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Philanthropic Planning: A Guide to Charitable Giving


 

Before I jump into specifics, I want to give you a big picture explanation of each strategy.


A Qualified Charitable Distribution (QCD from here on) is simply a way to give to charity directly from your IRA.


The biggest benefit is that for those over 70.5, QCDs aren’t considered income, so you don’t have to itemize to get the deduction. For those of you taking Required Minimum Distributions, QCDs will count towards your annual RMD. This means you can withdraw (and pay taxes) on less, get the same amount of net-income, and still take the full standard deduction.


The other option, Donor Advised Funds, are like a charitable checking account.


You contribute cash, stocks, or other assets, and get a deduction immediately. You’re then able to space your gifts out as you like. You can also sell assets within the DAF and not worry about capital gains.


Let's break it down. Here’s a flow chart showing the questions I use to determine the best charitable giving strategies for my clients.


Charitable Planning Strategy Flowchart

 

What is a Qualified Charitable Distribution?


Here’s the situation I see pretty often.


A client isn’t ready to begin taking distributions from their IRA at 72 / 73. Maybe they have a pension or other income that, along with Social Security, covers their spending needs. They live comfortably without drawing from their IRAs and they would rather not pay the associated income taxes on withdrawals. They have a couple charities they support regularly too.

 

Many of my clients in this situation use QCD’s as their main form of charitable giving.

 

With a bit of philanthropic planning, they can continue their donations, while minimizing the tax hit from an RMD that they don’t need. It’s often a win-win situation for everyone but the IRS.

 

In the past, it occasionally made sense to take the RMD and then write a check to charity. The donation would count towards itemizing tax deductions. While this is still possible, most retirees are finding it harder to find enough deductions to make itemizing deductions worthwhile. With the higher standard deduction, now $32,300 for couples over the age of 65, most folks just don’t have that many deductions.

 

When clients do elect to itemize, they often find that donations don’t give them a dollar for dollar deduction because of slippage. Slippage is just the difference between the deduction you expect and the deduction you get. This slippage comes from potential paying more in Social Security tax, the phaseout of itemized deductions, the addition of a 3.8% Medicare surtax or increases in cost for Medicare Parts B and D through IRMAA.

 

Giving using a QCD bypasses all these issues and keeps the amount of the distribution from ever showing up as income. There is no issue with slippage when using a QCD.

 

Qualified Charitable Distribution Example

 

Bill and Betty are both 72 years old. Here’s their financial situation.


·       They receive $45,000 from Social Security benefits

·       $20,000 of dividend income

·       $40,000 from Bill’s military pension

·       $29,296 RMD from Bill’s $750,000 IRA

·       They want to give a $29,296 donation to the University of Kentucky to offset Bill’s RMD

 

If the couple gives the $29,296 QCD directly to the charity, the couple’s AGI is $20,000 (dividend income) + $38,250 of taxable Social Security benefits + $40,000 pension = $98,250. Their itemized deductions include paying $3,500 in state income taxes and $2,000 in property taxes. Thus, their total deductions are $5,500, less than the 2024 standard deduction of $32,300. With the standard deduction, their taxable income is $65,950. Based on the 2024 married filing jointly tax tables, this puts the couple in the 12% tax bracket, with a total tax liability of $7,477.

 

If Bill and Betty instead decided to take the RMD and then donate the same $29,296 to charity, their situation would look like this:

 

The couple’s AGI is $20,000 (portfolio income) + $38,250 of taxable Social Security benefits + $40,000 pension + $29,296 (RMD) = $127,546. Their itemized deductions include paying $3,500 in state income taxes and $2,000 in property taxes. They would also deduct the $29,296, subject to the 2% of AGI floor, leaving a deduction of $26,745.08. Thus, their total deductions are $31,280.08, making their taxable income $96,265.92. Based on the 2024 married filing jointly tax tables, this puts the couple in the 22% marginal tax bracket, with a total tax liability of $11,796.

 

Making their donation via Qualified Charitable Distribution saved them $4,319 in taxes. That’s enough savings to cover season tickets for UK football!


How to make a Qualified Charitable Distribution


The mechanics of making a Qualified Charitable Donation are simple.


You just need to add your charity as an alternate payee of your IRA. From there, you can send whatever amount you need directly to the charity.


If you have an advisor, they’ll likely need the name of your charity and their address. Depending on the firm, sometimes they will send the check to you and require you to actually deliver the check to the nonprofit.


On the mechanics side, there are a couple items you should know.


  1. Make sure your name is included on the memo line of the check. I’ve seen charities receive a check directly from Charles Schwab or other firm, with no actual donor information. When this happens, they will have trouble acknowledging your gift.

  2. Include QCD from “your name” on the memo line. The QCD part is important, as many charities will provide a slightly different receipt with specific language acknowledging a QCD.

  3. Make sure the check is made out to the charity directly. If the check is made out to you, you will be taxed on that amount.

  4. Confirm that your withholdings on the QCD are set to 0. Oddly enough, tax withholdings from a QCD would count as taxable income.


How to report a Qualified Charitable Distribution

 

You’ll need to let your tax preparer know that you had a qualified charitable distribution and the amount of the QCD. Recording the QCD on your taxes takes an extra step, but it isn’t a big deal. Most CPAs have likely dealt with it before.


Know ahead of time that your 1099R will still show the amount donated via QCD as a taxable distribution. This is totally normal, as the financial firms aren’t in the business of confirming the tax status of your withdrawals.


