2023 Charitable Giving Strategies – Understanding Your Donor’s Intent and Philanthropic Strategy

For the mass affluent or even the average donor, one of the most meaningful aspects of accumulating wealth is the ability to give back in significant, influential ways. Families and individuals donate for a whole host of reasons, and taking advantage of tax breaks is low on the list of motivations. Still, tax benefits are an important secondary consideration when giving, one that requires a closer look. Families will look at charitable giving strategies and evaluate by taking into consideration their personal goals and circumstances and in consultation with their tax advisor.

Since 1917, individual taxpayers who itemized have been able to receive a tax break on their charitable gifts. However, the enactment of the Tax Cuts and Jobs Act in 2017 has reduced the federal tax benefit for many households. Beginning in 2018, the standard deduction nearly doubled. As a result, far fewer taxpayers are itemizing and receiving an actual tax break for their charitable gifts.

Understanding the factors impacting tax benefits

For itemizing taxpayers, the tax benefits of charitable giving will depend on factors that include:

• The type of asset contributed (e.g., cash, long-term capital gain property, short-term capital gain property, tangible personal property, self-created or intellectual property).
• The basis and fair market value of the assets donated.
• The type of charity to which the gift is donated – a public charity or a private foundation.
• The income level and tax bracket of the taxpayer. As a rule, an individual cannot offset their entire income in a year with a sufficiently large charitable gift. The amount one can deduct for charitable contributions is subject to different AGI limitations. There is a 60% AGI limitation for cash contributions to “50% charities”. There are two 50% limitations for aggregate deductible contributions. The deduction may be further limited to 30% or 20% the AGI limit depending on the type of property given and the type of organization that receives it. For large charitable gifts, amounts in excess of those limits can be carried forward for five more years.
   

Planned gifts can make it possible for donors to give more than they would otherwise, while providing important tax advantages. Understanding the tax advantages will better prepare your organization for the in-depth conversation with your donors as well as board members, finance committees, and other decision makers within your organization. Below is a high-level outline of what those options may be.

Cash contributions: Above-line deduction

Prior law allowed individuals who did not itemize their deductions the ability to deduct up to $300 ($600 married filing jointly) of cash contributions made to a public charity or certain foundations. Donations to non-operating private foundations, supporting organizations, or donor-advised funds did not qualify for this above-line deduction amount. This above-the-line deduction is no longer available for 2023. However, a bill has been introduced in Congress that would potentially raise the cap for non-itemizers’ charitable deductions to approximately $4,500 for individuals ($9,000 for joint filers). It remains to be seen whether this bill passes before the end of 2023.

Gift Appreciated Securities

Some of the most tax-efficient assets to give to charity are marketable securities held 12 months or longer that have appreciated with unrealized capital gains. By donating these directly to the charity, the donor receives a deduction based on the fair market value of the property, and neither the donor nor the charity pays a tax on the capital gains if the security is subsequently sold by the charity.

Donating highly appreciated stock enables a donor to automatically increase gift and tax deductions and save on capital gains taxes.

This is how it works: When a donor donates appreciated assets to charity, they generally take a tax deduction for the full fair market value of the asset rather than their basis. As a result, the value of the gift and the amount of the tax deduction increase, and the donor eliminates their capital gains tax exposure. When the charity later sells the stock, it pays no tax on the gain.

As an example, assume you are debating whether to donate $15,000 of cash, sell $15,000 in stock and donate the cash proceeds, or donate $15,000 worth of stock outright to the charity. What are the net tax savings of the different strategies?

Contribute to a Donor-advised Fund

A donor-advised fund (DAF) is a contractual arrangement that a donor enters into with a sponsoring charity to establish an account to benefit the donor’s chosen charities. If a donor is charitably inclined, they might consider a contribution to a DAF to offset unexpectedly high earnings and year-end bonuses. The basic concept of a DAF is straightforward:

• The donor contributes to the fund and subsequently recommends specific grants to favorite charities when ready.
• Keep in mind that the donor’s recommendations are subject to final approval by the administrating organization.
• The donor can claim a tax deduction for the year in which they put assets into a DAF; the amount and timing of any actual grant has no bearing on the tax deduction.
• DAFs are typically invested and grow tax-free. Donor-advised funds also enhance giving flexibility. A donor does not have to identify nonprofit beneficiaries when they make tax-deductible contributions to their donor-advised fund, and they can distribute their contributions and investment gains to recipients over as long a period as they wish.
   

