How the Tax Code Helps You Help Those in Need

By: Lori Booth-Houle, CPA, CFP®

We all have a keen awareness of the devastating impact of disasters around the world and in our backyard, as with Hurricane Harvey in Texas and Hurricane Irma in Florida.  The human suffering is profound, and we all want to marshal our resources to help.  The tax code offers several tax-favored strategies for giving that make our dollars go further and that could enable us to give more.

Most of us are familiar with the concept of charitable contributions as an itemized deduction on our income tax returns.  As a taxpayer, you are entitled to deduct charitable contributions of money or property made to qualified organizations if you itemize your deductions on Schedule A of your return.  Most charitable contribution deductions are subject to a limit of 50% of your adjusted gross income (AGI), but depending on the nature of the organization you’re giving to and/or the type of property you’re contributing, the limit may be lower.  You’re allowed to carry forward donations in excess of the limit for five years.  See IRS Publications 526, 561, and 1771 for all you could ever want to know about deducting charitable contributions as an itemized deduction.

Here are two other lesser-known, but still-potent strategies for charitable giving that might be worth considering, depending on your financial and tax situation:

Qualified Charitable Distributions (QCDs)

A powerful giving strategy for those taking IRA required minimum distributions is the Qualified Charitable Distribution (QCD).  A QCD allows an individual who is over age 70-1/2 to make a donation of up to $100,000 directly from an IRA account to a charity.  The donation must go directly from your IRA account to the charity—you cannot take an IRA distribution, deposit it in your checking account, and then write the donation check yourself.  The amount you distribute out of your IRA to charity, via a QCD, counts toward satisfying your IRA required minimum distribution.

Does a QCD make sense for you?  If you give to charity already and you have to take an IRA distribution, it really might.  While you cannot claim a charitable deduction on your Schedule A for any donation made with a QCD, the QCD amount distributed from your IRA is also not included in your taxable income (in other words, the IRS says that being able to deduct the QCD would be double-dipping, since it’s not reportable as IRA distribution income).

The bottom line:  the fact that the QCD amount is not included in your income means you will report a lower adjusted gross income on your personal tax return, which could result in a number of benefits.  For example, you may be subject to fewer deduction floors or phaseouts that depend on the level of your AGI, such as medical deductions, miscellaneous deductions (which include tax preparation and investment management fees), and your overall itemized deductions on Schedule A.  Having a lower AGI could also result in lower taxation of Social Security benefits, and it also has the potential to reduce your Medicare premiums.  Overall, a lower AGI gives you a better chance of paying lower taxes, despite the fact that doing a QCD means you cannot deduct the related charitable contribution.

Donor Advised Fund (DAF)

A Donor Advised Fund is a tax-advantaged account specifically earmarked for charitable contributions.  The account can be established with a charitable organization sponsor, either under the umbrella of a financial service company such as Charles Schwab, Fidelity, or Vanguard, or with a local or national community foundation.   Assets held within the DAF grow tax-free, and donors can make additional contributions as they wish.  The sponsor typically has guidelines that establish the minimum contribution to start an account, and the minimum for subsequent donations.  A donor may fund the account with assets (typically cash or appreciated securities, but other types of assets may be accepted depending on the DAF sponsor) and take an immediate tax deduction for the fair market value of the donation.  Amounts contributed to a DAF are treated as donations to a 501(c)(3) charity, and so are subject to the same percent-of-AGI deduction limits as regular charitable contributions. While all contributions to a DAF must ultimately flow out to charity, the donor has discretion as to the timing of those donations, and which organizations they will go to (as long as those organization are permissible recipients under the DAF rules).  Note that a DAF sponsor is not technically required to follow the donor’s instruction as to where donations will go, but in practice, they generally do.

Once donated to a DAF, those assets are no longer yours—they must be used for charitable purposes.  But that’s why you put them there in the first place, and the DAF vehicle has some key benefits.  From an estate planning perspective, DAFs are a great tool for removing assets from your estate if estate taxes are a concern.  But for the many donors without taxable estates, there are other, more tangible benefits.

First, a DAF enables you to donate appreciated investments such as stock, mutual fund shares, ETFs, etc.  You’re allowed to take a charitable deduction for the fair market value of the investments, and make any embedded capital gains in those assets essentially disappear.  In addition, contributions to a DAF can be a useful tax strategy in high income years—you can load up on charitable giving and get the associated tax deduction without having to decide right away where all the contributions are going to go.  And in low income years, you don’t have to worry about not having the cash flow to make charitable donations as long as you have assets in your DAF.

DAFs have other benefits that go beyond the tax savings they offer donors:

  • If you wish to make gifts anonymously, your donor-advised fund sponsor can do that much more easily than you can with a direct donation.
  • You can set up a DAF as a fund to memorialize a specific person or purpose (and name it appropriately).
  • DAFs could serve as a platform for teaching children about charitable giving and making it a family affair. Since the assets in a DAF are removed from the possibility of inheritance by a family member, more constructive conversations about family philanthropy and legacy may ensue.
  • If you want to make a large commitment to a charity (and get the related tax benefit for it immediately), but are concerned that it may not use a lump-sum donation responsibly, a DAF makes it easy to spread out donations so that you can ensure the charity is continuing to use the funds appropriately before making the next gift.

Are there downsides to DAFs?  There can be, and this is where information-gathering and awareness are critical.  DAFs are often criticized because there is no mandate to move the donated funds out to charities within a limited time. In addition, DAF sponsors profit from these accounts because they assess fees on them, and there are varying degrees of transparency around what these fees are.  So—maintain an awareness of how quickly you’re actually donating DAF funds to charity after you contribute to it, to make sure that timeline is in sync with your charitable intentions.  And make sure you understand the fees your DAF sponsor is charging to manage your account.

Lastly, whenever you’re making a charitable donation and have any concerns about the effectiveness of the charity involved, use an internet-based charity research tool such as GuideStar, Charity Navigator, or the Better Business Bureau’s Wise Giving Alliance, to make sure your dollars are supporting your charitable vision and intent.

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