Recently the Certified Financial Planning Board added the “Psychology of Financial Planning” to their six Principal Knowledge Domains, sitting alongside Investment Planning and Tax Planning. This move highlights how important understanding a client’s mental and emotional factors are in governing planning for their financial goals and future spending. Psychologist Karen Pine writes: “Gift giving is a social, cultural and economic experience; a material and social communication exchange that is inherent across human societies and instrumental in maintaining social relationships and expressing feelings.” Client gifting to both charities and family members brings them happiness and aligns their spending with their values, which becomes a major part of the financial planning process.
Legislation Changes Gifting Strategies
Charitable giving strategies shifted when the standard deduction nearly doubled with the passage of the Tax Cuts and Jobs Act of 2017(TCJA). Prior to the 2017 TCJA, people would give to charity and take a tax deduction by itemizing on their tax return, it is no longer that simple. Nearly 90% of taxpayers no longer itemize their deductions given the changes to the standard deduction and limits of $10,000 on the State and Local Taxes (SALT) deduction. We have put together a list of tax-smart gifting strategies to help you maximize generosity while minimizing the taxes you pay.
Bunch It! Cinch It!
Maximize deductions by “bunching” charitable deductions and then itemizing your deductions in those large giving years. This can be done by alternating every three or four years between the two tax options of the standard deduction and itemizing deductions. The goal is to reduce taxes by getting over the deduction thresholds. It can be hard to break the regular habit of gifting on an annual basis, but the tax benefits can be meaningful.
For example, a married couple who would donate $10,000 a year for the next five years would get no tax deduction for that charitable contribution out of a taxable account. In 2024, the standard deduction for single filer is $14,600 and married filing jointly clocks in at $29,200. If they were to bunch that five years of gifting into one year at $50,000, plus add their $10,000 SALT deduction, they would have total deductions of $60,000 compared to the MFJ standard deduction of $29,200. If they were in the 32% federal tax bracket, that deduction would save them around $9,000 in federal taxes.
“At the end it’s not about what you have or even what you’ve accomplished. It’s about who you’ve lifted up, who you’ve made better. It’s about what you’ve given back.”
Denzel Washington
Donate Appreciated Securities
You can gift long-term appreciated taxable equity positions for charitable gifting rather than cash if the charity accepts equity gifts. You can get a tax deduction if you are over the standard deduction threshold and remove unrealized gains from your taxable portfolio. The gains must be long term, meaning you hold the position for over a year, for this strategy to be implemented.
An example of this would be if you owned Amazon (AMZN) stock now worth $20,000, which you bought a decade ago for $4,000. You could sell the AMZN stock, pay long-term capital gains on $16,000, and write a check to the charity. Conversely, you could gift the $20,000 in AMZN stock directly to the charity and not pay any capital gains taxes. You have given the same value of $20,000 to the charity without creating a taxable event. The value of the donation is the stock price on the day of the gift.
To amplify this strategy you then rebuy the AMZN stock, resetting your cost basis. You have the same position in AMZN as before but now with no unrealized capital gains and have made a charitable gift.
Donor Advised Fund (DAF)
Flexibility reigns supreme for gifting with a Donor Advised Fund or DAF. Contributions can be made in cash, shares of privately held businesses, cryptocurrency, or appreciated securities. You can bunch your donation into one year to make the donation tax deductible or make a yearly contribution based on your income. The DAF monies can be invested and grow tax-free until you are ready to make a donation (some providers have policies that require you to disburse funds regularly to charity). They can then fund different charities with flexibility over time. There’s no minimum annual contribution requirement. The contributions to a DAF are irrevocable.
A Donor Advised Fund is a great estate planning tool. Any assets that you place in the DAF are no longer a part of your legal estate. This can be important for high-net-worth individuals worried about estate taxes and the potential sunsetting of the estate tax exemption at the end of 2025 when it will drop from today’s $13.61 Million down to $6-7 Million. You can make a bequest in your will so any remaining funds in your Donor Advised Fund are donated to your choice of charities after you pass away.
Charitable Remainder Trust (CRT)
How would you like to get a tax deduction, set up an income stream for life, and give to charity? Sounds pretty good! With Charitable Remainder Trust or CRT, you create an irrevocable trust that selects a qualifying charitable organization under IRS rules. When you transfer assets into the trust, you claim a partial tax deduction. One or more non-charitable beneficiaries are chosen; could be the donor, it could be other relatives, or even a friend. The assets grow in the CRT tax-free. The CRT then generates an annual payment equal to a percentage of the value of the asset at the end of each year. The minimum amount of the payment is 5% of assets and income distributed to the non-charitable beneficiaries is taxable. You can add more assets to the CRT in subsequent years.
