When a taxpayer makes a charitable gift, he or she typically receives an equivalent charitable tax deduction. However, sometimes they don’t end up lowering their taxes. Usually, in order to receive a charitable income tax deduction, a taxpayer needs to itemize his or her deductions. However, if the charitable contribution and other itemized deductions do not exceed the standard deduction amount, then it makes sense to take the standard deduction and forego the itemized deductions.
For example, the Charlie Charitable has a taxable income of $100,000 per year. It is a single taxpayer and its standard deduction amount is $12,550 (in 2021). He has $10,000 in state and local taxes (an itemized deduction). In addition, he makes a charitable contribution every year of $2,500 to him alma mater. His itemized deductions would be $10,000 plus $2,500 = $12,500, in another meaning, Less than the standard rebate amount of $12,550. It doesn’t make sense for Charlie to itemize his deductions because it would be less than the standard deduction he could take without itemizing.
A taxpayer can make gifts worth up to several years in one year, thus exceeding the standard deduction amount. Then the taxpayer cannot make any charitable contributions in the “off” years while still taking the standard deduction amount.
In our example, Charlie could make a charitable contribution of $10,000 in 2021. He would have total itemized deductions of $20,000. This would save him the tax on $20,000 (his itemized deductions) minus $12,550 (the standard deduction) = $7450. Assuming an interstate and federal circuit of 40%, that would result in a savings of approximately $3,000. In 2022, 2023 and 2024, he would take the standard deduction amount each year and the strategy would not affect his taxes in those years. In 2025, he can repeat the large charitable contribution of another joint opponent.
When Charlie makes a significant contribution, he can make it to the Donors’ Advisory Fund (“DAF”). He will get an income tax deduction in the year he makes the contribution, but he won’t have to Spread Funds from DAF to the charity that year. He can recommend grants from the DAF to any public charity he desires. Therefore, he can continue the distributions on alma materIf desired. But Charlie may decide to switch to a different charity. In the meantime, Charlie can invest the money as he decides is appropriate before distributing it to a charity.
DAF can be used in combination with other strategies. For example, Charlie could give his publicly traded estimated shares to DAF. With this strategy, Charlie would get an income tax deduction for the full value of the appraised share, even though he didn’t pay tax on the gains.
For example, suppose the $10,000 that Charlie gave to DAF was in the form of publicly traded stock of $10,000 but Charlie bought it for only $1,000. If Charlie had sold the stock, he would have had to pay tax on the $9,000 gain. Assuming a state and federal capital gains tax rate of 30%, he owes $2,700 on the gain. If he then contributes the proceeds to charity, he will have only $7,300 to contribute to charity. By giving the publicly traded estimated stock directly to the charity (or DAF), he will get more bang for his buck for his charitable donation.
DAF can be a great way to complement your charitable giving strategy. It allows an individual to double the tax benefits from charitable giving, while still retaining a say on the timing and recipient of the money. Your estate planning attorney can help you decide if DAF is right for you.
Stephen C. Hartnett, JD, LLM
American Academy of Estate Planning Lawyers, Inc.
9444 Balboa Street, Suite 300
San Diego, CA 92123
Phone: (858) 453-2128
Donors Advised Money After Advised: Is It Too Good To Believe? It first appeared in the American Academy of Estate Planning Lawyers.