How Charitable Giving Impacts Your Taxes
November 11, 2020
What is charitable giving and what does it have to do with financial planning?
We all like to give. It makes us feel good, it makes the beneficiary feel good. Everyone wins. But how can this be applied to financial planning?
Advisors tend to think about it a few different ways. First: cash flow. What can you afford to give, and when should you give it? A charitable donation is a cash outflow just like other expenses, and you’ll want to plan for that accordingly.
A second is taxes. It feels great to give all by itself, but if it can help you save on taxes, it might make you feel even better! When you make charitable donations, you can reduce your top line income by the amount that you give away if you itemize your tax deductions. Let’s look at that in a little more detail.
How do charitable tax deductions work?
The most important thing to understand about the tax impact of giving is that you can reduce your taxable income by the amount that you donate. Here’s an example:
Let’s say you and your spouse file jointly and that together you made $400,000 this year. That puts about $75,000 in the 32% tax bracket. If you make a charitable contribution of $75,000 to your favorite charity this year, then you reduce your taxable income to $325,000. That means that none of your income will fall into the higher 32% tax bracket.
Because you have to itemize your deductions to take advantage of this, you won’t get the standard deduction in addition to the charitable deduction, but this would still represent a substantial reduction in taxes you pay to Uncle Sam of about $16,000 for you.
That’s not exactly money in your pocket, but if you feel like you’d rather fully control how that money is spent rather than letting the government decide, then it represents a powerful way to direct your earnings.
How you give impacts how you’re taxed
When it comes to charitable giving you aren’t just limited to cash. There are many ways you can donate and many things to donate.
One of the most effective ways to give is through your appreciated stock. Working for a company where part of your compensation is through stock options can be very fruitful. Depending on how that compensation is set up though could cost you quite a bit of money in capital gains taxes to reap the benefits.
What if you could give to your favorite charity and not only let them use ALL of the value but limit the amount of taxes you will pay? Well you can, through charitable giving strategies. Here’s an example of how donating appreciated stock assets directly can deliver more for your target charity and reduce more of your taxes.
In the above example, we have stock to donate. The value that we’re considering donating has entirely been generated by capital gains. If we donate the stock directly, we don’t pay any capital gains on that amount, but if we sell the securities for cash, we have to pay $20,000 in capital gains tax. That capital gains tax would reduce the net amount to donate to only $80,000 in the cash donation scenario. That has a further $8,000 impact on your tax savings. To recap, by donating the stock directly, your charity would get $20,000 more and you would reduce your taxes by an extra $8,000.
And don’t worry too much about bumping into limits. You can deduct up to 60% of your adjusted gross income depending on the type of donation, so there’s a pretty high ceiling. And your favorite charity probably doesn’t pay taxes, so they will get 100% of the gift. Really cool, huh? There’s even more incentive to give this year with the passage of the CARES Act with an extra $300 above the line deduction you can claim.
How do you want to give?
Last year Americans gave away $450 BILLION to charities. How awesome is that! When the time is right for you, let’s take full advantage of how the government incentivizes us to give. Of course, we recommend that you run all donation and tax related questions by your accountant, who as we are comprehensive planners, are happy to work with.
At Farther, we think about life and we plan for your goals. I am excited to tell you more about ways to give and ways to save. If you want to chat with an advisor about what giving option is best for you, let’s schedule time to chat.