According the Giving USA 2024: Annual Report on Philanthropy, individuals in the United States gave over $374 billion to charity in 2023. Beyond the intrinsic reward of helping others, charitable giving also offers substantial tax benefits if it is approached strategically.
For those who support charitable causes, giving cash – which would include gifts by check, credit card, bank account, or simply handing over currency – is often the most common form of giving. While convenient, cash is one of the least tax efficient ways to make charitable gifts.
Key Takeaway:
Cash is NOT a tax efficient asset to gift to charity.
This blog post will explore the top tax-smart charitable giving strategies available to individuals which can both maximize the effectiveness of their charitable intent as well as reduce an individual’s tax liability.
Charitable Giving Strategy #1: Gifting Appreciated Stock
The first option for tax efficient giving is gifting appreciated stock directly to charity. While many individuals don’t think of the appreciated assets in their brokerage account as prime gifting material, the reality is that gifting appreciated stock can provide significant tax benefits.
The benefit of gifting appreciated stock is that all the capital gain that has accumulated over the years is not taxable to the taxpayer making the gift or to the charity receiving the gift. Additionally, the taxpayer still receives the full fair market value of the gift as an itemized deduction on their tax return. In the end, this strategy allows a double tax benefit, avoidance of tax on the capital gain while still receiving the full deduction.
For the capital gain on the appreciated stock to be excluded from the taxpayer’s income, the appreciated stock has to be long-term which means it has been held for over a year. Also, the positions must be held in a taxable brokerage account versus a tax advantaged retirement account. Other appreciated capital assets in addition to publicly traded stock can also qualify such as ownership of a private business or real estate.
Focusing specifically on the benefit of using appreciated stock, let’s assume a family chooses to make a $20,000 charitable contribution in 2024 using stock that has doubled in value since they purchased it over one year ago as shown in the following chart.
By gifting the appreciated position, this taxpayer is able to avoid capital gains tax on $10,000 of appreciation that otherwise would have been a taxable gain when sold. Assuming they are in the top capital gains tax bracket of 20%, have a state tax rate of 5%, and are subject to the net investment income tax of 3.8%, they would have owed $2,880 in capital gains tax if the shares were sold as calculated below.
This family would also qualify to utilize this contribution as an itemized deduction. Assuming they are already itemizing their deductions and are in the 37% federal and 5% state ordinary tax brackets, they would save an additional $8,400 in taxes from the itemized deduction for total tax savings of $11,280 from this charitable gift.
After all the tax savings, the $20,000 charitable gift will only cost this family $8,720. In other words, they saved 56% of their charitable contribution in taxes which means the after-tax cost of the charitable gift was only 44% of the total amount given to charity.
Key Takeaway:
Gifting appreciated assets results in a double benefit which includes avoiding capital gains tax on the appreciation while still receiving an itemized deduction for the gift.
Charitable Giving Strategy #2: Charitable Bunching
The second charitable giving strategy is charitable bunching, and it can be used on its own or in conjunction with gifting appreciated stock.
At the end of 2017, President Trump signed into law the Tax Cuts and Jobs Act which increased the standard deduction for American taxpayers. With a higher standard deduction in place, fewer individuals have sufficient itemized deductions on their income tax return and as a result simply take the standard deduction.
This means fewer donors are getting a tax deduction for their charitable giving. For those in this circumstance, it can be beneficial to combine or “bunch” multiple years of charitable giving into one year.
This allows them to itemize their deductions in that “bunching” year and then take the standard deduction during the following years. This strategy often produces a larger multi-year combined deduction than simply taking the standard deduction each year.
Brief Tax Review – Deducting Charitable Contributions: To understand how this concept works, the best place to start is with a brief review of how charitable deductions work. To begin we must discuss the standard deduction versus itemized deductions.
Annually when individuals file their tax return, they are entitled to deduct certain expenses from their income before calculating the taxes that they owe. Each taxpayer has the choice of using a standard deduction which is a set amount or tracking specific expenses that they have and deducting those specific expenses as itemized deductions.
If itemized deductions exceed the standard deduction, it is generally in the taxpayer’s best interest to itemize their deductions.
Key Takeaway:
Taxpayers have the choice of deducting either the standard deduction or itemizing their deductions on their tax return.
Allowable itemized deductions are listed in the Internal Revenue Code, but generally speaking, there are four major categories that make up itemized deductions. These are medical expenses (but only the portion that exceeds 7.5% of adjusted gross income), state and local taxes (but only up to a maximum of $10,000), mortgage interest, and charitable contributions.
For 2024, the standard deduction for a married couple under age 65 that files a joint tax return is $29,200. This means that a married couple whose itemized deductions are less than $29,200 would simply take the standard deduction. The following table demonstrates this concept.
To help clarify this how this works, consider an example of a married couple who has the following non-charitable itemized deductions.
- Medical Expenses: Given medical expenses have to exceed 7.5% of a taxpayer’s adjusted gross income before any medical expenses become deductible, it is rare for most individuals to have deductible medical expenses. Accordingly, we’ll assume this line is $0.
- State and Local Taxes: State and local taxes are typically made up of property taxes and state and local income taxes. The total deduction for state and local taxes is currently capped at $10,000 annually; so we’ll assume that the couple in this example has reached the $10,000 limit.
- Mortgage Interest: Finally, we will assume this couple has a home mortgage of $200,000 at 5% interest which results in $10,000 of mortgage interest expense.
Combining all these expenses results in total itemized deductions before any charitable contributions of $20,000 which is below the standard deduction of $29,200. In order to itemize, they would need more than $9,200 of charitable contributions. Otherwise, they would simply take the standard deduction.
To further illustrate how the benefit of charitable contributions is reduced by the high standard deduction, consider a scenario where this married couple gives $10,000 to charity. This would increase their itemized deductions to $30,000 and would result in them itemizing their deductions.
However, the first $9,200 of their charitable contributions would still provide no tax benefit as they simply serve to increase the married couple’s itemized deductions to the level of the standard deduction they were already entitled to. This concept is demonstrated in the following graphic.
Now with a better understanding of the standard deduction versus itemized deductions, we can discuss the charitable bunching strategy.
Charitable bunching occurs when a taxpayer makes multiple years’ worth of charitable contributions in a single year thereby “bunching” their deductions into a single tax year. Then in subsequent years, they simply take the standard deduction.
Key Takeaway:
Bunching charitable deductions can increase the tax benefits received by taxpayers.
To illustrate this concept by continuing the example above, consider the tax savings if the married couple were to bunch three years of charitable contributions ($10,000 x 3 years) into a single year.
This is contrasted with annual giving where the tax benefit of the first $9,200 of charitable gifts is lost year after year as most of the charitable giving simply increases the taxpayer’s itemized deductions to the point where they breakeven with the standard deduction that was already available.
Consider the following example which shows the total deductions over a three-year period for an annual giving strategy on the left versus a bunching strategy on the right:
As demonstrated, using a charitable bunching strategy results in an additional $18,400 of total deductions over the three year period. For a taxpayer in the 37% federal tax bracket and 5% state bracket, the total tax savings would be over $7,700.
A Donor Advised Fund Facilitates Charitable Bunching and Gifting Appreciated Stock: While the first two strategies are great from a tax perspective, not all charities accept appreciated stock and most individuals want to support charities on an ongoing basis rather than intermittently every few years.
These challenges can be easily eliminated by using a donor-advised fund. A donor advised fund is a charitable account which can accept appreciated stock and bunching contributions. The donor advised fund can liquidate any positions and hold funds within the account until the funds are ultimately directed to various charities.
