Tax reform. These words send shivers down the spine of many taxpayers. After the last tax law changes to the IRS code, we had major changes to the way charitable contributions are entered on tax returns. For most people, the ability to deduct a gift to religious, political, or 501c3 organizations simply vanished. This happened when the standard deduction was increased to $12,000 per individual, or $24,000 per joint tax return, and the ability to deduct charitable contributions was removed, unless you itemize.
In 2021, these rules were changed because of COVID. Last year, you could deduct $300 from your taxes or $600 for joint filers without itemizing. Currently, there will not be a similar deduction in 2022. Because of this, much of the fiscal incentive for philanthropy has been taken away from many of us; that is, unless you know the rules and how to use them to your advantage.
1. Play The Age Game
The first and easiest way to regain the charitable deduction is reserved for those over the age of 70 and a half. That number should seem familiar. That’s because, under the old rules for a required minimum distribution (RMD) from your traditional IRA or pre-tax work retirement plan, you had to start taking money out of the accounts when you reached that age. To say it was confusing figuring out if you needed to make a distribution at age 70, or if you could wait until 71, is an understatement. In December of 2019, the Secure Act raised the RMD age to 72, no half years anywhere to be seen, except one place.
More Alphabet Soup
A QCD is a qualified charitable distribution. This tax rule allows you to make a gift directly from your IRA, or qualified employer pre-tax retirement plan, while the IRS treats it as if you never received money, because you didn’t. But the best part is that they count it towards satisfying your RMD!
Now here’s where the confusing part about age 70 and a half comes in. The question you might ask is, “Steve, if they raised the RMD age to 72 how can I make a QCD earlier?” Well, that’s because, in typical IRS fashion, the rules were only changed for the RMD. So even though you don’t need to make an IRA distribution at 70 and a half, you can still make a qualified charitable distribution. The good news is that you get to give your favorite charity a gift and do it with pre-taxed money.
Rules To Keep In Mind
Make All QCD Distributions First
If you take more than your RMD out of your account(s) before you take a QCD, it won’t reduce your taxable distribution. Make sure you talk to your tax professional on how to do this and how it affects your specific situation. You can also review the IRS Publication 590-B (PDF).
Understand The Limits
There are limits on the amount you can give each year. That limit is $100,000 per taxpayer. Most will not reach that limit, but more and more RMDs are reaching those stratospheric levels, despite the current market. Also, you might remember that the older you are, the higher the percentage of your retirement account is required to be distributed.
Pro Tip: If you’re making charitable contributions with after-tax money, if you have retirement accounts, and if you are over the age of 70 and a half, make a QCD. You can save yourself from paying taxes and give the same amount to charity.
2. Utilize A Trust
The next option may not be for everyone, but it’s even more effective in reducing your taxes on highly-appreciated assets. If you have investments that have appreciated, like a stock or real estate, and you have huge capital gains that will be paid if you sell them, what can you do? Don’t fear, there are solutions.
Again, these solutions involve a philanthropic approach. By using a charitable trust, you can transfer your highly-appreciated asset into the trust and get an immediate tax deduction. The type of trust you use will depend on what you want to do with the income and the remainder of the trust.
The two main kinds of trusts are charitable remainder trusts (CRTs) and charitable lead trusts (CLTs). A CRT can provide you with lifetime income and the balance of the trust would go to the charitable beneficiary when you die. A charitable lead trust is where you give the income from a trust to charity now and the balance of the trust goes to your heirs when you pass away.
There are several types of each of these trusts and I’m only giving the most rudimentary description of how they work. My recommendation is that you contact an estate-planning professional to develop a plan of action that will work best for your situation.
Pro Tip: By collaborating with a financial planner and an attorney, the team can create a blueprint for you and draft the documents needed to implement the plan. Be sure to have them look at every aspect of your financial life or the pieces of the puzzle might not fit together. Too often in my career, I’ve seen people try to do it piecemeal, and it usually doesn’t go as intended.
3. Try A Donor-Advised Fund
Donor-advised funds (DAFs) are a newer innovation. Unlike trusts such as the CRT and CLT, these accounts are solely for giving to charity. They can be funded with any cash or investment, even highly-appreciated ones. Once they are in the donor-advised fund, the investment can be sold and reinvested elsewhere without any tax implications, while growing tax-free. You get a tax deduction, if you itemize, for the gift, so people often will bunch together multiple years’ worth of gifts to make it a deductible event.
The great news is that even after you make the gift, you can control who and when the fund pays benefits to charity. It can be one or multiple charities and you can direct it, or in many cases, the sponsor of the fund can do it for you. Donor-advised funds have grown in popularity as they are low cost and easy to open. The fees for a donor-advised fund are usually less than creating your own trust or foundation, but they aren’t free. Most advanced financial planners can help guide you to the DAF that fits your needs.
Pro Tip: Bunch your charitable giving for the next few years so it exceeds the standard deduction. That way you can gain back the tax deduction on your philanthropy.
TravelAwaits has a slew of financial planning tips to strengthen your retirement needs: