We last wrote about this subject in 2018 following the passage of the 2017 Tax Cuts and Jobs Act. That law changed the way many tax filers itemize deductions by increasing the standard deduction and limiting the deduction for state and local taxes to $10,000. As a result, fewer filers itemize deductions and consequently receive no tax benefit for charitable contributions (noting that the “above-the line” $300/$600 charitable deduction enacted as part of the COVID-19 incentives is no longer available in 2022).
Many Americans give to charitable organizations without consideration for the tax benefit, but if you are going to give, you should look for ways to find some tax benefits even if you no longer itemize. In 2018, we gave you some ideas to consider. These ideas are still valid, and we thought it a good idea to share some of them with you again.
Use Appreciated Securities
The tried-and-true approach of using appreciated long-term securities to fund your gifts remains valid, even if you do not itemize. By using appreciated stock, you avoid the capital gain tax on the sale, even if you do not get a deduction. This strategy can also save state income taxes in states that use the federal taxable income as the starting point for state income tax (like Ohio).
Use Your IRA
If you are older than 70½ and have a traditional IRA, you should consider using the IRA to make direct contributions to your charity. We have written about this strategy more than once. If the IRA custodian pays the charity directly, the distribution does not appear on your federal tax return as income and therefore is not taxed, putting you in the same (or better) position than if you took the distribution, paid tax on it, made the contribution and then deducted the contribution. There also can be state income tax (especially in Ohio) and other federal tax benefits to this approach, and it is still a great idea to consider, even if you do itemize deductions.
Bunch Your Contributions and Use a Donor Advised Fund
You may want to consider bunching multiple years’ worth of contributions into a single year. For example, if you normally give $5,000 to charities in a year, you could consider donating $15,000, $25,000 or even $50,000 in a single year, maximizing the deduction in that year, and then using the standard deduction in the other years. If you can, consider this approach in a year with high taxable income and/or when you have other deductible expenses, such as large medical expenses.
You can bunch contributions by giving a large amount to your favorite charity (letting them know, of course, about your strategy). Or, perhaps a better approach is to “pre-fund” your donations through a Donor Advised Fund (DAF). When you fund a DAF, you give money to a public charity, which then agrees to hold the money to fund future donations to other charities as “advised” by you. The charitable donation deduction is triggered in the year you fund the DAF, not when the funds are distributed to the ultimate charitable beneficiary. As a result, you can get a large, itemized deduction in the year that you fund the DAF, and then use the standard deduction after that. You can use appreciated securities to fund the DAF (with some restrictions), thereby increasing the tax value. Many charities sponsor DAF programs, including the charitable arms of Fidelity and Schwab, two of the custodians we use here at Ancora. There are some administrative fees associated with DAFs, which you should consider when determining whether to fund a DAF and how much you should give.
We also note that this bunching strategy can be beneficial even if you make charitable contributions and itemize deductions each year. Here’s an example. Let’s look at a married couple who pays more than $10,000 in state and local taxes, pays mortgage interest of $6,000 and makes $15,000 in charitable contributions. They have no other itemized deductions, so they have $31,000 in total deductions. In 2022, the standard deduction for this couple is $25,900. As you can see, the $15,000 in charitable contributions created $5,100 in increased deductions. In essence, $9,900 of the contributions were “wasted” (from a tax perspective).
Let’s look at what happens if the couple gives $30,000 to a DAF in a single year and nothing in the next year, all else equal. In the first year, the couple deducts $46,000 of itemized deductions and in the second year, the couple uses the standard deduction of $25,900, for a total of $71,900 of deduction over the two years, $9,900 more than would have been deducted over two years using the couple’s normal strategy. Pre-funding multiple years of contributions magnifies this effect.
As is always the case with taxes, each situation is different and you should consult with your attorney and/or tax advisor before adopting any strategy discussed in this article.