For individuals who decide to set up a donor advised fund, it is important to understand that a contribution to a donor advised fund is legally an irrevocable gift. Because of this, the taxpayer is not allowed to take back those funds for their own personal use in the future.
Since a gift to a donor advised fund is treated as an irrevocable charitable gift, the taxpayer is able to take the tax deduction in the year the funds are contributed to the donor advised fund. Going forward, grants can be made from the donor advised fund to specific charities as needed in current or future years.
Key Takeaway:
Both gifting appreciated stock and charitable bunching can be easily implemented by using a donor advised fund.
Charitable Giving Strategy #3: Qualified Charitable Distributions
As individuals enter retirement, often the most tax-efficient way to make charitable gifts changes. Individuals who are age 70 ½ and older can direct up to $105,000 per year, tax-free from their Individual Retirement Accounts (IRAs) directly to charities through qualified charitable distributions (QCDs).
QCDs are charitable gifts made directly to the charity from an individual’s traditional (pre-tax) IRA accounts. To be eligible, the individual making the gift must be at least 70 ½ years old, and the gift must go directly from the IRA to the charity (i.e. the check cannot be made out to the account owner).
The benefit of QCDs for the taxpayer is that the distribution is excluded from their income. This is advantageous because it avoids all tax on the distribution which often would be difficult to achieve by taking the distribution personally and then making the gift to charity given most seniors do not itemize their deductions.
Another benefit of QCDs is for seniors over age 73 who also have required minimum distributions (RMDs). Seniors are allowed to count their QCDs toward their RMDs thereby reducing the amount of taxable distributions they are required to take in a given year.
Qualified charitable distributions are limited to $105,000 per year for an individual. If a husband and wife both have IRA accounts and otherwise qualify to make QCDs, each spouse can contribute $105,000 from their own IRA for a total of $210,000 for the married couple each year.
The logistics of gifting directly from an IRA to charity typically involve filling out a charitable IRA distribution form with the custodian who holds the IRA account. The custodian then makes out the check to the charity and either sends the check directly to the charity or in some cases the check will be sent to the account owner for them to deliver to the charity.
As long as the check is made payable to the charity, sending the check to the account owner is acceptable as clarified in IRS Notice 2007-7 Q&A-41. However, if the check is made payable to the account owner, it will not qualify for QCD treatment even if the funds are immediately donated to charity.
Because qualified charitable distributions are excluded from income, there is no separate tax deduction allowed for the gift. Essentially, the taxpayer already received a full deduction by excluding the income altogether. To support the validity of excluding the income, the taxpayer should keep a written acknowledgement of the gift from the charity.
What Is The Value Of QCDs? The primary value of qualified charitable distributions is that seniors are able to fully avoid tax on the distribution even if they don’t itemize their deductions.
For a married couple where both individuals are age 65 or older, the 2024 standard deduction is $32,300. Without substantial other itemized deductions, most seniors do not receive any tax deduction for standard gifts to charity.
To illustrate the tax savings, let’s assume the following details. A married couple has minimal other itemized deductions and makes total gifts to charity of $25,000 from their pre-tax IRAs. They are in a 24% federal bracket and 5% state tax bracket for a combined tax rate of 29%.
By making the gift as a QCD, they would save $7,250 in taxes that they otherwise would have paid if they took the distribution personally and simply wrote a check to the charity using non-IRA funds.
Key Takeaway:
As individuals enter retirement, qualified charitable distributions become one of the best ways to make charitable gifts.
What Are Other Benefits of QCDs? While the primary benefit of QCDs is that they do not require a taxpayer to itemize their deductions to receive a benefit, the fact that the income is excluded can have other benefits as well.
For example, there are multiple phaseouts and thresholds in the tax code that are based on total income and impact things such as Medicare premiums and the net investment income tax (i.e. the 3.8% Obamacare tax).
By using QCDs, taxpayers are able to keep their total income lower and reduce the likelihood of exceeding the income based thresholds which ultimately allows them to keep more money in their own pockets.
