Are you looking for ways to minimize your tax liability at the end of the year? It’s never too early to start thinking about how you can reduce your taxable income through tax deductions, particularly as they relate to charitable donations.
If you’re unsure about the best way to support a cause you care about, here are four tips to make sure you make the most of any donation while minimizing what you owe the IRS.
1. Understand Eligibility Criteria
Before you start giving money or assets away to charity, you need to ensure that your donations are going to be eligible for that all-important tax deduction at the end of the year. There are some exclusions to how much you can give, making it impossible to completely whittle down your tax liability.
First, make sure you donate within annual charitable giving limits. The limits will depend on what you choose to donate: cash or non-cash assets. Cash donations are limited to 60 percent of your adjusted gross income.
Meanwhile, non-cash gifts have a lower giving limit of just 50 percent of AGI to public charities and foundations. The exception here is appreciated capital gain property which has a substantially lower limit with respect to your adjusted gross income. When made to qualifying organizations, you can deduct up to 30 percent of your AGI (20 percent to non-qualifying organizations).
Secondly, you must ensure you donate to eligible 501(c)(3) organizations. Charities without this designation may not qualify for contributions that will have the desired impact on your year-end tax liability.
2. Choose the Best Charitable Donation Vehicle
Cash is rarely optimal for you or your estate and heirs. As far as charitable donations, it can only be a deduction if you intend to itemize on your tax return. There are many ways to include charitable giving in your estate plan, many of which provide better tax advantages for you and an even bigger impact on the charities that are near and dear to your heart.
Before moving forward with a donation, consider your options and choose a vehicle that best fits your goals and portfolio.
Charitable Remainder Trust (CRT)
A charitable remainder trust enables you to donate cash and assets to an irrevocable trust that comes with a variety of strategic benefits. You take the charitable donation tax deduction now and those assets are no longer considered part of your estate upon your passing. At the same time, the trust can provide a recurring source of income for you and/or your beneficiaries for a set term. Even after taking income for your own lifetime, the trust can continue the income stream to your heirs for up to another 20 years.
At the end of the term, the remainder of the money in the trust is donated to the charity of your choice. According to the 10 percent rule, a minimum of 10 percent of the value of the trust must be donated to charity to maintain the tax advantages of a CRT.
Donor Advised Fund (DAF)
A donor-advised fund has a lot of crossover with a CRT but without the recurring income for you or your beneficiaries. You can make a tax-deductible donation to the DAF now and wait to dole out the funds to your chosen charities until the opportune time with stipulations that you set in place.
This also means that you don’t have to select a charity upon setting up the DAF. You have the flexibility to pick and choose as your life circumstances change and new opportunities for your generosity arise.
The benefits of a DAF also include no capital gains taxes when donating assets to the fund while ultimately reducing the size of your estate, very similar to a CRT. In fact, a DAF often can make an excellent choice as the remainder person (charity) for a CRT.
Appreciated Assets
How much would you have to pay out of pocket if you were to sell your appreciated assets? This can include stocks, bonds, and real estate that you have held for a given period.
Instead of cashing in your assets and donating the money to charity, you could consider donating the asset itself. By donating the asset, you can avoid capital gains taxes that can eat up the profit of the sale.
You can also combine this strategy with one of the others by funding a charitable remainder trust with real estate or other assets, essentially eliminating capital gains while allowing your investment (and future charitable contribution) to grow.
On the other hand, the charity that receives your asset can sell it for fair market value, netting a bigger influx of cash than what you would have been able to give from your personal sale after you are hit with taxes.
3. Keep Clear Documentation
The best thing you can do if you want to maximize charitable donation tax deductions is to stay organized and keep clear documentation of everything you give. Understand what types of records are needed based on what you give, including receipts and acknowledgment letters.
Any donation over $250 will require a written acknowledgment for tax purposes. However, you may choose to request a receipt for smaller gifts if you plan to make several over the course of the year. These make up the bulk of proof that you did indeed give to charity and help you itemize your deductions.
Depending on what sort of donations you made for the year, you should also understand what forms you need to file with the IRS.
4. Work with Professional Advisors
There are no one-size-fits-all solutions for all charitable giving. Instead, it depends on complex factors including your goals, how much must be reserved for retirement or a child’s education, what you choose to donate, and your overall income.
Tax and financial professionals can take a critical look at your assets and charitable goals. Then, they can advise you on the best vehicle and strategy. The costs of making a mistake can be heavy, and often turn on ticky-tacky IRS regulations. Recent studies show that many do-it-yourself CRTs are out of compliance and in danger of losing their tax-exempt status, requiring payment of back taxes, penalties, and interest.
Charitable giving may be just one part of a larger tax planning strategy. Experienced estate planning attorneys can help you see the full picture and leverage other strategies to reduce tax liability. Buying an annuity is likely not the answer, so don't be tricked into this. Surrounding your charitable giving with a team of qualified professionals who are fiduciaries and can weigh in impartially is essential to minimize your out-of-pocket spending while remaining as generous as possible.
Make a Meaningful Charitable Impact with Magellan
At Magellan Planning Group, we can help you set up a charitable remainder trust that provides for beneficiaries and charities at the same time – all while ensuring you are making the most of all eligible charitable tax deductions.
We are your one-stop shop for holistic wealth management, offering the comprehensive solutions you need for estate, financial, legal, and tax planning all under one roof. Reach out to us today to learn more about how our professionals can help you!
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.
This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group and Cetera Advisor Networks LLC.