taxes
Using a QCD Can Ghost Your RMD
If you are giving to charity, give your RMD, and reduce your taxable income.
Giving helps others, reduces your taxes, and as a bonus, lifts your soul.
There are many ways to make charitable gifts, whether you are a true philanthropist, anxious for tax deduction, or a little of both.
But the benefits of charitable giving go beyond advancing the cause of your favorite charity and reducing your taxes. When you give of your hard-earned assets, you will reap an intangible but very real benefit. Generosity is magic, and its benefits are incalculable.
This article presents a brief introduction to seven different ways you can give.
1. Direct Giving
Direct Giving is the simplest form of giving. You simply write a check or send money to your favorite charity.
Direct giving is also a great way to reduce your income taxes. You can deduct up to 60% of your adjusted gross income for charitable cash gifts if you itemize your deductions.
If you are trying to work out how to reduce your tax hit at the end of the year, charitable giving can be a great solution.
2. Gift Appreciated Stock
Another way to make a charitable gift is by donating appreciated stock to a charity.
When you make a gift of long-term appreciated stock to a public charity, you can avoid a capital gains tax and claim a deduction equal to the fair market value of the donated stock.
The limit on charitable deductions for appreciated assets is 30% of your adjusted gross income.
3. Qualified Charitable Distribution
A Qualified Charitable Distribution, also known as a Charitable IRA Rollover, is a tax-efficient way to fulfill your required minimum distribution (RMD) by donating money directly from your IRA to a qualified charitable organization. This unique strategy allows you to satisfy your RMD while also supporting a cause you care about.
The process is relatively straightforward. Instead of taking money out of your IRA and paying income taxes on it, you transfer funds directly to a charity, up to a maximum of $100,000 per year. The RMD transferred directly to a charity will be excluded from your taxable income. This will reduce your taxes and help your favorite charity.
A qualified charitable distribution is an excellent strategy if you made IRA or 401k contributions while you were working to reduce your income taxes but now realize you don't need the RMD income, and you certainly don't want the tax hit from taking the RMD.
4. Donor Advised Fund
A Donor Advised Fund (DAF) is a charitable investment account you create through a community foundation or a financial institution like Fidelity, Schwab, or Vanguard. A community foundation is a public charity that supports a city or region by aggregating local donations to address community needs and support local nonprofits.
When you donate to a donor advised fund, you get an immediate tax deduction, but unlike direct giving, you can take your time to choose which charity you want to receive your donation. A donor advised fund combines the benefits of direct giving with the ability to strategically plan your charitable donations.
Another aspect of using a donor advised fund is that your donations are kept private.
5. Private Foundation
Unlike a donor advised fund, a Private Foundation is a separate legal entity, typically a nonprofit corporation. It is essentially a private family charity. It can be established during your lifetime or at your death through your living trust.
Sometimes, for our wealthy clients whose estate value surpasses the estate tax exemption, we may include a zero-out estate tax provision in their living trust that will establish a private foundation if the estate is subject to the estate tax. The concept is that our client would rather have a portion of their estate fund his private foundation than pay an estate tax.
A private foundation does not do charitable work. Rather, it makes contributions to charities.
Because private foundations are private and not subject to public scrutiny like a public charity, the rules governing private foundations are more restrictive. For example, the rules limit the private foundation's ability to do business with family members. The rules also limit the types of investments and grants that a private foundation can make. As a result, you will need a tax advisor with experience in working with private foundations to guide you.
Private foundations are complicated and require a high level of expertise to operate without running afoul of the rules. But they are very good for creating a family legacy. Children, grandchildren, and great-grandchildren can learn to be philanthropists and have an impact on their community.
6. Charitable Remainder Trust
A Charitable Remainder Trust (CRT) is an irrevocable trust. The concept is that you fund the CRT with a particular asset, you receive an income stream for your lifetime or for a term of years, the remainder is given to a charity of your choice, and you receive a tax deduction for the present value of the remainder interest.
CRTs are often used with highly appreciated assets. Let's say you have founder's stock from a start-up company that has made it, or you own real property that has significantly increased in value. If you sell, you will incur a big capital gains tax. However, if you contribute the appreciated asset to a CRT and then sell, there won't be a capital gains tax. Since the remainder beneficiary is a charity, and charities don't have to pay taxes, the CRT won't have to pay taxes on the sale. As a result, you can avoid the capital gains tax on the sale and as trustee of the CRT, you can invest 100% of the profits in a brokerage account. You will then receive a 5% or more payout each year for the term of the CRT, and at the end of the term, the charity will receive the remainder.
CRTs are also great for IRAs. Under current law, if your children inherit your IRA, they must distribute it out within ten years, and the distributions are taxable income. In contrast, if you name a CRT as the beneficiary of your IRA and you name your children as your CRT income beneficiaries, then the funds can be distributed over your children's lifetimes, not limited to ten years. For more on using a CRT as the beneficiary of your IRA, click here.
7. Charitable Gift Annuity
A Charitable Gift Annuity is simply an agreement between you and a charity. It does not require you to create a trust or entity. Instead, you enter into a contract with a single charity and make a gift, and the charity pays you or you and your spouse a lifetime annuity.
Like a CRT, with a charitable gift annuity you will receive an income tax deduction based on the present value of the amount the charity will receive in the future.
Unlike a CRT, you cannot change the designated charity at a later date or direct the investments. Therefore, you need to be comfortable with the financial strength and expertise of the charity since they will have control over the investments.
In conclusion, there are many ways to make charitable gifts, each with its own benefits and considerations: direct giving, gifting appreciated stock, qualified charitable distribution from your IRA, donor advised funds, private foundations, charitable remainder trusts, and charitable gift annuities. Exploring these charitable giving options will help you find the best fit for your philanthropic and tax objectives and help you experience the joy of giving.
