Charitable Donations: Maximizing Your Tax Benefit Under New Tax Law

If you are like many of my charitably minded clients, you probably got a surprise when you filed your tax return and found that you no longer itemize your deductions and, therefore, will likely not receive a tax deduction for future contributions.  However, with some careful tax planning you might be able to structure your future donations in a way that generates a tax break once again.  The three techniques covered in this article are as follows:

  • Bunching donations by calendar year
  • Use of a Donor Advised Fund (DAF)
  • Qualified Charitable Distributions (QCDs)

First, let’s set the stage with an example for a married couple showing Schedule A of their tax return prior to and following the passing of the Tax Cuts and Jobs Act (TCJA).

As you can see, prior to the TCJA this couple’s itemized deductions were significantly higher than the standard deduction, and this was primarily due to their annual donations. However, when the TCJA significantly increased the standard deduction (but eliminated the personal exemption deductions), their itemized deductions came up just short of the standard deduction amount.

Bunching donations by calendar year

One way this couple could reduce their lifetime taxes is to effectively bunch their donations in a way that allows them to itemize every other year. Logistically, this means they will attempt to double up donations in one calendar year and then not make any donations the following calendar year. Below is an example showing what would happen if they were to accelerate most of their planned year 2 donations into year 1, making a large lump-sum donation of $10,000 in late December of year 1, rather than spreading the donations over year 2.

Even though the total itemized deductions for the two-year period does not change, by bunching $10,000 of their donations, they effectively increased their total two-year deduction from $48,800 ($24,400 x 2 years) to $57,400. This equates to a savings of $1,892 over two years, if this couple is in the 22% tax bracket.

$57,400 – $48,800 = $8,600 x 22% = $1,892

There are two significant disadvantages to donation bunching:
1) It requires having excess cash or other investments available to fund a lump-sum contribution.
2) It may be more difficult for the receiving not-for-profit organization(s) to match the lumpy contribution pattern with their financial needs. While the second donation strategy does not solve disadvantage #1 above, it can certainly eliminate disadvantage #2.

Use of Donor Advised Funds (DAFs)

At a high level, DAFs operate just as their name implies – you (the donor) advise the “fund“ managing entity regarding which not-for-profits you want to support.  From a donor tax perspective, this is just another form of donation bunching where you make significant donations to the DAF in one calendar year, and then none in the following year.  However, by putting a DAF between you (the donor) and the not-for-profit that will eventually receive the donation, you can now spread the benefit (distributions) to the recipient charity over time.

There are several types of DAFs, but the two I see clients utilizing most often are either a community foundation or self-administered DAF. Here in the Tri-Cities area we have a wonderful not-for-profit organization called Three Rivers Community Foundation (www.3RCF.org). There are several fund options available at 3RCF and they are even able to provide the service of vetting potential recipients on your behalf. This is especially helpful when you have a specific philanthropic area you want to address (education, arts, etc.), but need help finding the local organizations and programs that can benefit most from your donation. If you are interested, I encourage you to visit 3RCFs website and to contact them for more information.

If a significant portion of your annual donations go to your church (or other faith-based organization) or to not-for-profits located outside of the community, then a community foundation like 3RCF might not be a viable option. If this is the case, then consider creating your own DAF. Three online options that have low fees are Fidelity Charitable, Schwab Charitable, and Vanguard Charitable. The table below shows a comparison between these three options.

I personally chose to open a DAF with Fidelity Charitable based on the low minimums for initial deposit of $5,000, no minimums on additional contributions, and the ability to make individual grants as low as $50.

Once you have established an account with one of these organizations, you simply make “contributions” to your DAF as you are able (remember to bunch these by calendar year), and then when you would like the DAF to send money to a not-for-profit of your choice, you make an online “grant” request to the DAF administrator (ex. Fidelity Charitable) and tell them who the recipient not-for-profit is, how much you would like the grant to be, and when you would like it sent. Grant distributions can be one-time or they can be periodic, such as monthly.

One other nice feature of using a DAF is that your funds can remain invested prior to final distribution, and any earnings on the fund will be available for future grant requests. For all DAFs, it is important to understand that 1) your donation for tax purposes is based on when you contribute the money to the DAF (you do not get tax credit for the grants that go out of the DAF at a later date), and 2) your donation to the DAF is irrevocable…you can’t take it back once it is placed in the DAF. You should also make sure that you clearly understand the fees associated with the DAF option that you choose.

Qualified Charitable Distributions (QCDs)

If you are age 70 ½ or older, and you are taking Required Minimum Distributions (RMDs) from a pre-tax retirement plan such as an IRA, then QCDs are probably the best tax saving option for you. Instead of having to worry about bunching donations or using a DAF in order to maximize your itemized deductions every two years, you simply take the standard deduction each year and convert what would be taxable annual distributions from your IRA into tax-free donations to your favorite not-for-profits. This is accomplished by making the donation directly from your IRA to the charitable organization. Click here to read my previous blog for more information about QCDs.

Conclusion

While obtaining a tax benefit is never the real purpose of charitable giving (i.e. you don’t give away $1.00 solely to get $0.25 back in taxes – you give because you want to give), when possible, it is still wise to give in a way that reduces your lifetime taxes. Whether you personally benefit from the tax savings or choose to pass it on to your favorite charities through additional donations, these tax-planning techniques are worth consideration. Before implementing any of these strategies, make sure to consult with your financial planner and/or CPA to verify that these techniques will provide a tax benefit to you based on your specific circumstances.

Paul Hansen, CPA, CFP®

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