When a taxpayer makes a charitable gift, typically they get an offsetting charitable income tax deduction. However, sometimes it doesn’t end up reducing their taxes. Normally, in order to take a charitable income tax deduction, the taxpayer needs to itemize their deductions. However, if the charitable contribution and other itemized deductions don’t exceed the standard deduction amount, it makes sense to take the standard deduction and forego the itemized deductions.
For example, Charlie Charitable has taxable income of $100,000 each year. He is a single taxpayer and his standard deduction amount is $12,550 (in 2021). He has $10,000 of state and local taxes (an itemized deduction). In addition, he makes a charitable contribution each year of $2,500 to his alma mater. His itemized deductions would be $10,000 plus $2,500 = $12,500, i.e., less than the standard deduction amount of $12,550. It doesn’t make sense for Charlie to itemize his deductions since they would be less than the standard deduction he could take without itemizing.
A taxpayer could do several years’ worth of gifts in one year, thus pushing past the standard deduction amount. Then the taxpayer could make no charitable contributions in the “off” years and still take the standard deduction amount.
In our example, Charlie could make a charitable contribution of $10,000 in 2021. He’d have total itemized deductions of $20,000. This would save him the tax on $20,000 (his itemized deductions) less $12,550 (the standard deduction) = $7,450. Assuming he’s in a combined state and federal bracket of 40%, that would result in savings of nearly $3,000. In the “off” years of 2022, 2023, and 2024, he’d take the standard deduction amount each year and the strategy would not impact his taxes in those years. In 2025, he could repeat the large charitable contribution for another itemized deduction.
When Charlie makes the large contribution, he could make it to a Donor Advised Fund (“DAF”). He would get the income tax deduction in the year he makes the contribution, but he wouldn’t have to distribute the money from the DAF to the charity that year. He could recommend grants from the DAF to any public charity he desires. So, he could continue distributions to his alma mater, if he wished. But Charlie could decide to switch to a different charity. In the interim, Charlie could invest the funds as he determined was appropriate prior to their distribution to a charity.
A DAF can be used with other strategies. For example, Charlie could give his appreciated publicly-traded stock to the DAF. With that strategy, Charlie would get an income tax deduction for the full value of the appreciated stock, even though he never paid tax on the gains.
For example, let’s say the $10,000 Charlie gave to the DAF was in the form of a publicly-traded stock which was worth $10,000 but which Charlie bought for only $1,000. If Charlie had sold the stock, he would have had to pay tax on the $9,000 gain. Assuming a state and federal combined capital gain tax rate of 30%, he’d owe $2,700 on the gain. If he then contributed the proceeds to charity, he’d only have $7,300 to contribute to charity. By giving the appreciated publicly traded stock directly to the charity (or DAF), he would get even more bang for his charitable donation.
A DAF can be a great way to complement a charitable giving strategy. It allows one to maximize the tax benefit from charitable giving, while retaining a say over the timing and recipient of the money. Your estate planning attorney can help you decide if a DAF is right for you.
Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
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