Efficient Strategies for Making Charitable Contributions
As the year comes to end many taxpayers are finalizing their year-end tax planning, which may include gifts to charity. Discussed below are a several strategies to consider in planning for contributions.
Required Minimum Distributions (RMDs):
Under more typical circumstances, the recent passing of the SECURE Act would require an individual to take Required Minimum Distributions (RMDs) from retirement plans by April 1 of the year after turning 72. As the name indicates, these distributions are required, even if the individual does not want or need the additional funds. These additional distributions increase the individual’s adjusted gross income (AGI), which could result in placing the individual in a higher tax bracket, and increasing taxes on Social Security income, the alternative minimum tax, and the net investment income tax (NIIT).
While the CARES Act temporarily waived RMDs for all types of retirement plans (including IRAs, 401(k)s, 403(b)s, 457(b)s, and inherited IRAs), an individual who is charitably inclined and is not in need of the RMD, may avoid these potential results by donating his or her IRA RMD directly to a qualified 501(c)(3) charity. This strategy is called a Qualified Charitable Distribution (QCD).
The basic premise of QCDs is that an individual may fulfill the RMD requirement by directly transferring up to $100,000 from the IRA account to a charity or charities. It is important to note that the Secure Act did not increase the required age for QCDs. They can still begin when the individual turns age 70 1/2. This charitable donation is in place of the RMD that an individual would otherwise be required to take. Since the RMD is not distributed to the individual first, with the individual making a subsequent donation to charity, his or her AGI is not affected.
QCDs can be made from a traditional IRA, inherited IRA, inactive SEP IRA, inactive SIMPLE IRA, and a Roth IRA under certain circumstances. The $100,000 QCD limit per individual is for all QCD distributions from all IRAs in a given year.
Be aware that contributing to an IRA may result in a reduction in the amount of the QCD you can exclude from income. The aggregate amount of deductible IRA contributions you make to an IRA after you turn age 70 ½ will reduce the amount of the QCD that is not includible in gross income.
Donor Advised Fund (DAF):
Another way to support a charity (while at the same time receiving a tax deduction) is through a Donor Advised Fund (DAF). A DAF is essentially a charitable investment account; it is established solely to support IRS-qualified charities in which the donor is interested. A sponsoring organization (typically a charitable affiliate of a financial company or charity) manages the DAF, so the donor is not directly responsible for management costs, which keeps expenses minimal.
Once the donor makes the contribution, the sponsoring organization has legal control over the DAF. However, the donor can retain advisory privileges with respect to the distribution of funds and the investment of assets in the account. In donating cash, stocks or non-publicly traded assets to the DAF, the donor is eligible for an immediate tax deduction. DAF donors may be able to take a federal income tax charitable deduction of up to 60% (100% in 2020) AGI for cash gifts and up to 30% of AGI for gifts of stock and other appreciated assets. Additionally, while the assets are in the DAF, they grow tax free.
It is important to note that once the assets are transferred to the DAF, the contribution is irrevocable. These funds cannot be returned to the donor or any other person and cannot be used for any purpose other than making grants to qualified charities.
Charitable Remainder Trust (CRT):
A charitable remainder trust (CRT) is tax-exempt irrevocable trust that generates a potential income stream for the CRT donor, or other beneficiaries, with the remainder of the donated assets benefiting the donor’s preferred charity or charities. The donor makes contributions to the trust and is eligible for a partial tax deduction based upon the trust’s assets that will eventually pass to charity. There are two main types of CRTS:
- Charitable Remainder Annuity Trust (CRATs) - distributes a fixed annuity amount each year and additional contributions are not allowed; and
- Charitable Remainder Unitrusts (CRUTs) - distributes a fixed percentage based on the balance of the trust assets (revalued annually), and additional contributions can be made.
Cash, stocks, or non-publicly traded assets (i.e., real estate, private business interests and private company stock) are donated by the donor and the donor becomes eligible to take a partial tax deduction. The partial income tax deduction is based on the type of trust, the term of the trust, the projected income payments, and IRS interest rates that assume a certain rate of growth of trust assets.
Assets that have been held for a long period of time and have appreciated significantly in value during that period are particularly attractive for transfer to a CRT. When the CRT sells these assets, the gain is exempt from tax and the full amount of the proceeds are available for reinvestment. However, the income beneficiary will report the income received on his or her tax return.
You should also consider regular gifting strategies that we have discussed in the past, including:
- Giving Appreciated Non-Cash Assets. By claiming a deduction for the fair market value of an asset, the donor can potentially eliminate the capital gains tax he or she would incur if the donor sold the asset and donated the cash proceeds. This can result in more going to the charity and less taxes paid.
- Bunching Contributions. If a donor has deductions slightly below the level of the standard deduction, he or she may consider donating amounts for both 2020 and 2021 to charity in 2020, itemize deductions in 2020, then take the standard deduction in 2021. This could optimize the tax benefits of the charitable donations.
WMS will continue to monitor the charitable planning landscape and continue to make recommendations accordingly. Please contact us if you have any questions or would like additional information.