Private foundations also use DAFs to fulfill their 5% mandatory annual distribution requirement when the foundation is not ready to make a final decision about where to make their grants at the end of the year.

Offsetting the Tax Costs of a Roth IRA Conversion

A charitable gift could save the donor taxes on a Roth conversion. Roth IRAs offer two important tax advantages: (1) Unlike traditional IRAs and employer sponsored plans distributions, qualified Roth IRA distributions are tax free; and (2) Unlike traditional IRAs and employer-sponsored plans, Roth IRAs are not subject to required minimum distribution (RMD) rules that must begin at age 73. A change in the tax law and political developments could result in higher future taxes. If a donor believes their current tax rate is lower than it will be in the years they will be taking distributions from their retirement assets, a Roth conversion can be viewed as insurance against future tax rate increases that would otherwise apply. As a result, more retirement dollars will be available as a tax-free source of income and available to pass to beneficiaries. The bad news is the amount converted from a traditional IRA to a Roth IRA is taxed as ordinary income in the year of conversion and may push the donor into a higher marginal federal income tax bracket. Keep in mind that not all states tax distributions from retirement accounts (the donor should check with their tax preparer to see if state income taxes will apply to the Roth conversion). If the donor is charitably inclined and plans to do a Roth conversion before the end of the year, a large itemized charitable tax deduction can help offset the taxes due to the Roth conversion.

Make Qualified Charitable Distributions

A charitable rollover, also known as a qualified charitable distribution (QCD), can be an effective vehicle for charitable giving. QCDs enable an individual over age 70½ to make tax-advantaged charitable donations of up to $100,000 per year from their IRAs during their lifetime if the distribution is made directly to a charity. QCDs are only allowed from traditional IRAs; they are not allowed from employer-sponsored retirement plans. QCDs are not included in adjusted gross income and for those over their RMD age, the distribution will satisfy or help satisfy your required minimum distribution from an IRA. Any potential income taxes owed on these distributions are eliminated, which makes QCDs beneficial for standard deduction filers.

If a donor has IRAs with nondeductible contributions or multiple IRAs, there are special rules in determining what portion of deductible and nondeductible contributions has been distributed as a QCD and what portion of the remaining IRA is treated as including nondeductible contributions.

Be aware some states may not follow federal tax law and will not allow an exclusion of the QCD from state taxable income. The IRA owner should consult with their tax preparer regarding state taxability of QCDs.

Utilize Split-interest Charitable Trusts

Split-interest trusts are popular due to their dual beneficial interests: They can benefit a qualified charity and a noncharitable beneficiary. For individuals with Federal taxable estates (assets exceeding $12.92 million per individual, $25.84 million per married couple).

As interest rates increase, charitable remainder trusts (CRTs) provide more benefit since the deductible portion is higher. A CRT provides noncharitable beneficiaries with exclusive rights to distributions until their interests terminate; at that time, charitable beneficiaries receive the assets left over in the trust. CRTs have been particularly useful for investors who want to diversify highly appreciated assets but have been concerned about incurring the capital gains tax. The deferral or avoidance of capital gains tax has been a popular feature for funding CRTs with appreciated assets.

Individuals with large retirement accounts should consider naming a CRT as beneficiary, particularly in light of a recent law (The SECURE Act, 2019) that requires retirement account benefits to be distributed within 10 years after the year of the retirement account owner’s death. In general, a CRT provides a current income tax charitable deduction and a stream of income to noncharitable beneficiaries, such as the donor’s children, for a term of no more than 20 years or the life of one or more of the noncharitable beneficiaries. By using a longer payout term, a CRT can potentially avoid subjecting a beneficiary to a higher tax bracket and the 3.8% surtax on net investment income. When the trust term ends, the remainder passes to a charity or charities.

Encourage donors to consider making gifts to your organization this year, and advise them to consult with their advisor and their legal or tax advisor to determine which strategy could help maximize the benefits for them, their family, and their chosen charitable causes.

For more information, please contact your advisor.