Tax-smart year-end charitable giving

How to maximize donations under the new tax rules.

When our extended family gathers around my sister’s Thanksgiving table each year, we each express our gratitude for the people, events and experiences that shaped our lives over the past year. Inevitably, our thoughts and sympathies turn to the victims of recent disasters, such as those who lost their homes in the California wildfires and Florida hurricanes, and what we can do to help.

For families across America, Thanksgiving marks the beginning not only of the holiday season, but of the giving season. The official kick-off begins with next week’s Giving Tuesday and runs through year-end.

But as a result of the new tax law, which nearly doubles the standard deduction to $12,000 for individuals and $24,000 for married couples filing jointly in 2018, fewer Americans will itemize their deductions. That means most taxpayers will not be able to deduct their donations on their tax returns.

Certainly a tax break is not the major motivation for most philanthropy. But utilizing tax-smart giving strategies can allow some donors to give more and enable others to grow their initial contributions tax-free until funds are disbursed to designated organizations.

“It helps to be strategic,” said Karen Wallace, director of investor education at Morningstar Inc.

“With a higher standard deduction, consider clumping several years of charitable donations into a donor-advised fund,” Ms. Wallace suggested. That allows a taxpayer to itemize in the years that combined deductions for state and local taxes (capped at $10,000), mortgage interest and charitable contributions exceed the standard deduction amount and to claim the standard deduction in other years.

The donor contributes cash or appreciated assets to a donor-advised fund and receives an immediate tax deduction on the amount contributed. Cash donations are limited to 60% of the donor’s adjusted gross income. The value of donated securities is limited to 30% of the donor’s AGI. The donor can direct contributions of the donor-advised funds to various charities over several years.

Donating appreciated assets such as stocks, mutual funds or real estate either directly to a charity or to a donor-advised fund offers additional tax breaks. The donor deducts the fair-market value of the asset at the time of the donation while avoiding the hassle of selling the asset and paying taxes on the appreciated value. Instead, the donor transfers the asset to the charity, which in turn sells it. As a nonprofit organization, the charity would owe no tax on the sale. That stretches the value of the donor’s gift even further.

Cash or the value of assets contributed to a donor-advised fund continue to grow tax-free until disbursed to various charities, allowing the value of the gift to increase over time.

The Fidelity Charitable Giving Account and Schwab Charitable both have minimum initial donation requirements of $5,000, low annual administration fees and a variety of mutual fund investment options. At Vanguard Charitable, the initial minimum investment is $25,000.

Taxpayers age 70½ and older have an additional option to support their favorite causes while lowering their tax bill. They can use a qualified charitable distribution that allows them to direct up to $100,000 of their annual required minimum distribution directly from their individual retirement account to a qualified charity, said Keith Bernhardt, vice president of retirement income at Fidelity. The donation counts toward the RMD for the year if it is made by the Dec. 31 deadline.

Although IRA owners cannot deduct the qualified charitable distribution, the amount is not included in their adjusted gross income, which can reduce their income taxes and possibly lower their future Medicare premiums.

To qualify as a qualified charitable distribution, the charity must be a 501(c)(3) organization eligible to receive tax-deductible contributions. Donor-advised funds and private foundations do not qualify.

“At a certain level of wealth, clients are ready to move from checkbook philanthropy to a more formal giving vehicle, such as a private foundation,” said Page Snow, chief philanthropic officer for Foundation Source, which provides comprehensive support services to private foundations and partners with wealth management firms, law firms, accounting firms and family offices.

“If your client is weighing a choice between a private foundation and a donor-advised fund, you should be mindful of the fact that while the funds in a private foundation can always be transferred to a donor-advised fund at some later date, it is all but impossible to convert a donor-advised fund into a private foundation,” Ms. Snow said. “Your advice is therefore critically important to ensure they make the right choice.”

(More: Money in donor-advised funds can make impact before distribution)