Around Thanksgiving and the calendar (and tax year) end is when commercials and requests for donations tend to really pick up. Most people I talk to wish that they could give more financially to the causes they love but given the high cost of living and high taxes most people feel they cannot afford it. No matter how much you can afford to give, being intentional about your giving can provide a greater sense that you are helping the world around you. Understanding the tax implications of charitable giving and your options may also help in justifying why you might give a little more this year.
In 2018, the new tax code changed a lot of tax deductions. The standard deduction for a married couple filing jointly doubled to $24,400 and the State and Local Tax (SALT) deduction was capped at $10,000. The change resulted in a lot of families no longer itemizing their taxes (of which charitable giving is a part). Charitable organizations feared that this change in the tax code would result in lower individual giving, and it did.
According to Giving USA, giving by individuals decreased by 1.1% in 2018. However, this was preceded by a 5.7% increase in individual giving in 2017. There is speculation that 80% of this decline is due to the change in tax code, but there is no empirical evidence to prove it. The stock market also had a bad year, which impacts family’s willingness to give charitably.
For high income families, they mostly continue to itemize because of very high interest expense from big mortgages. Thus, charitable giving is still an itemized deduction that lowers taxable income and taxes. Here are some of the rules to keep in mind:
- You must donate cash or property. Giving your time doesn’t count.
- You must donate to a qualified tax-exempt organization. Churches, religious organizations and 501c(3). The IRS has a charitable organization search function on its website.
- Maintain some record of the donation, like a copy of a check or letter from the organization indicating your charitable contribution.
- Normally, you can deduct up to 30-60% of your Adjusted Gross Income (AGI) for charitable purposes. So, if you make $300,000 and maximize your 401(k) contribution at $19,000 as well as Dependent Care Account at $5,000, AGI would be $276,000. This means you could give between $82,800 and 165,600 away and be able to deduct that charitable giving as an itemized expense on your tax return. It’s a lot of money you could give, but few people can afford it.
Donor Advised Fund (DAF)
Big equity events (i.e. Initial Public Offering (IPO)) and windfalls of money offer an opportunity to maximize your tax benefit in a single year but make the actual donations to charities over many. A donor-advised fund (DAF) is an easy, tax-efficient way to contribute to your favorite charities (while minimizing your taxes). Anyone can open a fund with an initial contribution of $5,000 or more, after which the fund can be professionally managed and invested for future growth. Once a DAF has been established, the donor can make contributions to charities out of the fund’s assets at any time. For example, you could frontload a Donor Advised Fund with $50,000 and make donations to charities of $5,000 for 10 years from the DAF. The tax deduction of $50,000 would be realized in the year the DAF is funded. In big windfall years, be it an IPO or large vesting of Restricted Stock Options (RSU), giving $50,000 can save 48% of that in taxes. So, a $50,000 DAF would really only cost $26,000 because you get the rest as a tax deduction.
A DAF is also a good place to gift significantly appreciated assets. For example, if your grandmother gave you some Exon stock when you were a kid but it has her cost basis (the price she paid for it), the capital gain on that stock is likely huge! When you gift appreciated assets to the DAF, you get the tax deduction based on the current market value of that asset and the huge potential tax liability is removed from your portfolio. You can then sell the appreciated stock over time and give the money to charities.
According to Consumer Reports, DAFs are the fastest growing segment of charitable giving today. Fidelity, Vanguard, Schwab, etc., offer Donor Advised Funds to individual investors with different minimum funding levels and fees. Most charge fees less than 1% or cap the annual fee.
Deductions are limited to 60% of AGI for cash gifts and 30% for real property or stocks. The IRS has not specified a period of time required for donating funds in the DAF, but in general, there needs to be giving activity or the DAF could be considered inactive and the contents donated. DAF’s are not a place to stash wealth. Inevitably, there will be regulation to govern the need for a specific time frame or level of activity from these funds.
Before the end of the year, look at how much you have donated thus far and consider how much more you could give charitably. If you had a big windfall, consider this an opportunity to make a big impact by opening a DAF and making a large contribution from which you can give for many years to come.