It may be hard to believe, but the holiday season is here, which means many Americans are planning to donate to their favorite charities in the coming months. But are you aware that 2018 saw a 1.1% decrease in charitable gifting by individual Americans, compared to 2017? We find it unlikely that Americans became less generous people during 2018, so there are two likely reasons for this decrease. First, December of 2018 saw the S&P 500 fall 9.18%, the worst monthly performance since the market doldrums of early 2009, which undoubtedly created anxiety late last year. Second, changes in the 2018 tax law increased the standard deduction and capped the amount of state and local taxes (SALT) that individuals could deduct each year. As a result, millions of Americans are opting not to itemize their tax returns, meaning charitable gifts made less sense, at least from a tax perspective.
Keeping these facts in mind, there are two creative ways to donate to charity while still maximizing tax advantages:
Using your RMDs
If you have a traditional IRA, you must start taking required minimum distributions (RMDs) at age 70 ½ or else incur a penalty. You will also pay normal income taxes on this distribution. However, if you choose not to itemize your tax deductions for the current tax year, you may use some or all of your RMD (up to $100,0000) as a qualified charitable distribution (QCD). Your RMDs, rather than being taxed as normal income, get donated to the charity. Win-win for all involved, as you reduce your tax burden while the charity receives your donation.
Cluster Your Charitable Contributions
If you are not in your RMD stage of life, wish to donate to charity, and prefer to itemize your tax deductions, there is the option to lump your charitable contributions into a single tax year.
For example, consider a couple that has no mortgage, makes $5,000 in annual charitable contributions and has a SALT deduction capped at $10,000. In this case, they are likely to use the standard deduction of $24,000 and not itemize their tax return. They would, therefore, not receive any specific tax benefit from their charitable contributions. If they chose to cluster their charitable contributions, they could elect to make a few years of contributions all in a single year. For example, they could make five years of charitable contributions ($25,000) in a single year and choose to itemize their tax return in that year and use the standard deduction in all of the other years.
The biggest drawback to clustering is that most individuals want to maintain regular contributions over those five years rather than give in a single lump sum. If that is your preference, a donor-advised fund (DAF) may be beneficial. A DAF works like this:
- You make an irrevocable contribution of personal assets to the fund, including cash, stocks, or other assets.
- You immediately receive an itemized tax deduction for the current tax year based on your contribution ($25,000, for example).
- You name your donor-advised fund account, advisors, and any successors or charitable beneficiaries.
- Your contribution is placed into a donor-advised find account where it can be invested and grow tax-free.
- At any time afterward, you can distribute grants from your account to qualified charities.
Keep in mind; you may only itemize your contributions into the fund, not distributions out of the fund. If you are interested in exploring efficient methods for charitable giving, feel free to contact us to discuss which options may be best for your specific situation.