Updated: May 20, 2021
More so than ever charities and nonprofit organizations are counting on the support of donors to continue doing their good work.
Last year brought about a lot of giving opportunities as the nation struggled to deal with the coronavirus and the fallout throughout the economy.
I’ve been getting questions lately about maximizing tax deductions related to charitable giving. Let’s take some time to talk about some common strategies.
Consider giving your required minimum distribution‘s directly to charity.
By now you probably know that every distribution taken from a pretax retirement account counts towards your taxable income. This includes required minimum distribution‘s, otherwise known as RMD ‘s. When you reach age 72, you are required to take out a small percentage out of your pretax retirement accounts. Every year that percentage increases slightly.
Even if you don’t want to take the money out and would rather keep it invested, The IRS requires you to take required minimum distribution‘s. This is so that the IRS can collect tax money on your tax deferred accounts. If you fail to take an RMD in any given tax year you may be subject to an IRS excise tax penally of 50%.
One way to avoid an RMD hitting your tax return is to give your RMD directly to a qualified charity. When you give the full RMD amount to a charity, the IRS does not recognize this income on your current year tax return.
To do this, you will need to instruct your investment custodian that you would like to send the money to a qualified charity rather than dispersing it to your bank account or receiving a check at your home. To qualify for this charitable deduction loophole, the money will need to go directly to the charity straight from your investment account.
This is significant because Charitable deductions can only be taken on a taxpayers current year tax return if they itemize there deductions.
Taxpayers either itemize their deductions or take the standard deduction. These deductions are taken after determining a taxpayers adjusted gross income. As of the tax year 2021 the standard deduction for a married couple filing jointly is $24,800.
This means that every MFJ couple can take a $24,800 deduction from their adjusted gross income to determine their taxable income amount. Taxpayers will only choose to itemize their deductions if the total of their itemize deductions is more than the standard deduction amount of $24,800.
As mentioned previously, charitable donations are one of the itemized deductions. Therefore if your total itemize deductions don’t exceed the standard deduction amount, you wont receive a break on any donations made to charity.
So let’s say that Ethel loves to give money to her local church every year. She usually gives around $4000 per year to the church. Ethel just turned 72 so she will need to take a required minimum distribution from her traditional IRA in the amount of $4000 (it never works out this perfectly but I thought I would keep things simple).
Before working with a tax or financial professional, Ethel continues to make her regular donations to the church as usual, and at the end of the year she deposits her required minimum distribution into her bank account.
When she files her tax return, Ethel will need to pay tax on the $4000 required minimum distribution and since she takes the standard deduction on her return she will not be able to receive a tax deduction for her church donations.
After working with a CFP®, Ethel tells her IRA custodian to send her required minimum distribution in the amount of $4000 directly to the church. She will now effectively receive a tax deduction for her donations because the $4000 required minimum distribution will never hit her tax return, therefore reducing her overall tax liability.
Consider charitable donation stacking.
In recent years the standard deduction has been nearly doubled from $12,500 to $24,800 for couples MFJ. As mentioned before, itemizing your deductions only makes sense if the total of your itemized deductions is over the standard deduction amount.
In past years more people itemized their deductions because the hurdle to achieve greater than the $12,500 standard deduction amount was a lot easier. Now, it is a lot less common for households to have more than $24,800 in itemized deductions – – so a lot more people are defaulting to the standard deduction on their 1040 tax returns.
In a roundabout way, many people lost the tax benefit of their charitable donations because of this. Even though they are getting the higher standard deduction amount they do not see the direct impact of their charitable donations since they can no longer itemize.
One strategy that may help with this is something that I like to call charitable donation stacking. Essentially it involves holding off charitable donations into future tax years and later aggregating several years worth of charitable donations so that you beat the standard deduction threshold and can itemize your deductions.
Stick with me here... keep reading.
Let's say that John and Jenny donate $12,000 to the Red Cross every year. Since they have a little other itemize deductions they are not able to see a tax break reflected (specifically for the charitable donations) on their 1040 tax returns each year.
If they decided to hold off the $12,000 annual donations for a couple years, then donate $36,000 in the 3rd year, they would be over the standard deduction amount and would be able to itemize. Therefore, they would receive the higher standard deduction in previous two years and receive the full benefit of their charitable donations in the year in which they itemized.
As you can see, John and Jenny enjoy a tremendous tax benefit in 2022 when they "stack" their donations for the previous 2 years into the current tax year 2022. They receive over $20,000 more in tax deductions than they would have if they continued to spread out there donations.
I understand that this can be a little personal as most nonprofits and charitable organizations can’t afford to wait until the future to receive their funding. You may be able to pledge your future donation amount so that the organization can do some accounting and budgeting. You may also be able to coordinate with other members or donors inside the organization to eliminate gaps in donations received.
Take advantage of the $300 charitable donation deduction.
In 2020 the IRS is allowing a maximum of a $300 deduction for a charitable donations, even if you don’t itemize your deductions. That means if you gave $300 or more to charitable institutions in the tax year 2020 you can take a $300 deduction. Just don’t forget to include it on your tax return.
In the tax year 2021, this special charitable deduction amount is doubled for married filing jointly couples. If you file a joint return you can take a maximum deduction of up to $600 on your tax return. However if you’re a single filer he will still be able to take up to the $300 deduction limit.
The special donation deduction was put into place to encourage people to give to qualified charities and organizations throughout the pandemic.