When donating to a charity, you may ask yourself: should I give cash, appreciated securities or make a Qualified Charitable Distribution (“QCD”). The ideal assets to donate to charity are the ones that best fit your individual situation. Writing a check is certainly the easiest way to make a charitable contribution, but it isn’t the most tax-efficient since you are gifting after-tax dollars. However, gifts of cash can be deducted up to 60% of your Adjusted Gross Income (“AGI”).
Let’s explore three alternative assets to donate to charity that are more efficient than donating cash.
Appreciated Securities
If you have owned appreciated securities for a year or more, you can deduct the full market value of the securities on the day you make the charitable contribution. For example, if you bought stock ten years ago for $5,000, and now, when it’s worth $25,000, you donate it to a charitable organization, you are allowed to deduct the full $25,000 and avoid the long-term capital gains tax on the $20,000 profit. The $20,000 is a pre-tax deduction while the $5,000 of basis is an after-tax deduction.
The tax liability that you are giving away is based on your long-term capital gains rate. Your rate can be as low as 0%, or could be either 15% or 20%. The rates are dependent on your marital status and your taxable income. You may also be subject to the 3.8% net investment income tax.
A deduction for gifts of appreciated securities is generally limited to 30% of AGI when the gift is made to qualified charitable organizations. As an example, if your AGI is $100,000, a gift of securities with a fair market value of $30,000 or less is deductible. If you make a gift to a private foundation, the deduction is limited to 20% of AGI.
Qualified Charitable Distributions from Your IRA
If you are charitably inclined, a Qualified Charitable Distribution is another tax-efficient way to make charitable gifts provided you are age 70 ½ or older. A QCD allows you to transfer up to $100,000 per year from your IRA directly to a charitable organization while also satisfying your Required Minimum Distribution (“RMD”).
With a QCD, you don’t have to itemize income tax deductions to receive a tax benefit for your charitable contribution. The amount of your QCD is excluded from your gross income, meaning you will pay less tax. You end up with a 100% pre-tax charitable deduction with a tax savings between 10% and 37%, depending on your filing status and your top marginal rate. An added feature of QCDs is that they aren’t subject to the AGI limitations nor are they counted for purposes of the 60%, 30%, or 20% AGI limitations mentioned above.
The SECURE Act (see our January 2020 blog) states that if you turn 70 ½ in 2020, your RMDs will not be required until you turn 72. However, you can still make a QCD at 70 ½ even though you aren’t required to take RMDs. Taxpayers who turned 70 ½ prior to January 1, 2020 must continue to take distributions under the previous law.
The QCD is popular with retirees who plan to make charitable donations and don’t need the money from their RMDs. There are several benefits of excluding the QCD amount from your income.
First, given the recent tax legislation, 70% of taxpayers don’t itemize deductions by virtue of an increased standard deduction and the $10,000 limitation on deductible taxes (e.g. state and local income taxes and real estate and personal property taxes). When your gross income decreases by a QCD, you end up getting the tax benefit of a charitable deduction whether or not you itemize deductions.
Second, as a result of the QCD, your Adjusted Gross Income decreases. A lower AGI can result in less Social Security Income being taxed. You’ll also have less income to trigger the 3.8% surtax on net investment income. In contrast, a higher AGI can lead to higher Medicare premiums or lower the itemized deductions that are tied to AGI. For example, medical expenses are deductible to the extent they exceed 10% of AGI in 2020. Also higher income may reduce your eligibility for certain tax credits.
Maximizing Your Tax Savings with Charitable Gifts
The best way to limit the income taxes you pay while keeping 100% of your IRA money in your pocket on an after-tax basis is to take a taxable IRA distribution and make an offsetting charitable donation of appreciated securities. In general, this strategy works for anyone age 59 ½ and older. The best results occur when AGI limitations on the charitable deduction are not a factor, and your itemized deductions exceed your standard deduction.
As an example, assume your RMD is $50,000 and you donate $50,000 of low basis securities. From a tax standpoint, the deduction for the $50,000 stock donation negates the tax on the $50,000 IRA distribution. You are left with the $50,000 IRA distribution on which you didn’t have to pay income taxes, plus you gave away your capital gains tax on the appreciated securities. In essence, you have neutralized the income tax impact of taking an IRA distribution while also eliminating potential capital gains tax.
If you’re charitably inclined, there may be a way to maximize tax benefits through various gifting strategies. Our Wealth and Tax Advisors can navigate the complexities of your unique circumstances and help determine which type of charitable donation will result in the largest overall savings to you.
Kara works closely with other team members to provide seamless tax and compliance services to our clients. She has extensive experience in legacy and business succession planning, qualified and non-qualified stock options, restricted stock units and qualified and non-qualified retirement plans, as well as education and retirement planning, and income tax compliance for U.S. citizens working abroad and non-U.S. citizens living and working in the United States.
