Every year as April comes around, many of us find out very quickly how easy it is for your tax burden to add up and eat away at your take-home pay. The worst part is that when you realize it, it is sometimes too late to give yourself that much deserved tax break. While there are different strategies that can help reduce the amount of tax you pay, I wanted to focus specifically on charitable giving. Charitable giving is very attractive to many people because in addition to reducing your tax burden, you are also helping a charity of your choice.
Whenever I talk to anyone about charitable giving, I always make sure to address the common misconception that charitable giving is simply writing a check to your local charity or church. Charitable giving is much more than that and can involve many different types of assets like land, investments, businesses, houses, and many more. When considering the best strategy for you, we must consider what asset is being gifted, the size of the gift, who is it for, and what is your current age. Based upon each of these criteria, we can begin to build a tax-efficient strategy for your charitable giving. In this blog, we are going to look at two common strategies when it comes to charitable giving, which are Qualified Charitable Distributions and Charitable Lead Trusts.
Qualified Charitable Distributions (QCD) are specifically for people over the age of 70 and a half. To be considered eligible for the tax benefit, the donation has to be made from an IRA of someone who is over that age limit. This benefit can only be taken if the funds are transferred directly from the IRA to the qualified charity. Since distributions to yourself are generally taxable, this strategy can lower your adjusted gross income while also meeting the required minimum distributions rules for the applicable year. It is important to remember that the age for required minimum distributions is 73 for 2023, but is subject to change in the future. Removing your required minimum distributions from your income can also impact certain tax credits and deductions, including Social Security and Medicare. One important note is that there is a maximum QCD distribution of $100,000 per taxpayer. QCDs are important in retirement because the last place you want your hard-earned money going to is the IRS, especially when you have a finite budget and no money coming in.
Now we are going to look at a Charitable Lead Trust (CLT). A CLT is an irrevocable trust that disperses income to a specified charity. After the specified time period, the remainder in the trust can be given to anyone you choose, whether that is your children, grandchildren, sibling, etc. The best way to better understand this transaction is to provide an example. Say you have an investment account filled with $1,500,000 of closely-held stock, where you expect to receive $120,000 in annual dividends for the next 11 years. Your charitable giving goal is to donate the yearly dividends to a charity but gift the stock to your children. Some assumptions with this example are a 35% tax rate for gift transfers to children, a 35% combined state and federal rate on your future dividends, and that your lifetime gifting exclusion amount has been used previously. Option one is to hold that stock in a segregated account, receive the dividends and give them to the charity, and then gift the stock to your children. This option results in $42,000 in annual taxes from the dividend distributions and your children having to pay $525,000 in taxes when they receive that stock. Option two is to transfer that stock to a Charitable Lead Trust. In this example, you pay no tax on the annual distributions to the charity and your children pay no taxes on the stock, which is a ton of tax saved! In addition to this, you meet your charitable giving goals and help benefit a cause that you support.
This is a great time of year to consider if charitable giving could apply to you and potentially provide you with the benefits on your 2023 tax return. If you aren’t already working with a financial advisor, these are great examples of how helpful an advisor can be by pointing out these different approaches that help you save money.