A financial adviser’s job is to responsibly grow your assets without taking on any unnecessary risk. At Henssler Financial, we grow your assets because you have goals you want to accomplish with your money. Quite often, affluent individuals commit a portion of their assets to philanthropic efforts. While your adviser should not tell you how to spend your money, when it comes to charitable giving, your financial adviser should be helping you plan your donations to maximize the benefits to both you and the charity under current tax laws.
Estate reduction and tax deductions are generally not the driving force behind charitable giving, but it is an added benefit to those who take the time to make meaningful gifts. Your financial adviser should be asking you about your gifting intentions to help you maximize your charitable impact.
Outright gifts can be made throughout the year with ease. If you itemize deductions on your income tax return, you can generally deduct gifts to qualified charities. A qualified charity is a 501(c)(3) organization, which allows for federal tax exemption for the organization and tax deductibility of donations. When making charitable contributions for tax deductions, be aware that not all donations are treated the same. A donation to a public charity generally allows you to take a charitable deduction up to 50% of your adjusted gross income (AGI); however, donations to private foundations allow for a charitable deduction up to 20% or 30% of your AGI.
Qualified Charitable Distributions
If you are older than 70 ½ and taking your required minimum distributions (RMD) from your retirement accounts, you may want to consider charitable distributions or donating appreciated stock. Qualified charitable distributions were made permanent under the Protecting Americans from Tax Hikes Act of 2015. This allows those 70 ½ and older to directly transfer assets to a qualified charity up to $100,000 and satisfy part or all of their RMD. If you are already giving to your church or favorite charity during the year, utilizing the qualified charitable distribution can help lower taxable income, which, in turn, can affect itemized deductions, Medicare premiums and how your Social Security benefits are taxed.
The main benefit of donating your RMDs to charity is how it affects your adjusted gross income (AGI). Your AGI is used in several calculations regarding your taxes. One of the many examples is that your AGI is used to calculate limits for certain itemized deductions. An example of a limit would be the deduction limit for medical expense calculation. For medical expenses, you are allowed to deduct the costs that exceed 10% (7.5% if over 65) of your AGI.
To better illustrate this, let’s look at some hypothetical numbers. Let’s assume you are older than 70 1/2, have an RMD of $25,000, an income of $100,000 and medical expenses of $10,000. In these examples, let’s ignore the personal exemptions and standard deduction rules to make the example less complicated.
Example 1: After Tax Donation
Let’s say you do not donate your RMD directly to charity. This brings your income to $125,000. Because you are over 65, you can deduct your medical costs that exceed $9,375 (7.5% * $125,000). Since you still only have $10,000 of medical expenses, you can only deduct $625 ($10,000 – $9,375). Which will bring your taxable income to $99,375 ($125,000 – $625 – $25,000).
Example 2: Donating Your RMD Directly to Charity
Let’s assume you make a charitable distribution from your IRA. You do not get to take a tax deduction for the charitable donation; however, the distribution to the charity is not included in your income, so no taxes will be due. Your income is $100,000, so now your limit for medical expenses is $7,500 (7.5% * $100,000). Since you have $10,000 of medical expenses you will be able to deduct $2,500 ($10,000 – $7,500). Which will bring your taxable income to $97,500 ($100,000 – $2,500).
Example 3: No Charitable Gift
Let’s assume you do not make any charitable contributions. Your limit for medical expenses is $9,375 (7.5% * $125,000). Since you still only have $10,000 of medical expenses, you can only deduct $625 ($10,000 – $9,375). Which will bring your taxable income to $124,375 ($125,000 – $625).
When making a charitable contribution, it is better to directly donate the RMD. Between Example 1 and 2, you contributed the same amount to charity, but have a lower taxable income in Example 2 when the RMD was directly donated. This difference is amplified when your RMD bumps you into a higher tax bracket.
Naturally, if you are not making a charitable contribution, from a cash flow stand point, you will come out ahead if you take the RMD and pay the additional tax that is generated, as seen in Example 3. However, when we advise clients to donate all or some of their RMD, it is when they were already planning to make charitable contributions. From a tax planning perspective, it is more advantageous to use the RMD than other sources, because it will not increase your AGI resulting in unfavorable limits.
