Three Tax Savvy Charitable Giving TipsMarch 13th, 2020 by Jim Allen
There are many reasons for why people give to charity. Some give to share their good fortune, others as a way to remember or honor loved ones, and still others may give to support a particular cause or mission. While there are tax benefits to making charitable donations, rarely is that the reason for the gifts. However, the tax benefits can be useful and there are strategies that allow you to maximize tax savings while accomplishing your charitable goals.
Charitable giving can be as simple as the weekly donation at church or the gift of a bag of clothing, or as complex as sophisticated strategies like private foundations, charitable remainder trusts and charitable lead trusts. Listed below are three simple strategies for taking advantage of the tax breaks available while meeting your charitable planning needs.
Gifting Appreciated Property Instead of Cash
Because charities are tax exempt, they do not pay tax on the assets they receive from donors. So, this means that you can give them the assets that you would normally pay tax on, and the tax can be eliminated altogether.
- Say you had 100 shares of XYZ stock that you bought for $10 a share and is now worth $20. If you sell the stock, you would receive $2,000 and have a taxable capital gain of $1,000.
- Now, assume you planned on making a $2,000 contribution to your church with the sale proceeds. If you give the cash to the church, you have a $2,000 tax deduction, but a $1,000 capital gain, so the net benefit is only $1,000.
- But, if you gave the XYZ stock to the church instead of the cash, you have the same $2,000 deduction but without the $1,000 capital gain. So, you benefit from the full $2,000 deduction.
Since the church is tax exempt, the capital gain essentially goes away when the XYZ stock is sold. It makes a lot of sense to make gifts of appreciated property instead of cash in many circumstances.
The Charitable IRA Distribution
For those of you over 70 ½, there is an opportunity to transfer up to $100,000 per year from your IRA to a charity without any tax consequences. Called Qualified Charitable Distributions or QCDs, this tool can be attractive for those people you are forced to take their required minimum distribution (RMD) from their IRA each year. By transferring the desired donation amount directly from your IRA to your charity, this counts as part of your RMD.
The QCD is tax neutral, meaning you do not pay income tax on the IRA distribution, but you also do not get an income tax deduction. For those who are taking their RMD and not spending it, this can be the ideal source of funds to meet your charitable objectives.
Donating “Bad” Tax Assets at Death While Leaving “Good” Tax Assets to Heirs
When you die, some assets like stocks, mutual funds and real estate get what is called a “stepped-up” cost basis at death. This means that your heirs can inherit these, and the capital gain that was in the asset at the date of death is eliminated. This allows your heirs to sell that property without any capital gains (other than any growth after the date of death).
However, not all assets get a stepped-up cost basis at death. Generally, assets that provided a tax deduction or tax deferral (IRAs, 401Ks and other types of retirement plans) have something called “income in respect of a decedent”, or IRD. Meaning that the tax bill doesn’t go away at death – it will have to be paid by the beneficiary. So, from a tax standpoint, some assets are more valuable than others at death.
If you plan on making any charitable bequests at death, the ideal situation is to give charities the “bad” IRD assets and leave the “good” stepped up cost basis assets to your heirs. For example, consider the following estate plan:
- Brandon has two assets, shares of XYZ stock worth $100,000 that he paid $25,000 for and a 401(k) worth $100,000.
- He plans on leaving $100,000 to his alma mater at death and $100,000 to his children.
- The typical situation would be that Brandon names his children as beneficiary of the 401(k) and leaves the $100,000 of XYZ to the alma mater in his will.
This is the tax result of his estate plan –
- The charity inherits $100,000 of stock tax free
- His children will pay the IRD tax on the 401(k), leaving them roughly $70,000.
- Brandon’s estate plan is really 50% to charity, 35% to his children and 15% to the IRS.
If we simply make the charity the beneficiary of the 401(k) and leave the XYZ to Brandon’s children, the result is much better.
- The charity receives the 401(k) but, because it is tax exempt, does not have to pay the IRD tax. So, they still net $100,000.
- When Brandon’s children inherit the XYZ stock, it receives a stepped-up basis so they can sell it for the $100,000 without any capital gain.
- By making this simple change, Brandon’s intended plan of $100,000 each to kids and charity is accomplished.
Our motto at Anchor Bay Capital is “It’s not what you make that counts, but what you keep.” So, tax and charitable planning are always a major focus for us. If you would like to discuss your charitable planning situation with us, please contact us.
Jim Allen, CFP, ChFC, CDFA, Director of Financial Planning is a co-author of the book “the Tools & Techniques of Charitable Planning” published by National Underwriter.