The tax deduction is the value of the assets placed in the trust offset by the amount you are likely to receive in income from the CRT. The assets are removed from the donor’s estate and won’t be subject to any estate taxes. The CRT can be set up to last for the lifetimes of one or more of the non-charitable beneficiaries receiving the income stream or for 20 years. At the end of that timeframe, the remaining assets in the CRT are transferred to the chosen charity tax-free. We can help you explore and set up either a Donor Advised Fund (DAF) or a Charitable Remainder Trust (CRT) if you are interested.
“It is every man’s obligation to put back into the world at least the equivalent of what he takes out of it.”
Albert Einstein
Qualified Charitable Distributions (QCD)
People over the age of 70.5 can contribute directly from their IRA to a 501(c)3 charity, and the money comes out of the account tax-free, which would otherwise be taxed as ordinary income. The money must pass directly from your IRA custodian to the charity. Generally, a check is cut from the custodian and made payable to the charity from your IRA and the client provides the check to the charity. There is no tax deduction for this charitable donation since you are receiving the benefit of tax-free withdrawal from your IRA. Since the money came out of the account tax-free, it doesn’t add to your adjusted gross income, which is used by Medicare to determine the cost of your monthly premiums.
QCDs can go toward satisfying your required minimum distribution for the year if taken first. The following types of IRAs are available for QCDs to be taken from: Traditional, Rollover, Inherited, SEP(inactive), and SIMPLE(inactive). With the SECURE Act 2.0 passage, QCD amounts are now indexed to inflation increasing by $5,000 in 2024 for up to $105,000 per individual.
Gifting to Family
The annual gift tax exclusion in 2024 is $18,000 per donee. This is the amount you can gift without any documentation to the IRS. Married couples can give away $36,000 per donee with gift splitting. You will need to file IRS form 709 for any gift splitting.
529 Education Account Max Funding
A 529 education plan allows a donor to make five years of $18,000 of donations lumped into one $90,000 max funding contribution. If you use this strategy, no other gifts can be made to the same beneficiary for the next 5 years unless the annual gift tax exclusion is increased. This can be a good estate planning tool as the $90,000 is outside of the donor’s estate, but they still are in control of the assets. The 529 plan is an investment account that lets the donor control the funds while keeping them in their own name. The money grows in the account tax-free and, if used for qualified education expenses, comes out of the account tax-free. With few exceptions, the named beneficiary has no legal rights to the funds, unlike a UGMA/UTMA where the child takes control of the assets once they reach legal age. If the child named beneficiary chooses not to go to college, you can repurpose the money.
Making a Loan to a Family Member
With high home prices in the Bay Area and mortgage rates at or above 7% for the past year, we see more families lending children money for a down payment on a home. The loan parties should put together an official document, we recommend prepared by a lawyer, stating the terms of the loan, including the length of the loan and interest rate. The interest rate should be at the Internal Revenue Service Applicable Federal Rate; in April 2024 the rate for loans 9 years and longer was about 4.5%, well below current mortgage rates.
You should disclose to the mortgage company that the funds are indeed a loan; this may impact the rate received on any mortgage for the property. The borrower should pay the interest required by the loan and the lender should track the payments, which are taxable as income.
If the parents would like to forgive some of the loan in certain years as a gift, they can do so using the annual gift tax exclusion. To avoid having the whole loan appear as a gift, you shouldn’t have a formal plan in place. It is a best practice to change the amount of principal loan forgiveness each year and maybe skip a year. The lender writes the borrower a letter outlining the dollar amount of forgiveness of principal on the loan that year up to $18,000 for the annual gift-tax exemption. A married couple could forgive up to $36,000 for their child. If the child’s spouse was party to the loan they could forgive $72,000 in one year.
We Can Assist You!
Contact the Bedell Frazier Financial Planning department today. We can assist you on the charity side of the ledger by setting up a Donor Advised Funds(DAF) or Charitable Remainder Trust (CRT). We can model Qualified Charitable Distributions (QCD) if you want to give a set dollar amount per year, or we can explore how your financial plan will be impacted by giving 50%, 75%, or even 100% of your required minimum distribution to qualified charities. We can run a college calculator if you are interested in learning if you are on track for college savings for your child or grandchild for a particular college or university. We can put together some different scenarios to demonstrate at different price points how much you could gift to a child for major expenses like a home down payment and not jeopardize your retirement spending. We are committed to helping you help the people and causes you love, so please inquire about any of the gifting strategies discussed.
Thomas Howard
