Values Added

Part 5: How can I make my giving more tax efficient? Charitable planning guide

In the final part of our charitable giving guide, we’ll discuss how you can use your charitable giving program to reduce your taxes.

First, we value many kinds of giving: person-to-person, political, community aid, small organizations, large organizations, and more. However, the IRS doesn’t treat them all the same. If you want an income tax deduction, you’ll generally need to contribute to a tax-exempt organization (most commonly a 501c3) and also itemize your tax deductions.  

There are a huge number of technical opportunities and challenges to giving in a tax-efficient way. I won’t go into these in-depth but I will offer a few resources.

Donor Advised Funds

One of the most broadly beneficial techniques is to use a Donor-Advised Fund (DAF). You can learn more in our prior piece on the power of Donor Advised Funds. This approach is especially useful to anyone who has appreciated stocks or other investments in a regular investment account. If you don’t have a taxable investment account and/or generally donate cash, this technique can help you too. Using a DAF makes it easier to track your donations and separate out your charitable budget from your own money right from the start.

Charitable Bunching

A second commonly used technique is called charitable bunching. This technique may be useful to folks who regularly make significant tax-deductible donations and sometimes end up just below or just above the standard deduction level when they file their taxes. By “bunching” their charitable giving up into every other year or every third year, they can get a much bigger deduction that year and then still benefit from the standard deduction in the other years.

For example, imagine a married couple who contributes $5,000 to tax-deductible charities each year, deducts $10,000 in state and property taxes and deducts $8,000 in mortgage interest annually. Currently, they probably take the standard deduction of $25,900 (the standard deduction for 2022) each year, which is the same deduction they’d get if they didn’t give to charity at all. If instead of donating $5,000 every year, they donated $15,000 every third year, they can itemize and deduct $33,000 that year and still get to deduct the $25,900 (the standard deduction for 2022) in the other years. 

This creates less taxable income, which saves them thousands of dollars in taxes just for moving around the timing of charitable donations. Here is a helpful chart showing the benefit of charitable bunching from the Stark Community Foundation (note: it’s a bit out of date and uses an older number for the standard deduction):

Using a donor-advised fund and charitable bunching work really well together. By bunching your donations into the DAF into a single year, you can get more of the value of itemizing the donations and getting a tax deduction. But then you can keep some of the money in the DAF to distribute during the other years, so you can offer consistent annual support that the organizations can count on each year and still be able to respond to requests for donations at any time.

Giving Appreciated Assets

A third powerful tool is to give long-held appreciated stocks or other investments held in a taxable account to 501(c)(3) charity. These gifts have the same benefit to the charity as giving cash because the charity can sell the security and use the funds to further its mission. But you get an extra tax break by donating this way because you’re never taxed on the unrealized profit. 

To illustrate, let’s say you bought $1,000 of stock in 1980 and now it’s worth $11,000. If you sold the stock before donating, you’d have to pay capital gains taxes on the $10,000 profits you made and only have a smaller amount left to donate. But by donating the stock directly, you get to deduct the full $11,000 without having to pay any capital gains taxes at all. Since the charity is tax-exempt, it doesn’t have to pay capital gains taxes either. The tax liability just *poof* disappears when you make the gift! You can read more in the charitable hack that saved me thousands in taxes and increased my mindfulness.

Qualified Charitable Distributions

A fourth option is for people who have retirement accounts like IRAs and 401(k)s. People with these accounts are usually required to start making taxable distributions from those accounts each year once they turn 72. These required minimum distributions (RMDs) are required whether they need to use the money or not. Normally, they owe tax on these distributions, but if they want to donate to charity, they can potentially avoid this tax by making Qualified Charitable Distributions (QCDs)  directly from their retirement account to the charities they want to support. This technique is *not* combinable with donor-advised funds since QCDs can’t be made to DAFs, but it can help lower taxes for seniors who don’t itemize every year or who have to pay extra in Medicare premiums because of how high their incomes are. More recently, the IRS has said that people must make distributions from inherited IRAs as well so this technique is no longer limited to people 72 or older.

For those who usually give or will once give a tax-deductible amount that is a high percentage of their annual incomes, it’s important to understand a rule that generally limits the deduction one may receive for the donation of appreciated securities to 30% of adjusted gross income (AGI). This typically arises for people who have inherited wealth, sold a business, or otherwise have a significant amount of wealth relative to their income in a specific year. 

For those brushing up against this limit, it’s typically prudent to analyze whether to a) shift some of their donations to a few years in the future, from stock back to cash, b) realize that rolling over to the next year is fine in their situation, or c) not worry so much about the deduction and use it as an excuse to focus more on political giving. It gets pretty technical to weigh all of the considerations, we recommend getting professional help if this issue is relevant to you.

There are many tax considerations and understanding some of these techniques can create additional savings which you can use personally, give to the causes you care about, or perhaps a combination. If you’d rather avoid thinking too much about taxes, that’s okay too, paying taxes supports many good things.

Tying it all together:

  • Give generously, meaningfully, mindfully, prudently, and tax-efficiently!
  • Talk to friends, family, colleagues, and people whom you admire about how/where they give.
  • Don’t wait for the perfect system, get started!
  • Learn and grow. Like anything, the more you work on this, the more you’ll develop a flow. Over time your views might change, that’s a sign of growth and wisdom.

If you have any questions about giving or any of these posts spurred some new ideas for you, I’d love to hear about them. I personally read every email so do drop a quick (or not-so-quick) note. We’re here to help. You can see more ways to connect by clicking here.

Thank you for joining on this journey – it was a pleasure having you with me!

Charitable giving: A five-part series on more effective philanthropy

Photo by Elvert Barnes

Updated December 2022