Charitable giving is an excellent way to support causes you care about, but did you know it can also benefit your tax planning? While charitable donations should primarily be about helping others, combining philanthropy with tax efficiency can amplify the impact. However, many people don’t optimize their giving to maximize tax benefits. Here’s a breakdown of how to make the most of your charitable contributions.
Why Most People Don’t Benefit From Charitable Donations
The majority of individuals don’t reap tax benefits from their charitable donations because they take the standard deduction, which is often higher than their itemized deductions. Unless you itemize, giving to charity doesn’t reduce your taxable income. For most people, even if they do itemize, the tax benefit is minimal because the standard deduction has been significantly increased in recent years.
So, how can you make charitable giving work for you tax-wise? There are two strategies that can help.
1. Bundle Your Charitable Giving Into One Year
One effective strategy is to lump several years of charitable donations into one. This can significantly increase your itemized deductions in a single year, allowing you to exceed the standard deduction threshold and save more on taxes.
Here’s how it works:
Let’s say you typically donate $10,000 a year and, without it, your total itemized deductions are around $18,000, which is below the standard deduction. If you continue donating annually, you would just take the standard deduction, and over four years, your deductions would total $116,800.
But, if you bundle two years of donations into one, here’s the breakdown:
- Year 1: You give $0, and take the standard deduction of $29,200.
- Year 2: You donate $20,000, resulting in $38,000 in total deductions.
- Year 3: You go back to the standard deduction of $29,200.
- Year 4: You donate $20,000 again, bringing the total deductions to $38,000.
In this example, you end up with $134,400 in deductions, gaining an additional $17,600 in deductions. If you are in the 37% tax bracket, this could save you over $6,500 in taxes by simply timing your donations more strategically.
2. Donor-Advised Funds (DAFs)
A Donor-Advised Fund (DAF) is another powerful tool for tax-efficient charitable giving. A DAF allows you to donate cash, stock, or other assets to the fund and receive an immediate tax deduction. However, you don’t need to distribute the funds to charity immediately. You can let them grow and choose when to donate, giving you greater flexibility and control over your charitable giving.
You can combine the concept of bundling donations with a Donor-Advised Fund. For example, instead of giving $20,000 in one lump sum to charity, you could contribute that amount to a DAF and then decide later where to allocate it. Plus, you can invest the funds within the DAF, allowing them to grow over time before you distribute them to charity.
For most high-net-worth individuals, donating appreciated stock to a DAF is a particularly smart strategy. Donating stock allows you to avoid capital gains taxes, something you can’t do when donating cash.
Let’s break it down:
- If you donate $50,000 in cash, you’ll receive a deduction of $50,000 against your income, which results in $18,500 in tax savings (assuming a 37% tax rate).
- But, if you donate $50,000 worth of stock that you purchased for $10,000 (and it has $40,000 in capital gains), you can avoid the $40,000 in capital gains tax as well as receive the same $50,000 income deduction.
By using a DAF, you save at least $9,250 in taxes on the capital gains (assuming a 23.8% tax rate on long-term capital gains) and get to increase your cost basis by purchasing back the same stock with cash from the DAF. This strategy can lead to significant tax savings while also benefiting your charitable causes.
Many wealthy individuals use DAFs at year-end to lower their taxable income, making room for strategies like Roth conversions. This can be particularly beneficial in years when the stock market has performed well.
Maximizing Your Charitable Giving Strategy
To optimize your charitable contributions, consider reviewing your donations and investment portfolio at the end of the year. Doing so allows you to take advantage of any capital gains and maximize your tax benefits. By using strategies like bundling your donations and leveraging Donor-Advised Funds, you can give more to charity while reducing your tax burden.
Charitable giving doesn’t just make a difference for the causes you care about—it can also significantly improve your tax situation if done efficiently. Take the time to plan your charitable contributions, and you’ll reap the rewards both for others and for your financial future.