It’s not too early to begin thinking about your yearend gifts to charities. Charitable contributions are an excellent addition to your financial plan. Rather than waiting till the last minute to write a check on December 31st, we would like to give you some ideas that accomplish your giving goals and possibly save some income taxes simultaneously.
Donate Shares Instead of Cash
If you have non-retirement plan investment accounts, you may donate stock or mutual funds shares directly to the charitable organization. The financial planning strategy is to give investments with significant unrealized long-term gains. (This means investments that have been in your possession for at least 366 days, and the current market value exceeds your original purchase cost.)
There is a double income tax benefit by donating appreciated shares directly. First, you avoid paying taxes on the capital gains triggered if you sold shares and contributed the cash. Second, your charitable deduction (if you can itemize deductions on your tax return) is the fair market value of the shares donated, not the purchase price.
The charitable organization also receives a benefit because the contribution of shares at fair market value is more significant than the benefit they would have received if you had sold the shares and given the cash net of capital gains tax. There are two caveats for the charitable organization. The first is that the charitable organization must have an investment account to receive the shares. This donation transfers shares from your investment account directly to the charitable organization’s investment account. The second is that the charitable organization must sell the shares to convert them to cash to use the funds for your stated purpose.
Donor Advised Fund
A Donor Advised Fund works the same way as giving stock or mutual fund shares directly to the charity. However, the Donor Advised Fund (DAF) is the 501(c)3 organization, and the fund operates like an investment account. Instead of making charitable contributions directly to an organization, you can donate directly to the DAF. Your donations become the assets of the DAF; however, you can direct the resources of the DAF (in the form of grant checks) from the DAF to charities you want to support.
The income tax benefit is that you receive the full charitable contribution deduction in the year you deposit shares to the DAF, not in the year(s) the grants are distributed to the charities you want to support. This means you can give a sizeable donation in a year if you wish to consolidate itemized deductions. Then you can spread the grants to charitable organizations over multiple years as directed or as needed by the organization itself. This strategy also benefits the receiving organization because it removes the need for management to make investment decisions, and the charity receives a check for the gift you want to make.
The DAF has a minimum initial contribution requirement of $5,000. However, the initial deposit to the DAF can be an amount totaling multiple years of planned giving. “Bunching” multiple years of anticipated charitable donations into one deposit to a DAF account may even help you use the itemized dedication option on your annual tax return instead of taking the standard deduction.
Grant requests are made directly to the DAF, which reviews and processes recommendations. Grant recommendations are usually approved if the receiving organizations are IRS-approved 501(c)3 public charities and comply with some guidelines and restrictions. Grants can be made for as little as $50 and set up as one-time or recurring gifts.
You can combine both previous strategies to make your charitable donations very flexible. You can donate appreciated, unrestricted, publicly traded securities (i.e., stocks, exchange-traded funds (ETFs), mutual fund shares, and bonds) directly to a DAF. This allows you to take an itemized deduction for the stock’s full appreciated value without paying capital gains tax. This benefit also increases the funds available to grant because funds are not reduced due to income taxes.
Qualified Charitable Distributions
For those over 72 and who have IRAs, this strategy might be the best one yet. The Internal Revenue Service (IRS) requires you to withdraw funds from an IRA account when you turn 72. This means selling investments and pulling cash out of the IRA to be included in your taxable income. This forced withdrawal is called a Required Minimum Distribution (RMD).
Several years ago, Congress made a permanent adjustment to the tax regulations. IRA account owners can now make Qualified Charitable Distributions (QCDs) from an IRA account directly to a charity. The QCD can be used to satisfy some (or all) of the annual RMD. The real benefit of this approach is that the funds that come out of the IRA are not treated as your taxable income, meaning you pay no tax on the QCD distribution. You don’t get a charitable deduction, either. However, not increasing taxable income is good, especially when the IRS forces you to take the distribution because of your age! An important consideration is that any QDCs should be made before the RMD from the IRA is processed.
If you need help assessing any of these strategies for your financial plan, call your Telarray advisor today. The Telarray team is working on finishing any remaining 2022 RMDs. If, after reading this article, you are considering a possible QCD, please let your advisor know your plans as soon as possible.