Two Little-Known Ways to Give and Save Taxes
With the end of the approaching and final 2022 donations being made, tax season is quickly approaching. Here are two easy ways to make sure you get the most out of your charitable contributions.
The IRS and California allow taxpayers to deduct charitable contributions on their tax returns. This is the first of two legal, but often overlooked, strategies to maximize the tax benefit of your contributions to the Salvation Army Orange County or to other qualified charities.
IRA to charity
With some exceptions, an individual must begin taking minimum annual distributions beginning at age 72. However, rather than take a distribution from the IRA, you can have the IRA send the distribution (or part of it) directly to a charity. Doing this means that the portion distributed to the charity is not subject to tax.
You may ask: Why is this helpful, because I can already deduct the contribution on my Schedule A, Itemized Deductions?
The IRA-to-charity provision is particularly beneficial because it helps both high- and low-income taxpayers. Consider that this type of contribution:
- Reduces AGI with these potential benefits:
- Less taxable Social Security;
- Reduces potential for hospital insurance (HI) and net investment income tax (NIIT); and
- Reduces phaseouts of various tax benefits; and
- Provides a tax benefit for a taxpayer who is not itemizing.
Here is a simple example.
Doris is a single taxpayer who is 75 years old. She has no itemized deductions other than her charitable contributions. het charitable contributions of $20,000.
As a single taxpayer over age 65, her standard deduction is $14,700 for 2022. She is required to take $20,000 from her IRA in 2022. If she takes the distribution and then makes her contribution, her taxable income will be:
IRA distribution 20,000
Itemized deductions ( 20,000)
Total taxable income $100,000
However, if she makes her IRA distribution directly to the Salvation Army and/or another qualified charity, her AGI will not increase and she will take the standard deduction of $14,700 resulting in taxable income of:
Standard deduction ( 14,700)
Taxable income $ 85,300
Here is a second legal strategy you can use to reduce taxes with your qualified charitable contributions. Although this one is a little more complicated, it works for taxpayers with a big increase in income in one year.
The IRS and California allow taxpayers to deduct charitable contributions on their tax returns. This is the second of two legal, but often overlooked, strategies to maximize the tax benefit of your contributions to the Salvation Army Orange County or to other qualified charities.
Often toward the end of the year, you realize your tax bite is really going to hurt this year. Set up a Donor Advised Fund and make a large deductible contribution. In future years, you can direct the fund to send contributions to any Internal Revenue Code Section 503(c), which includes the Salvation Army and most places of worship.
Example of using a donor advised fund:
In late 2020, Pat received a large severance from his employer. A month later, he received a $500,000 distribution from a previous employer’s nonqualified deferred compensation plan when the company was sold. Pat was looking at an AGI of close to $1 million. Pat usually contributes around $15,000 per year to various charities. In December of 2020, he established a donor advised fund and put $75,000 into it. This gives him a $75,000 charitable contribution deduction for 2022 when he’s in a high tax bracket.
He will make his annual contributions from the fund rather than from his checking account. This is especially beneficial now that he is not working and considering full retirement. He is able to continue making charitable gifts, even though his income has dropped significantly and he wouldn’t get much tax benefit from personally making charitable contributions.
Add a bonus to this plan: If Pat contributes appreciated stock to the donor advised fund, he will have a deduction equal to the fair market value of the stock and avoid capital gains. (Remember, these transactions don’t qualify for the 50%/60%of AGI maximum.)
In general, a donor advised fund is defined as a fund or account that is:
- Separately identified by reference to contributions of a donor or donors;
- Owned and controlled by a sponsoring organization; and
- Structured such that the donor or any person appointed or designated by the donor (a “donor advisor”) has, or reasonably expects to have, advisory privileges with respect to the distribution or investment of amounts held in the separately identified fund or account by reason of the donor’s status as a donor.
The tax benefit for making the receives several tax benefits for the contribution
- A current tax deduction for the charitable gift;
- Avoidance of capital gains taxes if the gift is appreciated property; and
- Reduction of the donor’s gross estate by the amount of any contributed assets.
- Once the donation is made, it is irrevocable. There is no way the donor can get the funds back. They may only be distributed to a 501(c)(3) charity;
- The fund may not distribute to a donor or a person that is related to the donor or donor advisor. These distributions are treated as excess benefit transactions and are subject to an excise tax;
- A taxpayer may not make a tax-free transfer from an IRA to a donor advised fund if the donor claimed a deduction for amounts deposited in the IRA; and
- The fund may not be used to reimburse expenses, including fundraising expenses.
Some of the disadvantages are:
- Lack of control over distributions. Though the sponsoring organization has the final say regarding distributions, the donor has some influence in this area. Generally, if the donor chooses a valid charity, this recommendation will be followed;
TIP: The fund administrators will generally follow any donor request as long as they can verify the donee qualifies as a charitable organization. So, for example, a contribution to the Salvation Army will be honored, but it’s not likely that Anxiety from TP Shortage Sufferers, Inc. is a qualified charity, but you’ll have to look it up!
- Lack of control over investments. Investment choices vary greatly among funds. Some funds allow the donor’s investment advisor to manage the fund, or allow the donor to choose from a list of investment options. However, other funds do not give donors any choice regarding investments inside the funds; and
- Donors may not hire themselves or family members to do work for the fund like they may with a private foundation.
As previously stated you can donate appreciated stock to a Donor Advised Fund and avoid capital gain.
Example of donating appreciated stock to a DAF: In early December 2022, Lizette looked at her stock portfolio. She sold a piece of land at a $1 million gain in 2022, which she used to pay off her house and would likely not itemize in 2023. She had a stock portfolio that contained ABC stock with a basis of $200,000 and a FMV of $500,000. She contributes the ABC stock to the DAF. The result is that she has a $300,000 charitable deduction in 2022 when her income was increased substantially due to the gain on the sale of her land.
In future years she can make her $5,000 each annual contributions to the Salvation Army and her house of worship, as well as other miscellaneous contributions from her donor advised fund and use the standard deduction. She cannot claim a charitable deduction for these donations because she claimed a deduction for these amounts in 2022 when she contributed the stock to the donor advised fund.
If she still wants to own the stock, she can repurchase it at any time and reset the basis.
Of course, as with all tax strategies, and for more information consult a tax professional to make sure it is right for you.
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