Individuals, foundations, bequests, and corporations gave an estimated $449.6 billion to U.S. charities in 2019, according to findings in Giving USA 2020: The Annual Report on Philanthropy for the Year 2019. Individuals accounted for an estimated $309.7 billion, up 4.7% in 2019 versus the prior year. Foundations added an estimated $75.7 billion, while another $43.2 billion was given by bequest.
We tend to think about charitable donations around the holidays when it’s year-end and your gift to a charity may be sparked not only by your desire to help others, but by tax planning strategies. The standard deduction is much larger today thanks to 2018’s tax reform, which reduced the incentive to give for some folks. Besides a modest $300 above-the-line adjustment introduced last year via the CARES act, gifts to a charity can only reduce your tax bill if you itemize your deductions.
It is also important to remember that your gifts will not qualify for a tax deduction unless they are received by a tax-exempt organization, as defined by section 501(c)(3) of the Internal Revenue Code. For example, making donations to a personal fundraiser through GoFundMe is growing increasingly common, but they are not tax-deductible. While ensuring your gift is tax-deductible is one challenge, there are others you’ll need to navigate, too.
Let’s review eight important pointers when it comes to charitable giving.
- Utilize the Qualified Charitable Distribution. If you are over age 70 ½ years old, you can donate to charity directly from a qualified retirement savings account (eg. IRA, 401(k), 403(b)). The process is as simple as taking a regular distribution, except the check that you receive will be made out directly to the charity of your choice – just don’t forget to make a copy for your records and to show to your accountant!
One major advantage of this donation method is its reduction in your annual income. Why is this so important? Because you don’t need to itemize to receive the tax benefit! Since the donation is coming directly from your qualified retirement savings account, you are donating pre-tax dollars AND reducing the amount of any potential Required Minimum Distributions dollar-for-dollar. We consider this a win for both you and the charity.
- Don’t spread your limited dollars over too many causes. I call this “trying to butter everyone’s bread.” There are plenty of worthy charities. However, might it be a good idea to concentrate your limited resources on causes you are most passionate about?
You might consider educational charities, culture and the arts, health and organizations that look for treatments and cures for diseases, charities that benefit animals or the environment, your church or place of worship, human services, international relief, or organizations that support the poor in your community. The choices are almost limitless. Your resources are not.
- Get the best return. After you’ve found charities that meet your criteria, you may want the best return on your dollar. We want our cash to be spent and invested wisely, not frittered away by large administrative costs.
According to CharityWatch, “Ask how much of your donation goes for general administration and fundraising expenses and how much is left for the program services you want to support. Most highly efficient charities spend 75% or more on programs. “Keep in mind that newer groups and those that are working on less popular issues may find it necessary to spend a greater percentage on fundraising and administrative costs than well-established, popular groups.”
According to Smart Asset, which reviewed a report by the Tampa Bay Times and The Center for Investigative Reporting, 50 charities collected more than $1.35 billion in donations. Yet, $970 million went not to worthy recipients, but to the people who collected the money.
A small effort of due diligence on your part, or “kicking the tires” of the charity, will go a long way. There are several charity watchdogs you can find online. Do your homework. You may find your decision reinforced by what you find. Or you may decide to steer clear of a particular organization based on your research.
- Skip the middleman. Give directly to the charity and avoid solicitors. The middleman gets paid to raise funds. That’s a haircut on your donation you will want to avoid.
- Steer clear of emotional appeals. This is tricky and difficult. We want to help. We feel good about ourselves when we share our blessings with others who are less fortunate. It’s part of who we are. Emotional appeals pull at our heartstrings. No one, including myself, is immune to what may appear to be a worthy charity. And while you may want to concentrate on causes that have special meaning to you, make sure the charity is actually doing work that you want them to.
Furthermore, be careful about “flavors of the month”. For instance, when a disaster occurs, there are reputable outfits we are all familiar with. Sadly, fraudsters can also play on our desire to help, and donating to them means little if any money will make its way to those suffering from a natural disaster. Instead, your funds may simply line the pockets of scammers.
