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Giving Advice

Adam M. Grossman

GOT CHARITABLE giving on your mind? Join the crowd. Many folks donate at this time of year, with their charitable giving driven by the charities themselves.

As solicitations arrive, people decide on a case-by-case basis whether to pull out their checkbooks. But some folks follow a more structured process, and that’s the approach I favor. It includes asking these three questions:

1. How much ideally would you like to give? As a starting point, I suggest totaling up the gifts that you’ve made, on average, over the past few years. If you’ve been making gifts on the larger side, those figures will be on your tax return. If you use a donor-advised fund, most fund websites provide annual giving summaries. That’s what I would call the dollar-based approach to thinking about giving.

An alternative is to take a percentage-based approach. As the label suggests, some folks target a specific percentage of their pay for charitable giving. If your income varies significantly from year to year, this approach may be more appealing. I am, of course, not prescribing—or proscribing—any particular amount or percentage. I’m just suggesting that your first step should be to quantify your goals.

2. How much can you afford to give? To answer this question, I’d start with the pay-yourself-first framework. If you aren’t familiar with it, here’s how this strategy works: Assuming you have a sense of your long-term financial goals, you’d work backward to calculate the minimum you need to save each year to be on track for those goals.

For example, suppose you currently have $500,000 saved and your goal is to have $1.25 million for retirement in 15 years. In that case, assuming 5% returns, you’d have to save about $10,000 per year to hit that $1.25 million goal. If you take the pay-yourself-first approach, you’d just need to make sure you’re adding that amount to your savings each year. Then you can choose to allocate what’s left in any way you see fit, including charitable giving.

3. What are the tax considerations? On the surface, this seems like a simple question. If you’re in the 32% tax bracket, every dollar you give ought to save you 32 cents in taxes. Unfortunately, the IRS doesn’t make it that easy.

The wrinkle that affects the most people: the standard deduction. In 2021, an individual taxpayer is entitled to a $12,550 standard deduction and a married couple is entitled to $25,100. But under current rules, there’s a $10,000 cap on the deduction that can be taken for state and local taxes. That makes it more difficult than in the past to muster enough deductions to exceed the standard deduction. The result: If you don’t have any other significant deductions, charitable contributions may not provide any incremental benefit.

One solution to this challenge, as I’ve noted before, is to use a donor-advised fund. Then you can group several years of contributions together into one year, thereby exceeding the standard deduction and realizing a bigger tax benefit. You could repeat this process periodically—every two or three years, for example. Another benefit of donor-advised funds: They allow you to donate appreciated assets, thus sidestepping capital gains taxes. Some even accept cryptocurrencies.

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Donor-advised funds are terrific, but keep a few caveats in mind. If you’re donating appreciated stock, annual deductible contributions are limited to 30% of adjusted gross income. But if you’re donating cash, the limit is typically 60%. The IRS imposes other contribution limits, which are also important to keep in mind. For most people, these limits are very generous, but it’s nonetheless important to be aware of them.

Another tax consideration applies to investors who are contending with required minimum distributions. Beginning at age 70½, taxpayers are eligible to make contributions directly from their tax-deferred retirement accounts. This is called a qualified charitable distribution (QCD).

What’s the benefit? While contributions made this way aren’t eligible for a deduction, they carry a potentially more valuable benefit. They count toward required minimum distributions, up to a maximum of $100,000 per person. Not only can this lower your income tax bill, but it can also lower other costs which are tied to adjusted gross income. These include Medicare premium surcharges and the degree to which Social Security is taxed. If you’re in this age range, you’ll want to compare the relative tax benefits of a standard contribution to a QCD.

What about potential tax law changes? While Congress is never very popular, it’s certainly not winning new friends this year. For months, politicians have been debating potential rule changes, some of which would be retroactive to earlier periods in 2021. As an investor trying to make planning decisions, this makes things even more difficult. According to the latest version of the bill, there would be no changes to the income tax brackets next year.

The 3.8% net investment income tax, however, would apply to distributions from S corporations. If you own an S corporation and take sizable distributions on top of your salary, that would represent a tax increase in 2022. All things being equal, that would be a reason to delay tax deductions, including charitable contributions, until 2022. It’s important to note, though, that negotiations are ongoing. This change might or might not make it into the final rules.

Planning to make a very large donation? As noted above, in most years, deductions on cash contributions are limited to 60% of adjusted gross income. But for 2021, as part of the CARES Act, you’re permitted to deduct up to 100% if you contribute directly to a charity. The upshot: If you were so inclined, you could zero out your tax bill this year.

Adam M. Grossman is the founder of Mayport, a fixed-fee wealth management firm. Sign up for Adam’s Daily Ideas email, follow him on Twitter @AdamMGrossman and check out his earlier articles.

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Harold Tynes
Harold Tynes
11 months ago

Great article. I’m a big believer in Donor Advised Funds and have used Fidelity’s for almost 10 years. I’ve been fortunate to have some high income years where I contributed substantial amounts. This “bunching” effect has allowed to make more tax favored contributions. Many charities don’t accept stock so this is a way to give more and give to a broader group of charities on a day to day basis.

Jerry Pinkard
Jerry Pinkard
11 months ago

Good article as you always have.

I have always felt that factoring anticipated tax legislation into my tax planning is a fool’s errand. I am not smart enough to do that.

However, I have been convinced in recent years that federal taxes are as low as they are going to get for a longtime and are likely to go up substantially in next few years. Therefore, I have done large Tira to Rothe conversions the past 2 years incurring IRMAA penalties and slightly higher taxes. I saw little downside to this strategy and my Tira percent of investments is now about 37%.

Andrew Forsythe
Andrew Forsythe
11 months ago

Adam, thanks for a very helpful article. I’m hoping that in the future you might consider one comparing setting up a donor-advised fund with simply making qualified charitable distributions—pros and cons of each, how an individual’s situation makes one more appropriate than the other, etc.

William Perry
William Perry
11 months ago

My understanding of the current BBB provision related to S-corporation shareholders is that it expands the federal base of the 3.8 percent Net Investment Income Tax (NIIT) to apply to active business income for pass-through income so it would be the1120-S K-1 ordinary income items that would be subject to the revised NIIT regardless of any distributions to the shareholder. I completely agree with your comment “This change might or might not make it into the final rules”.

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