A recently enacted law creates a new way to potentially improve your tax situation through charitable giving.
We are all familiar with the adage that it’s better to give than to receive. Aside from the overall wonderful feeling that comes along with generosity, by giving you may also be able to maximize your tax savings when donating to a qualified charitable organization.
The PATH Act
The PATH act was a piece of legislation passed by congress at the end of 2015. Its full name is “Protecting Americans From Tax Hikes,” and in essence the bill put forth several provisions that applied to taxpayers of various sorts. However, of notable interest and the focus of this article is how it affected the tax implications assoiciated with charitable giving.
The PATH act permanently extended one's ability to exclude from their end of year gross income any payments made from their IRAs that qualified for charitable purposes. The individual needs to be at least 70½ of age to qualify and the total amount is not to exceed $100,000 per individual for any given tax year. This applies to distributions that took place after Dec. 31, 2014.
Benefit: The charitable rollover approach reduces your income by the full amount of your gift, which can not only lower your tax bracket, but also potentially move you below thresholds where other tax benefits are phased out.
When is it best to employ this strategy?
• This strategy is most effective when taking the required minimum distributions, but taking the standard deduction rather than itemizing.
• The distributions are made as a direct transfer to your designated Donor-Advised Fund for charity.
Direct transfer is important because taxable IRA distributions must be included in adjusted gross income as would be the case if they first came to the individual. In addition this route would result in the possibility that one's income taxes for Social Security benefits may increase as well as the premiums on Medicare insurance.
Suppose you are a single individual whose 2016 income will be $100,000, including $36,000 in Social Security benefits and $60,000 in IRA distributions, to satisfy your RMD. You also plan to do $25,000 of charitable giving.
* This, of course, is a very simplified example to illustrate a situation when a charitable rollover may provide additional tax benefit. As your situation may vastly differ, it is wise to consult with your financial advisor and tax professional as to best use for your portfolio.
Ultimately, the charitable rollover gives you yet another option for executing your charitable giving goals.
Giving appreciated shares of securities (stock, mutual funds, etc.) could be of benefit to you, especially if you happen to be in the 39.6% tax bracket and subject to 20% capital gains tax or the additional 3.8% Net Investment Income Tax.
The fair market value (FMV) of shares of securities given to charity (as well as the FMV of real estate, collectibles, and some business interests) can be deducted on your federal tax return up to 30% of your Adjusted Gross Income (AGI). One way to take advantage of this tax benefit is to contribute appreciated shares to a donor-advised fund (DAF).
What is a Donor Advised Fund?
Generally, a donor advised fund is a separately identified fund or account that is maintained and operated by a section 501(c)(3) organization, which is called a sponsoring organization.
• DAF accounts are made up of individual donors, and once contributions are made the organization assume legal control over the fund.
• The donor retains advisory privileges in regards to distribution and assets the account invests in.
Over the years the IRS has placed increased scrutiny on organizations that appeared to be abusing this form of charitable giving. Thus it is important to always do proper due diligence with the organization to which you plan to contribute.
If found to be in violation of appropriate use the IRS may:
• Prohibit deductions for charitable contributions under Internal Revenue Code section 170
• Impose additional taxes on both the organization and fund management
• Impose additional taxes on donors
• Deny or revoke the charity's 501(c)(3) exemption.
Because the DAF is, itself, a charitable organization, you receive a charitable contribution deduction for the fair market value of your contribution for the current tax year. From the DAF, you can recommend grants to charities of interest to you. Checks are then issued on your behalf. Some DAFs, are pass-through accounts that accept your gifts and immediately direct a grant to the charity of your choice. Individual DAFs are unique to you and can maintain an account balance over time.