- Why wait until the last minute? Many nonprofits get a big chunk of cash at year-end. If possible, you can set up monthly payments that help even out the cash flow of these organizations, making it easier on their budgets—and your finances.
- Rethink the small donation. Ten dollars is ten dollars, and plenty of ten-dollar donations will add up, but processing costs for the charity are high. Besides, if you give once, you’ll probably be inundated by requests that raise a nonprofit’s costs, diluting the impact of your one-time gift.
- Failure to develop a strategy. As I’ve said, we are tempted to respond when we hear a well-crafted message. Sometimes, it is a worthy cause. Our desire to help is admirable, and it speaks volumes about who we, but be careful about exhausting limited finances and reducing donations to causes you care about the most.
Will you be paying higher taxes on your capital gains?
The short answer is probably “No.” The longer answer is, “I don’t know” because tax hikes proposed by President Biden may or may not be enacted into law by Congress.
Last month, President Biden unveiled The American Families Plan, which proposes an increase in the tax rates on long-term capital gains—the appreciation of value realized upon the sale of assets held more than one year—for households earning more than $1 million in income. This will not directly affect the tax liability of over 99% of Americans, but if the plan becomes law, let’s look at ways we can use tax planning strategies to avoid or lessen the impact.
Stocks have rallied sharply over the last year. You have benefited, but the sale of an asset could create a tax liability based on your tax bracket and how long you’ve held the asset. Today, the maximum long-term rate on capital gains is 20% plus the 3.8% net investment income tax (NIIT) on certain income. But for those who earn more than $1 million per year, the rate may go much higher!
Currently, the top ordinary income tax bracket is 37.0%. That could rise to the pre-2017 rate of 39.6% if President Biden’s plan is approved. If you earn over $1 million, you may pay that 39.6% rate on the sale of assets held over one year plus the 3.8% NIIT. It could lead to a substantial increase in taxes for less than 1% of Americans.
How could that impact be lessened if we assume the capital gains tax rate is increased?
- If a higher rate is not made retroactive, we can consider recognizing profits in tax year 2021, thus avoiding the new rate. This is called harvesting gains and unlike when harvesting losses, you don’t have to wait 30 days to buy back the asset in order to avoid a wash sale. When harvesting gains, you can buy back the investment immediately after the sale.
- Another way to sidestep the tax is to simply avoid large asset sales in taxable accounts, assuming there isn’t a compelling reason to do so. The only constant in tax law is change, and a future Congress and president could adjust the rates again.
However, there is an important caveat: the time-honored tradition of passing on assets to heirs without paying taxes could be in jeopardy. It is proposed that inherited assets could be taxed on unrealized gains in excess of $1 million.
- We can also strategically time the sale of assets by ensuring that we do not pass the $1 million limit on income. That would ensure the maximum federal rate paid would remain at 20% plus the 3.8% NII tax. It’s a far cry from 43.4%.
President Biden’s proposals must still make their way through Congress and may be modified before a finalized bill reaches his desk and is signed into law. Our team has been closely monitoring the situation.
As always, we remain proactive in updating you on major changes in the tax code since tax planning is a vital component in long-term financial planning. We also encourage you to consult with your tax advisor before implementing any tax strategies and we are always happy to help you coordinate with them.
I trust you’ve found this review to be educational and informative.
Let me emphasize that it is my job to assist you in all financial matters. If you have any questions or would like to discuss any issues that you feel may affect your financial future, please give me or any of my team members a call.
As always, I’m honored and humbled that you have given me the opportunity to serve as your financial advisor.
Table 1: Key Index Returns
|MTD %||YTD %|
|Dow Jones Industrial Average||2.7||10.7|
|S&P 500 Index||5.2||11.3|
|Russell 2000 Index||2.1||14.8|
|MSCI Emerging Markets*||2.4||4.4|
|Bloomberg Barclays US Aggregate Bond Total Return||0.8||-2.6|
Source: MSCI.com, Bloomberg, MarketWatch
MTD: returns: Mar 31, 2021—Apr 30, 2021
YTD returns: Dec 31, 2020—Apr 30, 2021
*in US dollars