Furthermore, RMDs are not all or nothing. You can divvy up your mandatory withdrawal, using some of it for living expenses, transfer holdings to a taxable account, gifting money to a 529 Plan, or make a qualified charitable distribution. Each option has its own tax advantages.
Appreciated Assets
If you are younger than 70 ½, you could be giving a lot more by donating appreciated assets rather than writing a check. You’ve already been taxed on the money in your checking account as it likely came from your paycheck that had taxes withheld. Depending on your income, you’ve paid the IRS anywhere from 10% to 39.6% of your earnings.
But let’s say you have your money in investments. You bought shares of a stock years ago for about a quarter of what it is worth now. You could sell the investment, pay the tax on your capital gains then give the money to the charity. Again, the IRS is getting their cut—this time probably around 15%. If you’re in the top tax bracket, 20%. You could be selling nearly $1,200 in your investments to cover the taxes due to both the IRS and the state of Georgia just so you have $1,000 to give to a worthy cause. This doesn’t even count the 3.8% tax on investment income that those in the top tax brackets may have to pay.
Instead of selling the investment, you can gift your stock shares to the charitable organization. You receive a tax receipt for $1,000, the fair market value of the gift the date you donated it. Keep in mind your gift of appreciated assets is generally deductible up to 30% of your adjusted gross income, so in this example, donating $1,000 in stock shouldn’t be a problem. Best of all, your charity of choice receives $1,000 to carry out its mission.
Legacy Giving
If you are interested in a lifetime of philanthropy and leaving a legacy after you are gone, you may consider charitable trusts, family foundations or donor advised funds. A charitable remainder trust allows you to provide for your family while funding a charitable organization. Assets are moved from your estate into the trust. A designated trustee is responsible for the management of the assets. A portion of the income produced by the trust is paid to the non-charitable beneficiary for a specified period outlined in the trust documents. The charity’s rights to the assets is generally delayed until the non-charitable beneficiary has received their portion of the income generated from the trust’s assets.
Estimating the tax benefit of a charitable trust is a little more complicated, as it is based on the amount of income received, the type and value of the asset, the ages of the people receiving the income, and an applicable interest rate. Generally, the higher the payout rate, the lower the deduction. The deduction can vary from 20% to 50%, depending on how the IRS defines the charity and the type of asset.
A private foundation, or a family foundation, is a tax-exempt legal entity created, funded and operated by a high-net worth family or business. Donors have complete control over how contributions are invested and how grants are made. Foundations are considered “non-operational” when their main effort is focused on giving grants, or “operational” when they mainly run charitable programs. This distinction is important, as it affects the deductibility of contributions. Cash donations to a non-operational private foundation are deductible up to 30% of the donor’s AGI, while gifts of appreciated stock and real estate may be deductible up to 20% of AGI. Gifts to operating private foundations are deductible up to 50% of AGI for cash and up to 30% of a donor’s AGI for appreciated stocks.
Donor-advised funds are private funds administered by a community foundation or third-party financial institution that manages charitable donations for a number of unrelated contributors. Donor-advised funds are ideal for charitable stock donations because assets can be transferred relatively quickly with an immediate effect for tax planning purposes. Assets are considered immediately removed from the donor’s estate, but grants from the donor-advised fund do not have to be instantaneous. Benefactors can make recommendations to the fund regarding the grants the fund makes to charities. Most donor-advised funds will follow a donor’s wishes as to when, how much, and to which charities grants are given.
Like other charitable donations, gifts to a donor-advised fund are considered donations to a public charity for tax purposes, which means the donor is allowed to take an immediate income tax deduction of up to 50% of AGI for gifts of cash and 30% for gifts of long-term capital gain property. Investment growth of the funds in a donor-advised fund are not eligible for a charitable deduction.
Regardless of how you give, you’ll want to work closely with a tax adviser and a financial adviser experienced in charitable giving to make sure you take the correct deduction and have the proper documentation needed to substantiate your deduction.
If you have questions or need assistance, contact the experts at Henssler Financial:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
