Thinking about making some charitable contributions before the year is up? Here are some things to consider from a financial planning and tax perspective.
The end of the year is the most popular time for charitable giving: Nonprofit and charitable organizations receive on average more than 40% of their annual revenue during the holiday giving season. Not only are people in a spirit of generosity around this time of year, it’s also a great time to optimize your finances for tax purposes.
Charitable contributions can typically provide you with a big tax benefit if you itemize your deductions and are a high-income earner. And even though cash contributions are the most common, there are other ways to give, including donor-advised funds, appreciated assets, and funds from your IRA.
If you’re thinking about making a donation to your favorite causes before the end of the year, here are a few tips and strategies to consider. Note that each of these strategies assumes you’re itemizing deductions, rather than taking the standard deduction.
Before you take any action, we recommend you discuss with your financial advisor or tax professional.
Make sure you’re giving to a qualifying organization
If part of the intent of your charitable donation is to get a tax deduction, make sure you’re giving to an organization that qualifies as tax-exempt. Tax-exempt organizations are defined by section 501(c)(3) of the Internal Revenue Code. Some examples: religious organizations, certain political organizations, nonprofit educational agencies, and social welfare organizations.
If there’s a particular organization that you’re interested in giving to, you can check whether they are eligible to receive tax-deductible charitable contributions on the IRS website.
Donate appreciated assets
When you donate shares of a stock, mutual fund, or exchange-traded fund (ETF) that has grown in value, you essentially get two tax breaks. For starters, you avoid long-term capital gains tax, thereby reducing your taxable income. Second, you can claim a deduction for the contribution.
You must have held the asset in a taxable account for a minimum of one year to use this strategy.
Make a charitable donation to offset tax costs associated with an IRA conversion
Do you have funds in a traditional IRA and are thinking about switching to a Roth IRA before December 31? Because contributions and earnings to a traditional IRA are taxed upon withdrawal, you could have a bigger tax bill after converting to a Roth. To offset those taxes, consider making a sizable deductible charitable contribution.
Use the qualified charitable distribution (QCD) rule
If you own a traditional IRA and are at least 70 ½ years old, you can exclude the required minimum distributions (RMDs) from your adjusted gross income if you donate those funds to charity. QCDs must be made directly to the qualifying charitable organization, but because RMDs can have a big impact on your tax bill, using this strategy can reduce your taxable income. (Note that even though the SECURE Act increased the age of RMDs to 72, the age for QCDs remains 70 ½.)
Contribute via a donor-advised fund (DAF)
This is more of a recommendation going into next year and beyond. Donor-advised funds, or DAFs, have introduced a streamlined way to give to charity.
These funds are like a savings account for your charitable contributions: You place funds into the account, and those funds grow tax-free until you donate them to the charitable organization of your choice at a later date. The simplicity of the experience — especially where record keeping is concerned — has made these funds an increasingly preferred vehicle for giving, especially among high-net-worth individuals.
There are a couple of caveats: There is a minimum required investment (which varies by fund) and they come with some fees. But at the end of the day, you’re still able to use contributions as a tax deduction.
What’s new for 2020?
Generally, there’s a deduction limit of up to 60% of your adjusted gross income for charitable contributions, but the CARES Act eliminates that limit for cash contributions to certain public charities for 2020.
There are exclusions to the provision, including donating to private nonoperating foundations and supporting organizations, as well as contributions made to establish or maintain donor-advised funds (DAFs).
Would you like to learn more about the ins and outs of deducting charitable donations from your taxes, and discuss which charitable giving strategies may be the best fit for your financial plan? Learn more about our tax services and schedule some time to chat with us today.