We have all heard the phrase “it is better to give than to receive.” Recent scientific research supports the notion that giving one’s time, talents and treasures is a powerful pathway to finding fulfillment in our lives. One of my favorite quotes on the topic is:
“If you want happiness for an hour, take a nap. If you want happiness for a day, go fishing. If you want happiness for a year, inherit a fortune. If you want happiness for a lifetime, help somebody.”
Here is something you may not know. There is a lesser-known benefit that can be obtained from charitable giving. In the vernacular of the behavioral economist and Nobel Laureate Richard Thaler, it is known as transaction utility. More simply stated, it is the happiness we get from the value of a good deal.
To experience the joy of a good deal a few things are preferred. First, it is helpful but not necessary that you actually get a good deal. Second, you must consciously realize (or believe) that you are getting a good deal. What follows are some of the rules of the road for obtaining a good deal in your charitable giving by maximizing the tax benefit you receive when making them.
Establishing your good deal…
By lumping charitable gifts into one year, you can increase the tax benefit of your charitable giving by more than 30%. By changing the property given to charity from cash to low tax basis stock or stock funds, you can increase the tax benefit of your charitable giving by another 20% or more. In total, by changing the timing of charitable gifts and the property used to make them, you can get Uncle Sam to share in more than 50% of the cost of your charitable giving. How is that for a deal?
To get the best deal you should maximize the tax benefit of your charitable deductions and avoid capital gains taxes that you would otherwise incur. The techniques used to maximize these tax benefits are relatively straightforward.
Itemized Deductions vs. Standard Deduction
Let’s assume that you are married and file a joint tax return with your spouse. In 2021, you are entitled to a standard deduction of $25,100. You can take the standard deduction or if greater, you can itemize your deductions. The most common itemized deductions are state income and property taxes (currently capped at $10,000), mortgage interest, and charitable deductions. If the sum of each of your deductions exceeds $25,100 then you are better off itemizing. If the sum of all of your itemized deductions is less than the standard deduction then you are better off taking the standard deduction. You enjoy no income tax benefit from charitable gifts made in a year when your standard deduction exceeds your itemized deductions. By intentionally lumping charitable gifts into a single year, you may be able to increase your itemized deductions so that they exceed the standard deduction in that year and as a result increase your deductions over time.
For those who file as a single person the standard deduction in 2021 is $12,550.
The following example illustrates the potential tax benefits obtained by lumping charitable gifts.
David and Victoria Jones have the following annual deductible expenses:
· State income and real estate taxes = $10,000
· Mortgage interest = $10,000
· Charitable Gifts = $5,000
Using the typical direct annual gift approach, the Jones’ total annual itemized deductions would be $25,000. Because their total itemized deductions of $25,000 do not exceed the standard deduction for a married couple ($25,100) they would take the standard deduction every year. Over a four-year period, the Jones’ would deduct a total of $100,400 using the direct annual gift approach. Alternatively, if the Jones’ make $20,000 of gifts to charity in one of the four years and no gifts in the other three years, their total allowable deductions over the four-year period would be $115,300. The annual deductions the Jones’ would enjoy over the four year period is illustrated in the table below.
Table 2: Summary of annual deductions
Let’s assume that David and Victoria have a combined Federal and state tax rate of 38%. Based on that tax rate, the increased deduction would result in tax savings equal to approximately 28% of their gifts to charity merely by changing the timing of the gifts!
If the Jones prefer that their charities receive equal amounts over the years, they could use a donor advised fund (DAF). A DAF would allow them to receive the deduction for the lump sum in one year and direct their donations over the four years.
Donating Low Basis Stock
The second technique used to get the best deal is to donate low basis stock to avoid taxes on capital gains. This can be a benefit even if you don’t itemize. Let’s say you have $1,000 in a stock (or a mutual fund) for which you paid $400 implying you have an unrealized gain of $600. If you donate the stock, you avoid taxes on the gain and get a charitable deduction of $1,000. If you like the stock and want to continue owning it, just use the cash you would have used to make the donation to replace the donated stock. Pro tip: a single position in a stock or fund may be made up of several “tax lots” if you purchased the stock via multiple transactions including dividend reinvestment. These tax lots have different acquisition prices. You may donate shares from the lot with the lowest price (largest gain) to avoid the most capital gains tax.
Special rules for those over age 70 1/2.
Once you are over age 70 and one half, there is another opportunity for Uncle Sam to offer a lending hand. You can designate all or a portion of required IRA distributions to charity. In the tax code this is referred to as a qualified charitable distribution (QCD). This opportunity is particularly beneficial if you do not itemize your deductions because the amount of the IRA distribution designated to charity is not included in income regardless of whether you itemize your deductions.
If these tax strategies sound appealing, but you are not sure how they apply to you, consider the table below. It provides rules of thumb applicable to each of these strategies based on your age and whether you itemize your deductions or take the standard deduction.
Table 1: Gifting alternatives rules of thumb
While both QCD and donating low basis stocks offer charitable deductions which may lower taxes, donating low basis stock additionally helps to avoid future capital gains taxes.
Be aware that while the above rules of thumb have broad application, there are a variety of other tax rules related to charitable giving that are beyond the scope of this article. Our goal is to raise awareness of some of the common techniques available to enhance the tax benefits of your charitable giving. As with any tax matters, consult with your C.P.A. to determine how the rules apply to your specific circumstances.
We hope this information enhances the joy you experience by helping others.