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The Tax Man Cometh - Part 3

The Tax Man Cometh - Part 3

| December 16, 2020

Part 3 of our month-long discussion on year-end tax strategies will focus on using charitable gifts to reduce your tax liability. The techniques below are things that should be reviewed with your accountant as we are not tax advisors. The information provided is for education purposes only, your tax situation is unique so we encourage you to work with Grover Financial Services and your accountant to maximize your tax strategy. 

Each of the ideas below, is a service and account type Grover Financial Services offers however, to get the most out of using these techniques getting your financial team together on it is a must. That means both your advisor (us) and your accountant or tax preparer need to work in lockstep with you to execute these strategies.

Tax-Efficient Charitable Gifts

There are three ways we suggest using charitable gifts to create tax-efficiency in your portfolio and potentially reduce your tax liability at the end of the year.

Charitable Gifts from an IRA

If you are nearing retirement or already in the thick of it you are well aware that Required Minimum Distributions or RMDs begin at age 72. Did you know that at the same age you can make Qualified Charitable Distributions or QCDs of up to $100,000 per year to a public charity? An exception to this rule is donor-advised funds so you must give the gift to a public non-profit organization. 

How does this work? Well, even in crazy old 2020, void of RMD requirements, the Qualified Charitable Distribution is excluded from your taxable income. This is good because it reduces your income rather than acting as a deductible.

Bunching Charitable Gifts

Is there ever good news when it comes to taxes? Sometimes, it’s rare, but it does happen, and here is one of them. With the new higher standard deductions($12,400 for single filers, $24,800 for married couples in 2020) taxpayers get a bigger break. This means that with the higher deduction you won’t have to itemize deductions for anything less than the state thresholds. 

But with the IRS there is always a dark side. Say, for example, you are a married couple with a $10,000 state tax deduction and you have made $14,000 in charitable contributions. The IRS will allow you to use the higher deduction threshold of $24,800. One of the two downsides is that you won’t get any additional tax benefits from the charitable contribution. What if you do this every year? Well, if you are a generous person and give like this each year the IRS sees the pattern, and again, you won’t realize any tax benefits for charitable contributions. 

But wait there’s more…

Say you have money earmarked for charitable gifts that could be made over a two- to three-year period and you decide to make them all in a single year. A portion of that gift will “become” tax-efficient.

Let’s take a look a second look at our couple with a $10,000 state tax deduction who have made $14,000 in charitable contributions. Say this couple decides to make all their gifts for 2020 and 2021 outright to either the charities themselves or to a donor-advised fund in the tax year 2020. When they do this their aggregate 2020 deduction would rise from $24,800 to $38,000. This higher number reflects their real estate taxes for 2020 as well as $28,800 in charitable gifts. What would happen is that $13,200 if the gift money would “become” tax-efficient.

How does that add up? By using a donor-advised fund, the couple can name specific charitable beneficiaries in 2020 and 2021, even though they will revert to using the $24,800  standard deduction in 2021. So the $13,200 that “becomes” tax-efficient is the difference between the $38,000 in combined gifts and real estate minus the $24,800 standard deduction. 

This can be a little complicated but it is a good method for reducing tax liability. Again, I am no accountant so it’s always important to bring them into the conversation as a necessary best practice.

Charitable Remainder Trusts

Investors who can gift money to charity can defer capital gains by creating what is known as a Charitable Remainder Trust or CRT. To do this, you take your capital gains, before securities are sold, and place them in the CRT. When you do this you will only be taxed on the realized capital gain as it is paid out to you over time. This process can be complicated with several moving parts and different rules. Also, there are several variations to this type of trust that can be used to meet different goals and different payout or income needs you may have. So it is important to note here, that if capital gain tax rates go up in the future you may end up paying more in taxes over time. 

Again, using Grover Financial Services and your accountant simultaneously when creating this type of trust will keep things running as smooth as possible and potentially help you avoid mistakes that could cost you more money. 

I hope I have given you some food for thought and some things to discuss with your financial team. Join us next week for Part 4 of our month-long discussion on year-end tax strategies when we will take a look at estate and gift tax strategies to manage your tax liability. Have a wonderful week!

P.S. If you enjoyed what you've read here and found it beneficial, we encourage you to share it with your friends and family. I firmly believe that an educated investor is more confident, which leads to healthy finances and fewer sleepless nights. 

Source: 2020 Year-End Tax Planning