Charitable organizations face financial needs on a month-to-month basis, yet many people tend to concentrate their charitable distributions at the end of the year. We often do this as part of year-end tax planning, yet this doesn't necessarily serve you, or the organizations you support, in the most effective way.
Let's begin with the fact that for many people, it doesn't pay to itemize deductions. In 2023, the standard deduction is $27,700 for a married couple filing jointly and $13,850 for a single tax filer. The deduction is bumped up by $1,500 per person for those 65 and older. There's a good chance you don't have more than $27,700 of qualifying deductions to itemize. If you claim the standard deduction, charitable contributions are not deductible.
Even if you do have enough deductions to make itemizing a better option, your giving plans don't have to wait until the end of the year. Here are three different, tax-effective forms of charitable gifting that you can implement at any time.
Qualified charitable distributions from a traditional IRA
More than a quarter of all households have money saved in traditional IRAs. Distributions from these IRAs must begin after you reach age 73, even if you don't need to draw income to meet your needs. If you made pretax (tax-deductible) contributions to the IRA, or if it is a rollover IRA (to which you rolled assets from a workplace retirement plan funded with pretax contributions), all distributions are subject to tax, typically at the highest marginal ordinary income-tax rate that applies to you. Even if you made after-tax contributions to the IRA, all distributions attributable to earnings will be taxable.
A way to avoid having IRA payouts adding to your taxable income is to direct those distributions to a qualified nonprofit organization instead. The IRS has a provision for “qualified charitable distributions (QCDs)" that allows money to be rolled directly from a traditional IRA to charitable organizations. Using this strategy, the charity benefits, but you don't first have to claim the income or assume its tax liability.
Individuals aged 70 1/2 or older can roll up to $100,000 each year to qualified charitable groups using QCDs (the maximum allowed will increase in accordance with inflation by $1,000 increments). The potential benefits to your bottom line are many:
- Your IRA balance is reduced, lowering future required distribution amounts
- It avoids adding IRA distributions to your adjusted gross income, which may keep you in a lower tax bracket
- Because you avoid adding to your income, it may help you qualify for lower Medicare premiums, which are based on income levels
A direct pipeline from your IRA to your favored charities is a tax-efficient way for older Americans to fulfill their charitable goals. QCDs can be an especially effective way to manage required distributions after turning age 73 if you don't require income generated from your IRAs to meet your living expenses.
Creating a charitable remainder trust
Another strategy to help you manage your tax liability while providing for the long-term financial needs of a favored nonprofit is a charitable remainder trust (CRT). Rather than selling appreciated assets that would be subject to tax once liquidated, you instead move them into the CRT. The benefit to the charity will occur in the future. In the meantime, payments will be generated from the asset, directed to non-charitable beneficiaries.
Payments are typically made to the granter and/or the granter's spouse, but other beneficiaries could be named in certain circumstances. The primary benefit is twofold—you claim a tax deduction equal to a portion of the amount placed into the trust while providing a steady stream of income for yourself or another non-charitable beneficiary.
When you establish and fund the trust, that decision is irrevocable. The assets must remain in the trust. You can receive payments that are at least five percent and no more than 50 percent of the value of the assets, as determined by an IRS calculation at the time the trust is funded. The trust can be established for up to 20 years or the life of the beneficiaries. When the term of the trust ends, the remaining assets in the trust are directed to charity. The key tax implications are:
- Non-charitable beneficiaries owe taxes on payments received from the trust, but it spreads out the tax impact over a series of years. Tax treatment (ordinary income taxes, capital gains, etc.) can vary based on the form of the payouts from the trust
- The value of the “remainder" that is directed to charity could be deductible to you. The present value of the portion of the CRT that is considered a gift is based on interest rate assumptions set by the IRS
- Assets moved into the trust are removed from your estate, potentially limiting estate tax liability
A provision of the recently enacted SECURE 2.0 Act allows you to make a one-time, $50,000 qualified charitable distribution transfer to a CRT. This can help you reduce the value of a traditional IRA without facing tax consequences.
Setting up a donor-advised fund
A simple way to describe a donor-advised fund (DAF) is that you set aside a lump sum of money into a managed fund, potentially claim an immediate tax deduction for that amount, then direct gifts from the fund to charities over a period of time that is as short or as long as you wish.
Cash, stocks, bonds, mutual funds, and other types of assets can be placed in the fund. The value of the donated assets can be claimed as tax deductions using the following guidelines:
- Cash donations up to a value equal to 60 percent of your adjusted gross income
- Appreciated assets up to a value equal to 30 percent of your adjusted gross income
Other tax benefits include avoiding capital-gains taxes on appreciated assets that are placed in the fund, and tax-free growth of assets placed in the DAF. Once assets are placed in the DAF, the gift is irrevocable and you can no longer access those assets.
Funds can be directed to most IRS-qualified public charities. A sponsoring entity of the donor-advised fund is responsible for reviewing charities to ensure their legitimacy. Donations to approved charities can occur on your timetable, quickly or over a number of years. If assets remain in the fund after your death, you can designate who should carry on your philanthropy after you're gone. It can be an effective way to connect the next generation to your family's philanthropic values.
Think beyond cash donations
While you may appreciate the simplicity of writing out a check for a charitable cause, that approach has its limitations. The three strategies outlined here should be explored in more detail. Each offers a way to improve the tax efficiency of your philanthropic endeavors.