Your CPA will take a copy of your receipt from the charity showing how much you contributed and then they will reduce your taxable withdrawal by that amount. You’ll see the full amount withdrawn on Form 1040, Line 4a. The good news is the taxable IRA distribution in Line 4b will the lowered by the QCD amount.

 

What is a Donor Advised Fund?


Let's consider Bob, an extremely generous widower who donates $12,000 each year to his church. Despite his giving, Bob doesn't get any tax deductions for his donations.

Why? Because with the current standard deduction levels, his giving isn't enough to justify itemizing his tax returns.


The Solution: Donor Advised Fund


A Donor Advised Fund (DAF) acts like a charitable bank account that allows you to make donations and get tax deductions in a more flexible manner. Here's how it works:


  1. Initial Donation: Bob can take three years' worth of his annual donations, which amounts to $36,000, and contribute it to a Donor Advised Fund.

  2. Tax Deduction: By doing this, Bob can itemize his deductions and claim the $36,000 in the year he makes the initial donation to the DAF.

  3. Scheduled Giving: In the subsequent years (2024, 2025, and 2026), Bob can direct the DAF to give $12,000 each year to his church, just as he was doing before.

  4. No Change for the Recipient: The church continues to receive the same annual donation from Bob, with no interruption or change in the amount.


Donor Advised Fund Benefits


  1. Maximized Tax Deduction: Bob gets to claim a significant tax deduction in the year he contributes to the DAF.

  2. Flexibility: Bob has the flexibility to direct the funds to his church or any other charitable organization over the years.

  3. Simplified Record-Keeping: All donations are consolidated into one account, making it easier for Bob to manage his charitable giving. He only has to account for the gift to the DAF, not each individual gift to his church.

  4. IRS is the Only Loser: The only entity that misses out on this arrangement is the IRS, as Bob is now able to claim a deduction he couldn’t otherwise.

 

How to set up a Donor Advised Fund through Schwab Charitable


Setting up a Donor Advised Fund (DAF) through Schwab Charitable is a straightforward process.


To begin, you need to create a Schwab Charitable account. This can be done online by visiting the Schwab Charitable website and filling out the application form, which includes providing personal information and agreeing to Schwab Charitable's terms and conditions.


Once your account is set up, you'll fund it with an initial contribution. This contribution can come from various sources such as cash, stocks, or other appreciated assets. Schwab Charitable will then sell any non-cash asset and credit your account with the proceeds.


After funding your DAF, you can start recommending grants to your favorite charities. You can do this online through the Schwab Charitable website, where you can select from a wide range of IRS-qualified public charities. You have the flexibility to determine the timing and amount of each grant, and Schwab Charitable takes care of the administrative details, including sending the grant checks and providing necessary tax documentation.


Additionally, any remaining funds in your DAF can be invested in one of Schwab Charitable's investment pools, potentially growing tax-free and increasing your charitable impact over time. This setup allows you to make charitable donations on a flexible schedule, receive immediate tax deductions, and simplify the process of managing your philanthropic activities​​.

 

Donor Advised Fund Tax Benefits

 

Donor Advised Funds (DAFs) offer several compelling tax benefits that make them an attractive vehicle for charitable giving. One of the primary advantages is the immediate tax deduction you receive upon contributing to the DAF. Whether you donate cash, appreciated securities, or other assets, you can take a deduction for the full fair market value of the donation in the year the contribution is made, subject to IRS limits. For cash donations, you can deduct up to 60% of your adjusted gross income (AGI), while for appreciated securities and other assets, the limit is typically 30% of your AGI. If your donation exceeds these limits, you can carry forward the excess deduction for up to five additional years.


Another significant tax benefit of donating appreciated assets, such as stocks, to a DAF is the avoidance of capital gains taxes. When you donate these assets directly to the DAF, you don't have to pay taxes on the appreciation. This can result in a substantial tax saving, as capital gains taxes can be as high as 20% for long-term holdings. By avoiding this tax, you effectively increase the amount available for charitable purposes. This means that both you and the charities benefit more from the donation, compared to selling the assets first and then donating the proceeds.


Moreover, once the assets are in the DAF, any investment growth is tax-free. This can further enhance your philanthropic impact over time. The funds in the DAF can be invested in various options provided by the DAF sponsor, allowing the balance to grow without incurring taxes on the gains. When you are ready to recommend grants to your chosen charities, you can distribute these funds as you see fit. This tax-free growth can significantly increase the amount available for charitable giving, allowing you to support your causes more robustly and sustainably. Thus, the combination of immediate tax deductions, avoidance of capital gains taxes, and tax-free investment growth makes DAFs a highly tax-efficient method of charitable giving.


What are Donor Advised Fund fees?


Donor Advised Funds (DAFs) typically charge fees to cover the administrative costs associated with managing the fund.


These fees can vary depending on the sponsoring organization and the level of services provided. Generally, DAF fees include an administrative fee, which is a percentage of the fund's assets, and may range from 0.60% to 1% annually. Additionally, there may be investment management fees for the underlying investments within the DAF, which also vary based on the selected investment options. Some DAFs might charge additional fees for specific services such as grant processing, customized reporting, or financial advice. It is important for donors to review and understand the fee structure of their chosen DAF, as these costs can impact the overall funds available for charitable grants.


Despite these fees, many donors find the benefits of tax efficiency, convenience, and strategic giving outweigh the associated costs​​​​​​. It's all about the charitable planning.



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