Reader Question: Why doesn’t my charitable giving increase my tax deduction? I gave a larger amount of donations than usual last year, but my tax deduction didn’t seem to change. Can you please tell me why and if there are any more tax effective ways to give?
Over the last several years you may have noticed that despite diligently organizing all your charitable donation activity and providing it to your tax preparer, the amount of your tax deduction simply doesn’t change. This can be a confusing and frustrating experience given that in the past this process likely led to a larger tax deduction. So, what is going on and is your tax preparer missing something?
Unfortunately, calculating your tax benefit from charitable giving is not as simple as subtracting your total donations from your tax bill. Charitable donations are recorded on Schedule A of your tax return, which is used to determine if you can itemize your deductions. Schedule A includes several different potential deductions including mortgage interest, property and state taxes, medical expenses over a specified limit and charitable donations. When your tax preparer is working on your return, they will tally any of the deductions relevant for you. If your total is greater than the standard deduction amount, you are allowed to itemize. If not, then you simply receive the standard deduction.
For 2023, the standard deduction is $13,850 for single filers, $27,700 for married filing joint (MFJ) with an add-on amount for filers over age 65. For example, let’s say you are MFJ filers, and you have mortgage interest of $10k, state and property taxes of $8k and charitable donations of $5k. This adds up to $23k in itemized deductions- an amount below the standard deduction. Therefore, you would receive the same tax deductions whether or not you made the $5k of donations. In fact, you would have to make over $9,700 in charitable donations to see any change in your tax bill. In essence, you don’t get any tax benefit for making charitable donations under a certain amount.
You may be thinking: But wait, I used to see a difference in my tax bill when I completed those exact same donations in the past. What’s different now? This is very likely because of some changes to tax law created with the passage of the Tax Cuts and Jobs Act (TCJA) in 2018. The TCJA nearly doubled the size of the standard deduction- this makes it harder for most taxpayers to get over the threshold to itemize. It also limited the value of the property and state tax deduction as the total is currently capped at $10,000. Prior to the TCJA, there was no cap. This limit significantly impacts those who pay higher amounts of state tax (high income or higher tax states) or who own higher value or multiple properties.
So, are those getting the standard deduction just out of luck with no way to get a tax benefit from their charitable giving? The good news is that there are strategies that can allow you to regain some level of tax benefit. Below we describe some of the most common options to consider- the effectiveness of each strategy depends on your age, assets, and targeted giving amounts.
This strategy involves completing twice your level of charitable donations in alternating years. Bunching allows you to achieve a tax benefit if the bunched donation amount brings you over the threshold to itemize your deductions in that tax year.
For example, if your usual total annual donations are $8k, you would instead donate $16k in 2023 and complete no donations in 2024. Let’s say for 2023 you have $10k of mortgage interest, $10k of property and state taxes and you choose to bunch donations at $16k. This adds up to $36k in tax deductions which is over the standard deduction amount ($27,700) meaning you get to itemize. If you choose not to bunch donations, your total deduction amount is $26k which is less than the standard deduction. This means you will receive the same deduction whether or not you made your regular $8k of donations.
The challenging part of this strategy is that it forces you to double up your donations to charities in one year and then provide no donations in the following year. This could be problematic for your own cash flow or perhaps this does not meet your preferred giving schedule.
Donating Appreciated Securities
If you have a taxable investment account that holds individual stocks or mutual funds you purchased many years ago, there’s a good chance that they have appreciated or grown significantly in value. When you go and sell some of the stock or fund, you will realize a portion of these long-term capital gains and likely will pay some level of tax on that gain. However, if you instead donate shares of the security directly to a charity, you will pay no taxes on the capital gains. This allows you to move out securities with high levels of unrealized capital gains from your taxable account, complete your donation and save on future taxes.
As an example, let’s say you have 100 shares of Apple stock that are worth $18,000 today. However, you bought them 10 years ago for $1,800. This means you currently have $16,200 of unrealized capital gains that you are likely to pay around $2,500 of taxes on if you sold the stock directly. If instead, you donate the stock directly to a charity, you will not pay taxes on the gain.
One consideration for this strategy is that not all charities are willing to accept appreciated securities as donations. It’s important to check with your chosen organization before deciding if this will work for you.
Donor Advised Funds
Donor advised funds (DAFs) are a giving account established at a public charity. You can establish these accounts easily with many major custodians such as Schwab, Fidelity, etc. DAFs allow donors to make a charitable contribution, receive an immediate tax benefit and then recommend grants from the fund over time. They allow you to take advantage of both a bunching strategy and donating appreciated holdings while also allowing you to keep your regular donation schedule. You can elect to bunch donations when you are doing the initial contribution and will receive full value for the contribution on your taxes in that year (much like bunching). However, you can then complete your regular giving by requesting grants from the fund on whatever schedule you and your charitable organizations prefer. You are also allowed to complete contributions of appreciated securities to a DAF which can further maximize your tax benefits as explained in the previous section.
Qualified Charitable Donations (QCDs)
One final strategy that is available for those who have turned 70.5 and have value in a traditional pre-tax IRA is called a Qualified Charitable Donation (QCD). Generally, any distribution taken from a pre-tax IRA is fully taxable as ordinary income. However, once you have reached 70.5, you are allowed to donate funds directly to a charity from your IRA (up to $100k) and not pay any taxes on the distribution. This can be a great way to complete charitable giving at levels that would not allow you to itemize your deductions, while still saving on taxes.
You are also required to start taking distributions from your IRA when you reach age 73- otherwise known as required minimum distributions (RMDs). Any QCDs that you make will count towards your RMD. So, for those who do not need their full RMD value to live on, using some of that value to make donations directly can help to meet your charitable goals and reduce taxes. See our past blog post for other ideas to consider if you don’t need your RMD.
As you can see, there are many strategies to increase the tax advantages of your planned charitable giving. However, it is often not as straightforward as making your regular donations and automatically lowering that year’s taxes. We recommend consulting with your financial planner to consider your personal income and tax profile as well as charitable goals so you can choose a strategy that will work best for you.
Liz Alf is the Principal of Clerestory Advisors and fee-only CERTIFIED FINANCIAL PLANNERTM located in Minneapolis, MN. She is a member of the National Association of Personal Financial Advisors (NAPFA) the Fee Only Network and Wealthtender. She enjoys serving clients with on-going financial planning and investment management services.