6 Tax Smart Ways to Give Back This Season
Updated: Jun 5
Your charitable contributions may have a broader impact if your approach to giving is informed by knowledge of options for meeting tax obligations you might not yet have considered. Combining your financial support for the causes to which you donate with efficient tax strategies can enable you to accomplish more with your annual budget for giving. That means you can make your money go further for the nonprofit organizations you want to help and/or for your loved one’s education by having a tax‐smart plan for your donations.
Tax Efficient Ways of Giving
Before you write checks to your chosen charities in 2022, especially if you’ve earned a high income this year, consider ways to maximize your gifts and reduce your income tax. These and other opportunities allow you to reduce your taxable income and have a greater effect with your giving:
1. Give Appreciated Investments as Donations.
When it comes to making donations, many people overlook the potential benefits of giving appreciated investments. By doing so, they miss out on an opportunity to both lower their tax bill and support a cause they care about. When you donate an appreciated investment, you are eligible to take a federal tax deduction for the year in which you make the donation.
This can be a particularly valuable deduction if you have owned the investment for more than one year, as it can then qualify you for a bigger deduction than on those you have held for less time. In addition, by donating an investment that has not appreciated or has lost value, you can sell it and claim the losses on your taxes. This can then give you an additional IRS deduction when you donate the sale proceeds to an eligible nonprofit organization. As such, it is clear that there are both financial and charitable reasons to give appreciated investments as donations.
You can avoid some tax on capital gains by taking a federal tax deduction for the year you donate appreciated investments to eligible nonprofit organizations. If you contribute an appreciated investment you’ve owned for more than one year, that can qualify you to claim a bigger deduction than on those you’ve held for under a year. On investments that have not appreciated or have lost value, it can be best to sell those and claim the losses, then donate the sale proceeds to an eligible nonprofit and thereby qualify for an additional IRS deduction.
2. Give Through a Grantor Retained Annuity Trust (GRAT).
A Grantor Retained Annuity Trust, or GRAT, can be an excellent way to give to your favorite charities while also potentially reducing your federal gift tax liability. With a GRAT, you transfer ownership of certain assets to the trust, and the trust then pays you an annuity for a specified period. At the end of the term, the remaining assets in the trust are transferred to the charity of your choice. Because the value of the assets may have appreciated during the term of the trust, this can be an extremely efficient way to make a charitable gift. However, it is important to consult with a qualified tax advisor to ensure that a GRAT is right for your particular situation.
An option for giving to your chosen charities, possibly with virtually zero federal gift tax on your contributions, is to donate through a Grantor Retained Annuity Trust. Funding through a GRAT account can enable you to transfer the appreciation of some of your assets’ value to your preferred nonprofit. The amount above the IRS’s threshold “7520 rate” is eligible for this form of charitable giving. In periods of low interest rates, this approach can be especially appealing to many benefactors. Discuss this alternative with your tax advisor to see if it is a good approach for you.
3. Donate Through a Donor Advised Fund (DAF).
A DAF is an often-used alternative for charitable giving in the form of donating investments that appreciate. The DAF option for giving provides taxpayers with a tax-smart approach to donating some stocks and/or other appreciated assets and qualifying for an IRS income tax deduction. Your financial advisor can assist you in setting up and funding a donor-advised fund for your charitable giving.
A donor advised fund (DAF) is a great way to donate appreciated assets and get a tax deduction. With a DAF, you can donate stocks and other investments that have gone up in value. And, since you get a tax deduction for the donation, you can lower your taxable income. Plus, you can advise the fund where you want your donation to go. So, if you're looking for a tax-smart way to give charitably, a DAF may be right for you. Talk to your financial advisor about setting up a DAF today.
4. Give Someone a Game-Changing Education.
Sponsoring your child’s education through a 529 education savings plan is the tax-smart way to manage this essential for his or her future. You can contribute a maximum of $16,000 each year, or double that as a married couple splitting your gifts to the funding recipient’s 529 plan. You will not incur any federal gift tax, and you do not need to use the IRS lifetime gift tax exemption.
Additionally, some states allow state income tax deductions for contributions to their state’s plan. Other states allow deductions no matter which plan you choose for your investment. You can front-load a maximum of five times the federal annual gift tax exclusion in a year. That means you can contribute up to $80,000 to a recipient in just one year. A married couple can split gifts to give as much as $160,000 per recipient in a year.
5. Cut Your Estate Taxes as You’re Giving.
With the holidays fast approaching, many of us are thinking about how we can help those in need. While there are many ways to give back, one of the most efficient ways to do so is to make a charitable donation. Not only will your gift make a difference in the lives of others, but it can also help to reduce your estate taxes.
Sending your charitable donations before the end of the tax year helps reduce your estate taxes. Individually, you can give up to $16,000, and by opting to split gifts, you and your spouse can give a combined total of $32,000 to each recipient without incurring U.S. gift tax. There is no limit to the number of recipients to whom you can contribute these amounts under this tax rule. This annual $16,000 gift tax exclusion is not counted against the current (2022) U.S. gift tax exemption of about $12 million for an individual taxpayer or $24 million for a married couple.
6. Combine Your Multi-Year Deductions into a Single Year.
There are tax savings opportunities in giving, whether or not one’s income qualifies him or her for deductions totaling significantly over the threshold for the current standard deduction. One example is that the taxpayer can still reduce his/her tax debt by bunching multiple years of charitable donations into just one year. That will enable the benefactor to effectively have enough above the threshold for itemizing expenses to realize a savings on the annual income tax. In other years, they can still benefit from taking the standard deduction.
The IRS tax code provides certain deductions that are available to taxpayers in multiple years. Examples of these deductions include the cost of attending professional development seminars, the cost of starting a new business, and the cost of moving to a new job location. However, taxpayers often overlook the fact that they can combine these deductions into a single year.
Doing so can provide a significant tax benefit, especially for taxpayers who are in a higher tax bracket. There are two main ways to combine multi-year deductions. The first is to deduct the expenses in the year they were incurred. The second is to deduct the expenses in the year they were paid. Either method can provide a tax benefit, but Deducting expenses in the year they were paid will typically result in a larger deduction. Taxpayers should consult with a tax advisor to determine which option is right for them.
Financial Planning and Charitable Giving
Proceeding with a well-informed tax strategy is the most practical way to ensure that you are making the most of your opportunities for giving back. An experienced financial advisor can help you identify the best ways to support your favorite causes in ways that make the most sense for you.
Your advisor will show you how using the right charitable vehicle(s) can help maximize the effects of your giving. Having an expert in philanthropic giving to offer sound guidance can help you find the best ways to realize your own financial goals while supporting the organizations that are working to help make a better world.
For Tax Planning Advice
Solas Wealth is focused on coaching high income earners on investment planning and tax strategy. Our tax planning experts can help you throughout the year with techniques and approaches to increase the impact of your altruistic giving and more efficiently manage your tax liability.
Talk to a Solas Wealth financial advisor, at (239) 451-3261 to learn more about tax-smart ways to make your charitable donations this year.