As we get closer to the end of the year, charitable giving is often top of mind for clients around the holiday season.  Some clients dedicate a percentage of their income, a set monthly amount or give spontaneously when they feel the time is right to give to their organization of choice.  

Most clients are aware that there is a tax break associated with charitable giving, however most don’t realize that they probably aren’t benefiting from it.  The IRS gives you the ability to deduct your charitable donations when you itemize deductions on your tax return vs taking the standard deduction.  The itemized deduction option (Schedule A) isn’t utilized as often as it once was due to the TCJA of 2017, which limits the deductions for most people to a capped amount of SALT (state and local taxes), mortgage interest, medical bills (in excess of 7.5% of AGI) and charitable contributions.  

This means that unless you pay excessive mortgage interest or medical bills, there is a good chance that you receive no tax benefit for your charitable contributions.

One strategy to maximize your tax break is to pre-fund multiple years worth of contributions into a Donor Advised Fund.  Once the money is in the DAF, you can spread the donations to your charities of choice over multiple years or your lifetime.

For example, let's say you normally give $5,000 a year spread across various charities, your church and your alma mater.  If you open a Donor Advised Fund and contribute $25,000 to it, you will get a tax deduction of the full $25,000 in the year that the account is funded, not when the donation is made.  You can then make grants to your charitable organizations from that account at whatever cadence you want.

Lump funding can be a great way to reduce your taxable income in the years that you are in a high tax bracket. We often see a tax bracket change when clients receive a large commission, RSUs with an increased stock price, or by selling significant equity stakes in a tech company.  

Taking tax savings a step further, another tax efficient way to fund the Donor Advised Fund is to transfer an investment with a long term capital gain.  By doing this, you receive the compounded tax benefit of avoiding capital gains tax in addition to the increased deduction from current year income.  Let’s look at two scenarios to see the impact of this giving strategy:

• Scenario 1:  You sell $15,000 worth of Duolingo stock (DUOL) every year for 10 years to give a cash gift to various charities and your alma mater throughout the year.

• Let’s assume you are married filing jointly in the 35% tax bracket and there is no benefit to itemizing your deductions so you take the standard deduction.

• Let’s also assume that your basis in the stock is $5,000 so there is a long term capital gain of $10,000.

• Estimated federal tax paid on the gain = $2,180 ($10k * 20% LT Gain + 3.8% NIIT) * 10 years = $21,800

• Net Benefit to Charity = $15,000 * 10 years = $150,000

• Donor Out of Pocket = $150,000 + $21,800 capital gains tax = $171,800

• Scenario 2:  You lump fund a Donor Advised Fund with $150,000 worth of Duolingo stock to donate over the next 10 years

• Same assumptions as Scenario 1, only you will itemize your tax return this year which will enable you to reduce your taxable income by $150,000 = tax savings of $52,500 (35% * $150,000)

• You transfer your DUOL shares into the Donor Advised Fund instead of selling them which means you avoid the long term capital gains tax 

• Net Benefit to Charity = $150,000

• Donor Out of Pocket = $97,500 ($150,000 - $52,500 less tax)

As you can see in this comparison, the charitable funding method (DUOL stock) and net benefit to charity is the same, however the minor logistical details can reduce the cost of the donation by more than 40%. If you look at it another way, the donor could increase their charitable impact by more than $100,000 over 10 years with the same out of pocket cost as scenario 1.  

• Scenario 3:  You lump fund a Donor Advised Fund with $264,307 worth of Duolingo stock to donate over the next 10 years

• Same assumptions as Scenario 1, only you will itemize your tax return this year which will enable you to reduce your taxable income by $264,307 = tax savings of $92,507 (35% * $264,307)

• Net Benefit to Charity = $264,307

• Donor Out of Pocket = $171,800

Whichever way you look at it, this tax strategy can be impactful and beneficial to both the donor and the non-profit organizations.  Tis the Season to be Merry!

Fine print = these scenarios are for hypothetical purposes only and may not apply to you or your situation. Please consult a tax professional to verify how this might impact you.  One must also consider their tax bracket, utilization of the standard deduction, maximum gift limit based on AGI, AMT calculations, long term capital gains bracket, among other considerations.