Can Qualified Charitable Distributions Be Made To Any Charity? Qualified charitable distributions can only be made to certain charities. Qualifying charities include 501(c)(3) charities, but do NOT include the following charitable entities:
- Private Foundations,
- Supporting Organizations (charities that support other tax-exempt entities),
- Donor Advised Funds
Charitable Giving Strategy #4: North Dakota Endowment Fund Tax Credit
The fourth tax efficient giving strategy is specifically useful for North Dakota taxpayers. North Dakota allows taxpayers to claim a state income tax credit of 40% for gifts made to North Dakota qualified endowment funds.
To claim a North Dakota state income tax credit of 40% , the taxpayer must contribute at least $5,000 to an eligible permanent endowment fund. The maximum credit per year is $10,000 per taxpayer or $20,000 per year for married couples filing jointly. In other words, the maximum gift that qualifies for the credit is $25,000 for an individual and $50,000 for a married couple filing jointly.
If the entire credit is not utilized in the year the gift is made, the credit may be carried forward for 3 additional tax years. On the federal side, taxpayers are also able to deduct the contribution, but the amount deducted must be reduced by the amount of the North Dakota tax credit received.
The donation can be made using cash or appreciated stock (See Charitable Giving Strategy #1) and used in tandem with a charitable bunching strategy (See Charitable Giving Strategy #2).
To illustrate the value of this approach, consider an individual who donates $20,000 to an ND qualified endowment fund. This individual would receive an $8,000 ND tax credit (40%), and if they are in the 37% Federal tax bracket and fully itemizing their deductions, their Federal tax savings would be $4,440 (37% of $12,000). Thus, the “after-tax cost” of the $20,000 gift would be $7,560 (or 38% of the total contribution) as a result of the $12,440 of tax savings.
The following table shows the tax savings and the net cost of the gift at various gifting levels.
If the individual chooses to make the gift with appreciated stock and avoid tax on the capital gain, the tax savings can be even higher than what is shown in the table above. Given the generous tax benefits available, it is important to understand what a qualified endowment fund is and what funds qualify.
According to North Dakota state law, a qualified endowment fund is:
“a permanent, irrevocable fund (comprising cash, securities, mutual funds or other investment assets established for a specific charitable, religious, or educational purpose and invested for the production or growth of income, or both, which may either be added to principal or expended) held by a qualified nonprofit organization or a bank or trust company holding the fund on behalf of a qualified nonprofit organization.”
In other words, a qualified endowment fund is a permanent fund where the principal of the fund is never spent. Only the annual income of the fund is available for spending. The idea is that the permanent fund will produce income annually and provide an ongoing source of funding for the charity for years to come.
Many North Dakota charities have established a qualified permanent endowment fund for the benefit of their charitable organization. For individuals considering making a contribution, it is important to confirm with the charitable organization prior to making a gift that the contribution will go to the charity’s permanent endowment fund and that the specific fund qualifies for the North Dakota tax credit.
Key Takeaway:
The 40% state tax credit available for gifts to North Dakota qualified endowment funds can result in very tax efficient charitable giving.
Conclusion:
For families who are charitable, maximizing the impact of their charitable giving is important. Whether the goal is to reduce the after-tax cost of giving on their family budget or ultimately use the tax advantages to enable larger gifts to charity over the course of their lifetime, maximizing the tax benefits of charitable gifts can go a long way to helping them reach their goals.
The key point to remember is that cash is not the most tax-efficient way to make charitable gifts. Giving appreciated stock, bunching charitable deductions, making qualified charitable distributions from pre-tax IRAs, and taking advantage of the 40% North Dakota qualified endowment tax credit can result in significantly higher tax savings for those who are charitable.
If you are interested in learning more about how to develop a tax efficient charitable giving plan that is coordinated with your overall financial goals, we would love to connect to see if what we do is right for you.
