Charitable Giving

Since the beginning of taxation in the United States in 1913 Congress has chosen to use tax law to encourage and discourage certain behaviors. One behavior that Congress has highly encouraged since 1917 is charitable giving. It is widely known that charitable contributions are deductible for federal income tax purposes and therefore are a very important part of year-end tax planning. What most people do not realize however is that there are multiple ways to give to charity and some have more favorable results than others. The bunching strategy and even better yet donating appreciated property can help maximize your tax savings from charitable giving.

Tax Reform

What changes did the recent tax reform make to charitable giving? The most important change related to charitable giving was the increased standard deduction to $12,200 for single filers and $24,400 for a married couple filing together in 2019. The standard deduction is the “freebie” deduction the government gives you if it exceeds the sum of your state and local taxes (currently limited to $10,000), your mortgage interest expense, and your charitable contributions.* Since the state and local tax deduction is now limited to $10,000 and mortgage interest is generally paid monthly with little flexibility, charitable contributions become the focal point when trying to maximize the government’s “free” gift of the standard deduction to you.

If every year you and your spouse had $10,000 in state and local taxes and $14,000 in charitable contributions your itemized deductions would total $24,000. Since the government gives you the greater of your itemized deductions or a $24,400 standard deduction, your above property taxes and charitable contributions would generate zero tax savings. In other words, you could have given $0 to charity and your income tax liability would have been the exact same, no impact whatsoever!

Standard Deduction

$10,000 State and Local Tax Ded.OR$24,400 Standard Deduction
$14,000 Charitable Ded.
$24,000 Itemized Ded.

Bunching

One strategy to take full advantage of the increased standard deduction is to lump your charitable contributions every other year. This strategy is often referred to as bunching. If instead of taking the above approach, you wrote a $14,000 check to charity in January and another $14,000 check in December and did not write one next year you would increase your itemized deductions to $38,000 this year and next year would still get the $24,400 standard deduction.

Your total tax deductions over the two years would be $62,000 instead of $48,000 simply because you wrote next year’s check at the end of this year.

Year 1

$10,000 State and Local Tax Ded.OR$24,400 Standard Deduction
$28,000 Charitable Ded.
$38,000 Itemized Ded.

Year 2

$10,000 State and Local Tax Ded.OR$24,400 Standard Deduction
$0 Charitable Ded.
$10,000 Itemized Ded.

Gifting Appreciated Stock

What if you could get double tax savings by making a charitable gift? When you gift appreciated property you can do just that. Consider for a moment the stock market performance in the last ten years as of the time of this writing. If you are a buy and hold investor you likely have stocks with large unrealized gains. When you dispose of those stocks you will pay tax on the gains at up to a rate of 23.8% depending on your level of income. However, if you gave some of those appreciated securities to your charity of choice you actually get double tax savings – you do not have to pay tax on the gains and you get to take a tax deduction for the current fair market value of the securities donated. It is important to note that the appreciated property you wish to donate must be long term, meaning held for at least a year and a day, to qualify. The below example shows the combined effect bunching and gifting appreciated stock could have at a 24% tax rate.

In scenario A you have a state and local tax deduction of $10,000 and charitable cash contributions of $14,000 annually. In scenario B you gift appreciated securities with a value of $28,000 and a basis of $20,000 in year 1 and year 3 and make no charitable gifts in years 2 and 4. At the end of year 4 you have made the same amount of gifts to the charity and have saved an additional $8,928 in taxes. This difference is the result of double tax savings and bunching. Not only do you get a deduction for the gift but you also avoid paying taxes on the $16,000 of total unrealized gain.

Why Not?

A common reason people shy away from this strategy is that they want to give their favorite charities a recurring annual or monthly amount instead of a large one time gift. Thanks to donor advised funds, this has become an extremely easy obstacle to overcome. In the above example, you can gift the appreciated stock of $28,000 to a donor advised fund in year 1 and take the full tax deduction in year 1. You can then instruct the custodian of the fund to sell a portion of the stock each year or all at once and make a donation to your charity of choice over time. Donor advised funds are easy to set up and fund and generally allow the donor the ability to recommend when, how often, and to whom donations are made. In addition, donors can typically direct how the funds are invested until they are donated. Fidelity is the largest donor advised fund provider in the country, and there are other great local options such as the East Texas Communities Foundation. For a comparison between a few of the larger funds see here.

A limiting factor of the above strategy is that the value of the appreciated property cannot be deducted beyond 30% of your adjusted gross income (AGI) in the current year. The taxpayer in the above example would need AGI of at least $93,333 to fully deduct $28,000 of appreciated securities in year 1 and year 3. If the fair market value exceeds 30% of AGI it carries forward for up to five years.

In the end, if your total itemized deductions are near the new increased standard deduction amount under tax reform you should consider gifting appreciated property or, at a minimum, consider the bunching strategy mentioned above to yield greater tax benefit from your charitable donations.

 

You can also deduct medical expenses if they exceed 7.5% of adjusted gross income (this 7.5% AGI floor is increased to 10% beginning 1/1/2019). Most people do not incur this level of out of pocket medical expense each year and for this reason considering a medical expense deduction is not applicable for most and therefore not mentioned above.