinking about after our time together. We have a 5-year-old son, a 4-year-old daughter, and a 20-month-old son. Just last month, I took my 5-year-old to the KState-Texas football game in Austin. He loves KState because I do. But I was pretty surprised to hear him tell my wife that he wants a football field cake for his birthday with a giant Longhorn in the middle. That was one of his main takeaways from the game–not necessarily the takeaway I was hoping for him to have!

People do the same thing with tax law–they’ll jump to a conclusion that the IRS didn’t necessarily expect. When the new tax law was implemented in 2018, there was one big change that had a major impact–the standard deduction doubled to more than $24,000. The concerning takeaway was that people may dramatically lower their charitable contributions if they aren’t getting a deduction for them. Before the change, it was critical to keep track of any relevant medical expenses, charitable donations, etc. Depending on your situation, that still could be the case. But, a large portion of Americans, even high earners, will now take the standard deduction.

There has been a lot of concern as to how this would affect charitable giving. For millions of Americans, they no longer receive a tax deduction for their charitable contributions because they take the standard deduction instead.

Even if you are on the brink of whether you should take it or itemize your deductions, there are a couple of strategies you should know. Whether you give through a tithe to a church or give to multiple charities or a combination of both-here are two ideas that may come in handy to ensure your charitable contributions count during tax time.

Donor-Advised Funds

Donor-Advised Funds are an excellent tool for charitable giving. Quick summary: When you give to a charity, that is an event that can be a tax deduction. A donor-advised fund has the same effect. When you put money into a DAF, that is when you get the deduction. You then make grants from the DAF to the charities of your choosing. There are a couple of potential benefits:

Give a significant amount in a single year: Bunching

This is the most powerful part of this article if you are not yet 70 years old. Bunching is simply combining several years of charitable giving into one year. Why is it such a great deal? Well, let’s say you own a home and do a little bit of charitable giving each year. Maybe your property taxes are $10,000, and you get to throw in a few thousand for mortgage interest and another $10,000 for charitable giving. Before 2018, you would itemize those deductions and see a real benefit for it. Now, with a standard deduction of $24,400, you do not see a benefit.

Instead of continuing to give $10,000 per year, you should bunch multiple years of charitable donations into one. Let’s say you took $40,000 and put it in a DAF. You just gave yourself an enormous deduction this year. You can also still give to your church or charities in the exact same way. The $40,000 is in your DAF, and you can grant the same dollar amount you normally would each month or year. So, the charitable causes you support still get your same support. But you got to experience a significant tax deduction. See the picture below for an example.

Gift shares of appreciated stock when you do give. In addition to bunching your donations, don’t simply give cash. If you have stock shares that have appreciated in value, give those. Let’s say you have $100,000 in XOM that you bought for $30,000 decades ago. That’s a prime candidate to give to charity. If you don’t want to part with the particular stock? Great. Still give the stock. Take your cash and purchase the shares again. You just increased your cost basis and removed the future capital gains tax bill.

In the picture above, let’s pretend that a married couple is making $380,000/year. This is a very simplified example, but the round numbers make it easy to capture the idea. You can certainly fill in your income, mortgage, tax, and charitable giving information to make it applicable to you. As you can see, they are maxing out the property taxes eligible for deduction (remember: even if your property taxes are $20,000/year, you can only deduct $10,000 in the new tax bill). They are also deducting their $10,000 in mortgage interest. Finally, they’re giving $10,000 to charity each year.

In their current giving mode, they barely see any tax benefit. Why? Their itemized deduction is not significantly more than the standard deduction. Plus, their income ($380,000) happens to be almost $60,000 into the 32% tax bracket (married filing joint). This means if they can find a way to lower their taxable income down to ~$320,000, they will enjoy a substantially lower tax bill. In this example, this family has a huge opportunity to use a donor-advised fund and combine multiple years of giving into one.

In the picture above, let’s first address the church or charities receiving the donations. They don’t experience any difference at all. Why? Even though the family made a $40,000 charitable contribution in 2019 and none for the next three years, they can still grant $10,000 per year however they want. So, if they give $800/month, they can still grant that same amount every month to the charity of their choice for the next four years. So their church and charities see no difference. But your tax bill is in a great spot. In 2019, your $60,000 itemized deductions saved you almost $20,000 in that year. For the next three years, you still get to enjoy the standard deduction, which saves you about $8,000 each year. You can then do another mega-giving year and take another $60,000 deduction in 2023 before taking the standard deduction through 2026. Bunching your charitable contributions into one year can be a great benefit, especially if you happen to be in a high-income year.

Keep your Giving Organized

The second reason to use a donor-advised fund is the simplicity around record-keeping. If you do itemize deductions, you have to keep receipts in some form. Technically speaking, you could get audited, and if you claim a significant deduction for charitable giving, that auditor may want to see proof of that. An even more likely example: let’s say you like to give to 10 different charities. At the end of the year, you have to collect receipts from all 10. With a donor-advised fund, you don’t ever have to do this again. Donor-advised funds are categorized as a 501(c)(3) (a tax-exempt charitable organization). This is fantastic for you because when you give $50,000 to a DAF, that’s your tax deduction right there. That’s the only record you need to keep. Your grants out to your ten favorite charities each year do not have to be kept track of. So, when the auditor comes, log in to your DAF, show the exact amount you gave in any year, and it’s much easier.

Qualified Charitable Distributions

Your RMD (required minimum distribution) is a percentage of your pre-tax assets (IRA/401k) that the IRS forces you to take as a distribution each year once you reach age 70.5.

So, let’s say you have $3,000,000 in an IRA. The new tax law directs the IRS to force you to take out slightly less than 4% in year one, and then a slightly higher percentage each year after that (the actual amount is calculated at market close on Dec. 31 for the upcoming year). Let’s pretend your RMD amount for the upcoming year is $120,000. If you want to use part of that for your charitable giving for the year, here are a couple of things to keep in mind-pay close attention to the last one.

-First, great decision. QCD maximizes your deductions.

Why are QCDs such a great deal? Because it’s an exclusion from your income, not a deduction. Exclusions are much better. For many Americans, you won’t even be able to take your deduction. Especially for someone over 70 (maybe your home is paid off), your itemized deductions are likely less than the standard deduction. But with a QCD, you get the benefit of both. Let’s pretend you give $20,000 to charity. Utilizing a QCD means that your income is now only $100,000 from your RMD, not $120,000. Then, you still get to take the standard deduction when you file your tax return. If you are over 70 years old and give charitably and you have an IRA, you should utilize QCDs.

-Second, QCDs are capped at $100,000 per year

Quick note: You cannot give more than $100,000 in a single year through a QCD. So, even if you have a large IRA and your RMD is greater than $100,000, your QCD is capped.

-Third, DO YOUR QCD FIRST

Why all caps? Well, this is a goofy part of our tax code. A “first-out” rule governs RMDs. This means that whatever money comes out of your IRA first automatically counts towards your RMD. So, you cannot take your RMD (or take distributions from your IRA for any reason that accidentally equals the amount of your RMD) and then do a qualified charitable distribution. If you try this, your “QCD” will not be a QCD, and it will count as taxable income. You can certainly itemize deductions at this point, but you have lost some of the benefits behind QCDs.

Have any questions you would like us to write about? Some of our best articles come from questions and issues brought up by everyday investors like you. Send me a note at justin@brownleewealthmanagement.com or Contact us!