Here are four ways to save on income taxes while providing contributions to your favorite charities. These loopholes are all fully allowable, but you should discuss them with your tax advisor before doing any of them.
4 Ways to Save on Income Taxes
- Donate Appreciated Securities
Rather than donating cash to a charitable organization, donate appreciated securities. Donations of appreciated stock owned for more than one year are deductible based on the stock’s fair market value, and the gain does not have to be reported. Donations can also be made of dividend reinvestment shares, spin-off shares, stocks in demutualized life insurance companies received for “free,” inherited stock or stock received as a gift. This is also a good strategy when you do not have records of the tax basis since the deduction is not dependent on the cost. - Donor-Advised Funds
Contributions to donor advised funds (DAF) are fully deductible in the year they are made, and the fund managers can make the contributions to your requested charities anytime in the future. Cash and appreciated securities, as described above, can be contributed to the fund. The deduction is taken when the fund receives the contribution regardless of when the contributions are disbursed to the charities of your choice. Assets in the DAF can also earn income on a tax-free basis and provide additional contributions that can go to charities of your choice. Multiple family members and others can be authorized by you to designate the distributions to charities. DAFs are an alternative to setting up a charitable foundation, which involves costs and annual tax filings. For those interested in setting up a foundation an appropriate advisor should be consulted. - Qualified Charitable Distributions from an IRA
People age 70½ or older, and those taking required minimum distributions (RMD) from an Individual Retirement Account (IRA) can direct their distributions to be made directly to their charities, and this is called a Qualified Charitable Distribution (QCD). Such contributions would not be deductible, but the IRA QCD withdrawal would not be taxable for federal tax purposes. This method would particularly benefit people who do not itemize or would otherwise get no tax benefit from their charitable payment. This would also reduce adjusted gross income, possibly benefiting Medicare premium payers with high adjusted gross income. There is a maximum QCD of $100,000 per year per taxpayer. Spouses can each make qualified charitable distributions of $100,000. QCDs can only come from traditional IRA accounts; they cannot come from a SEP that is active, Roth IRA, 401k plan or any other type of pension or retirement plan. The QCD might be taxable for state purposes and you should check your state’s income tax rules. QCDs cannot be made to a donor advised fund or private foundation, only directly to a charitable organization.
If you have a 401k, 403b or other type of retirement plan that RMDs must be taken from, a suggestion is to roll the account over to an IRA and then make the QCD. Caution: There could be other issues when rolling over a 401k or other retirement plan. For instance, a 401k participant over 73 and not retired and who is not a more than a 5% owner does not have to start RMDs; there are ERISA liability and bankruptcy protections to a qualified retirement plan that might be better for the participant than the IRA protections or vice versa; rolling over a retirement plan might need spousal consent under certain circumstances; or the beneficiary designations could be different and the rollover would change them unexpectedly. Also, the retirement plan investments might be managed while the IRA would not be, and an investment advisor might then need to be engaged. Taxes are important, but how you manage your wealth and who you designate it to go to might be more important. Do not let taxes drive the cart. - IRA Bequest
All distributions from an IRA or retirement account are fully taxable by the recipient with an exception for distributions to charitable organizations. A suggestion for those who want to leave funds to a charity upon their demise is for these funds to come from an IRA or other retirement account. This can be done by designating the charity as a beneficiary. An alternative suggestion is to roll over some funds from your existing IRA to a new IRA Rollover account and designate the beneficiary as a specific charity or your DAV from which future distributions could be made. Providing funds to a charity from your retirement account would free up tax-free cash that can then be left to your heirs. These funds will also be estate tax-free for those fortunate enough to have a taxable estate.
Other Loopholes
This column covers four methods that are easy to implement and that could apply to most taxpayers at any income level. There are many other tax-saving charitable giving maneuvers that can be employed, and if you would like to leave substantial amounts to charities, then you should discuss this with your tax advisor.
Caveat
There are limitations on the maximum amount of charitable contributions that can be deducted in a single year, with the non-deductible amounts able to be carried forward for a limited number of years. There are also strict compliance and substantiation regulations. These should be discussed with your tax advisor before making any contributions.
Takeaways
These loopholes all work for the right people at the right time. Show this blog to your tax advisor and find out how you could benefit from these loopholes.
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