Charitable Deductions: How to Use the Tax Code to Give and Save More
The holidays are a special time. It’s a time for celebrating, reflecting, and for most Americans, it’s the time when we think the most about giving back to our communities. Nearly one third of all giving in the United States occurs in December and last year, some Americans learned that their charitable dollars didn’t make as much of an impact on their tax bill as it had before. This week, we’ll dive into a crucial aspect of wealth: charitable giving and how Americans can take advantage of the recent changes to the tax code to continue to save money on taxes.
In this post we’ll explore:
How to prioritize intention when choosing the charity or charities you give to
How the landscape of charitable giving has changed since the Tax Cuts and Jobs Act
How to use the current tax code to maximize your giving and minimize your tax bill
In previous posts we’ve written about how creating greater intentionality in your spending leads to higher levels of happiness. In their book Happy Money: The Science of Happier Spending (2013), Professors Elizabeth Dunn & Michael Norton found that how people spend money matters more than how much they spend. In one study, individuals that spent $5 on someone else reported being more happy than those that spent up to $20 on themselves. Giving can have a huge impact on you, the giver. What’s more, knowing that you can make an impact and save on taxes are two things that are sure to add to your holiday cheer.
The first step to intentional giving is to come up with your own personal mission statement for your charitable contributions. Amy Johnson, a professor at Pepperdine University who teaches Servant Leadership, encourages people to ask two questions while developing their giving strategy: “What is the impact you want to make?” and “Where do you want to make this impact?” Once you understand the scope of the impact you want to make, you’ll begin to make the connection between where your strengths can best serve the charities whose mission is the same as yours.
Once you create your mission statement, you will be ready to find the charities that align with your mission. Here are a few of the larger website and services that can help you narrow down your list of charities:
Guidestar is an amazing online resource containing records from the nearly 2 million nonprofits registered with the IRS. Conducting a search on Guidestar for non-profits is easy - you can search for charities by area, location or size. Guidestar also gives you access to the charity’s Form 990 - which is the non-profit version of a tax return. If you want to understand how your non-profit of choice allocates their money, Form 990 is a great place to start.
If you’re looking for more detail, Charity Navigator offers a free search tool to find out how your charity ranks against others. Their scores are based on financial health, transparency and accountability. Each charity receives a star ranking (4 stars is the highest) based on these three factors. Today, as I searched for the charities I donate to, I noticed they are collaborating with a few other organizations to generate an ‘Impact Score’.
Finally, if you don’t have time to do extensive searching yourself, I recommend taking a look at GiveWell. The GiveWell organization has performed extensive due diligence to narrow down a select list of trustworthy charitable organizations.
Now that you know who your money is going to and why it’s going there, it’s time to decide how much.
The passing of the Tax Cuts and Jobs Act of 2017 doubled the standard deduction for all taxpayers while increasing the percent of total income you can donate to charity for a deduction. What does this mean? Put simply, it means that it’s harder for most Americans to receive a tax benefit, but we can now give more of our income to charity. If you’re lost, don’t worry. We’ll give you an example momentarily...
The main change revolves around the standard deduction, which is how much you can claim in expenses to reduce your taxable income. After the change, most taxpayers lost the tax benefit of charitable contributions (also known as the charitable deduction) they once enjoyed.
If you filed taxes in 2017 (the year before the Tax Cuts and Jobs Act went into effect) as an individual, you were able to reduce your taxable income by taking a standard deduction of $6,350; if you were married and filing jointly, your standard deduction was $13,000. If your deductions exceeded the standard deduction, then you could have opted to itemize your deductions and reduce your taxable income by that amount.
Let’s go through a hypothetical example - meet Mia and Jack...
In 2017 Mia and Jack had $20,000 in deductions:
Home mortgage interest deduction: $10,000
State and Local Tax deduction (known as SALT): $6,000
Charitable Contributions: $4,000
Because $20,000 was greater than their standard deduction of $13,000, they itemized their deductions and their taxable income was reduced by $20,000.
In 2018 the Tax Cuts and Jobs Act took the standard deduction from $13,000 to $24,000 for married couples. If their deduction amounts stayed the same, they were better off taking the standard deduction of $24,000 in 2018.
What effect has this new policy had? While it’s allowed wealthier Americans to deduct more, the result has so far shown that it’s reduced the amount of taxpayers who itemize and can claim a charitable deduction. When it comes to charitable giving, the distinction between itemizers and non-itemizers is important. 83% of itemizers report giving to charity compared with only 44% of nonitemizers. On average, non-itemizers contribute less than 20% of total charitable giving. According to the Tax Policy Center, only about 10 percent of taxpayers itemized their deductions post-Tax Cuts and Jobs Acts - before it was around 30 percent.
The bottom line: if you’d like your charitable dollars to reduce your taxes, planning ahead will benefit you greatly. Let’s walk through three strategies you can use to maximize your impact while minimizing your tax bill.
Combine several years of donations into one year of gifting. If you’ve found a charity or charities that align with your charitable mission but don’t have an amount that would equate to additional tax savings, create a short term goal of saving and investing the annual amount for a few years. Let’s say you donate $2,500 a year to charity and in 2018 you took the standard deduction. If you saved $2,500 for the next four years, you’d have at least $10,000 for a charitable donation in 2022. Should you itemize that year, the cumulative $10,000 donation will likely save you more money in taxes than four separate $2,500 donations.
Gift appreciated stock. By donating stock that has appreciated for more than a year, you are actually giving 20 percent more than if you sold the stock and then made a cash donation. The reason is simple: avoiding capital gains taxes. If you donate your stock directly to a charity, you won’t have to pay capital gains tax.
Contribute to a Donor-Advised Fund, take the full allowable deduction that year, give to charities over time. Think of a donor-advised fund as a charitable investment account that you can use to donate to the charities you care most about. Once the money is transferred to your donor-advised fund, it is considered an irrevocable gift, which is why you can claim it that year for a tax deduction. If your income has increased significantly in a given year and you’d like some of it to go towards a charity or charities of your choice, gifting a larger amount (up to 60% of your income that year) to a donor-advised fund will again allow you to itemize and claim a much larger deduction.
Cristina Livadary is a fee-only financial planner based in Los Angeles, California and is the CEO of Mana Financial Life Design. Mana Financial Life Design provides comprehensive financial planning and investment management services to help clients organize, grow and protect their wealth throughout life’s journey. Mana specializes in advising professionals in the tech industry, as well as women who work in institutional investing, through financial planning and investment management. As a fee-only fiduciary and independent financial advisor, Cristina never receives commission of any kind. She is legally bound by her certification to provide unbiased and trustworthy financial advice.