While potential tax reform may impact your financial planning in 2022, there’s still time this year to take advantage of the current climate and potentially save on your 2021 tax bill. As we approach the year-end holidays and giving season, your charitable strategy can be a powerful force to make a difference for the causes you care about and potentially minimize some of your tax burden.
Whether you're writing checks to your favorite charities, preparing for retirement or at the height of your career, or if you’ve had a high-income year from selling your business or receiving a bonus, you can still take action to reduce your taxable income. Work with your trusted financial advisor to leverage these five giving strategies and create more impact before it’s too late:
Choosing the right asset to fund your giving can elevate your philanthropy. Instead of writing checks or entering your credit card number, look at your portfolio with an eye toward donating long-term appreciated securities (stocks, mutual funds or bonds) or often overlooked private company stock (LLCs, LP interests, C- or S-corp stock). Cryptocurrency (Bitcoin, Bitcoin Cash, Ethereum and Litecoin) is also an excellent philanthropic funding source right now that absolutely must be considered.
Why? Capital gains taxes may be eliminated when you contribute long-term appreciated assets directly to a charity instead of selling the assets yourself and donating the after-tax proceeds. When you assume 20% for federal long-term capital gains taxes, plus a 3.8% Medicare surtax, this leads to a potential increase of at least 23.8% in your charitable contribution and a potential reduction in your tax liability.
Many savvy investors perform routine portfolio rebalancing to ensure that their investment mix is consistent with their goals. Often this involves selling investments that have done well, which generates capital gains taxes in the process.
One simple strategy is aligning your charitable giving with the rebalancing process. Instead of donating cash, using credit cards or writing a check to a favorite charity this year, consider donating the most highly appreciated security that you have held for over a year. Capital gains taxes typically will not apply to you or the charity receiving the donation. Then, because you used an asset in your portfolio and didn’t “spend” the cash you would have originally donated, you could use that cash to make additional investments.
An interesting example of this strategy could give you the added benefit of resetting the cost basis on your favorite stock at its current higher fair market value. If you aren’t ready to say goodbye to a particular stock in your portfolio, you could donate the stock, then use the original funds you would have donated to repurchase your shares and reset your cost basis. Your holding period starts over when you repurchase the stock, so you’d need to hold the new stock for 12 months or more before you are eligible for long-term capital gains rates on any future appreciation.
While donating long-term appreciated securities typically eliminates long-term capital gains exposure, you are limited to 30% of your adjusted gross income (AGI) for deducting contributions of these appreciated securities. This is sufficient for most people, but there are some years when you might benefit from a larger current year charitable deduction. In those select situations, you may choose to supplement a charitable gift of securities with a charitable contribution of cash. This strategic combination of giving provides an opportunity to reduce your tax liability.
This strategy can be even more impactful this year: COVID relief legislation allows you to deduct up to 100% of your AGI for cash donations to eligible public charities, excluding donor-advised funds. Talk with your financial advisor to find the right mix of securities and cash donations that will have the most impact for your individual situation.
If your tax bracket is higher now than what you expect it to be in the future, consider frontloading your charitable giving by making a large contribution now, rather than smaller gifts in retirement. Not only could you qualify for tax savings in the present year, but you’ll also have charitable assets earmarked for future grant recommendations. This strategy allows you to continue supporting charities generously when you are on a fixed income in retirement—that time in your life when you may be more focused on high-impact philanthropy.
To make this strategy even more effective, consider using a donor-advised fund, like the Giving Account® at Fidelity Charitable® to make that pre-retirement contribution. Donating to a charity with a donor-advised fund qualifies you for an immediate tax deduction while also allowing you the time to explore the causes and organizations you want to support. No rushing around, which could take the joy out of giving. Even better, funds contributed to a donor-advised fund can be invested for potential-tax free growth, possibly providing even more support for your favorite charities in the long run.
The $25,100 standard deduction (for couples filing jointly) in 2021 may be difficult for some taxpayers to reach, especially since there are fewer tax deductions available than in years past. If you fall into this category, it may not make sense to itemize your tax deductions. But how can you still receive a tax benefit for charitable giving? One strategy to consider is called “bunching.” This year, you could contribute multiple years’ worth of your planned annual giving to surpass the itemization threshold. In off years, you could then take the standard deduction.
This strategy could also be effective if your income is particularly high this year, perhaps as the result of a year-end bonus, or if you’ve sold a business or long-term appreciated real estate, benefited from taxable inherited assets or otherwise.
Regardless of your reasons for bunching, combining multiple years’ worth of giving in a single year can help you exceed the standard deduction and qualify you to take a higher income tax deduction than you would from just a single year’s gift. If you use a charitable vehicle, such as a donor-advised fund, to supplement this strategy, you could also keep up your same level of support for nonprofits in future years by drawing on the charitable balance you set aside this year.
Converting a traditional IRA to a Roth IRA typically means paying significant taxes. However, because the conversion can still be a smart strategy for your holistic financial picture, you can help minimize that tax-triggering event by making a charitable contribution. This strategy may work if you already donate regularly to charity, have sufficient non-retirement assets to pay the cost of the conversion and would consider making a larger-than-usual charitable donation in the year of the conversion. Again, consider using the long-term appreciated assets in your portfolio to fund your charitable gift to potentially realize even more tax savings than you would when making a cash donation.
If you’re like most people, you give to charity because you want to make an impact on the world or support the causes you care about. But how much and when you give is typically a financial decision. Tax incentives and tax-savvy strategies like these may help you give more than you could otherwise and provide more resources to the causes you care about. Before new tax laws are enacted and change the picture, make sure you seize this moment before year end to make tax-smart charitable gifts and change lives.
Head of Fundraising
Karla Valas leads fundraising for Fidelity Charitable, the nation’s largest grantmaker. The expertise from her team of Charitable Planning Consultants helps advisors have more sophisticated financial planning conversations that incorporate charitable strategies, such as donor-advised funds. Ms. Valas has expertise in complex assets and previously led a team of attorneys who facilitate thousands of charitable donations of appreciated private company stock and other nonpublic assets annually. She a B.A. from Mount Holyoke College, a J.D. from New England Law and an LL.M. in Taxation from Boston University School of Law. Ms. Valas is admitted to the bar in New York State and the Commonwealth of Massachusetts.
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