There’s a reason why everyone waits so long in the year for their giving. Taxes.
Here’s my effort to get you to minimize your taxes while you give. This only applies to US law. I have no idea how other countries do this. I hope it’s way easier. The simplest way would be having a tax system that emphasizes a broad base and low rates as outlined in the book A Fine Mess (I don’t get any money for this link, but it’s a tax book that you can actually read).
A Few Words About Deductions
We’re going to break this down into two categories. Above-the-line deductions and below-the-line deductions. Above-the-line deductions apply to everyone. The easiest above-the-line deductions are related to placing funds into special retirement accounts or health savings accounts. Another, which we’ll talk about later, is tax-loss harvesting. Tax-loss harvesting is selling investments at a loss and taking a deduction.
Below-the-line deductions only apply if you can get your total below-the-line deductions to exceed your standard deduction (over $12K in 2020 for those filing as single, doubled if filing jointly). If you do below-the-line deductions, you do what’s called itemizing.
Unfortunately, charitable donation deductions are only for those who itemize (though there are still some benefits to non-itemizers who donate appreciated assets). Typically, itemizers are folks who own a home or run their own business and can rack up deductions. But there are other ways to fall in this category. You can find the entire list of below-the-line deductions buried in the US tax code.
For clarity, a deduction is a way to reduce your adjusted gross income. Reducing your adjusted gross income means less money you get taxed for at your highest tax bracket. A deduction is different than a credit, a credit meaning you get a straight-up cash return. Because deductions are based on a progressive tax bracket, deductions are more beneficial to those in upper tax brackets with higher incomes. This makes it a regressive benefit.
Your adjusted gross income also interacts outside of taxes. This includes interactions like how much your monthly student loan repayments are.
Charitable Gifts And Below-The-Line Deduction Limits
You can only itemize 501(c)3 nonprofit charitable deductions. But your max deduction will vary based on two elements:
1. Whether the 501(c)3 (a type of nonprofit) is a public charity or a private foundation.
2. Whether you’re giving cash, an appreciated asset, or some combination.
Public Charity Vs Private Foundation
If you’re giving to a public charity, then you can deduct up to 60% of your annual gross income (special limitations given to capital gains gifts discussed later). If you’re giving to a private foundation, then you can only give up to 30%. Private foundations tend to have concentrated funding. You often see family foundations classified this way.
If you’re not sure which classification your favorite charity has, you can look up their 990. If you see their 990 has a 990-PF at the top left of the form, then they’re a private foundation. If it just says 990, then they’re a public charity.
There are many exceptions to the limit rule that I won’t go into, which apply when giving to certain kinds of charities or giving with particular personal property assets.
Giving Appreciated Assets vs Cash
Our goal is to exhaust our long-term appreciated assets (called capital gains property) first. An appreciated asset is something you hold onto as an investment that gains value over time. This could be all kinds of things from different kinds of stocks (even complicated stocks like closely held stock), real property (land and homes, though typically only if it’s highly marketable so it sells easily), cryptocurrency (BitCoin, Ethereum, and all the rest), and to a much lesser extent personal property (things like paintings and collectibles that can increase in value). We’re not going to talk about personal property because it gets too complicated.
When you’re giving an appreciated asset, you want to look at three things (1) whether you’ve held the asset for more or less than a year, (2) how much the asset’s value has increased, and (3) whether you’ve realized the gain of an asset (you don’t want to realize the gain of an appreciated asset if you’re going to gift it).
1. Over/under a year
Whether you’ve held an asset for more than a year determines whether you get to deduct the gains from your original purchase price (called the cost basis) or if you only get to deduct the original purchase price. Holding an asset for longer than a year gives you the benefit of getting to deduct the original purchase price plus any gains (in total, the current fair market value). If you’ve held the asset under a year, then you only get to deduct the original purchase price (called a cost basis).
One important note with donating appreciated assets is that you can only use appreciated assets to deduct so much. The max is 30% of your adjusted gross income (20% for private foundations), and then you have to make up the remainder with cash. Note that when you give appreciated assets held longer than a year that your total limit to public support charities (even with cash) drops to 50%. Technically, you can give up to 50% within a year of capital gains property, but you can only deduct the cost basis rather than the FMV.
2. Appreciation: the more the better
As you’ve identified which of your assets you’ve held more than a year, now look at which ones have appreciated the most as a percentage. Those are the ones you want to give. You can keep doing that until you’ve reached your cap of appreciated asset giving, which is 30% of your adjusted gross income. You can always repurchase what you’ve gifted to the extent needed to rebalance your portfolio.
3. Don’t realize the gain
Realizing the gains of an asset occurs when you use the asset to purchase another asset (including regular goods), or you’ve sold the asset for cash. Once you realize a gain, you have to pay taxes on it. This is why it’s extra important when you give stock that you give it directly rather than sell it and give cash. It’s also important to know that when you use one cryptocurrency to purchase another that you’ve just realized the gains for the first and must pay taxes on those gains (if the gains exist). If you give an asset directly, then you do not realize the gains. This is true whether you’re making a deduction or not.
Finally, giving cash is the last resort. It offers less benefit compared to appreciate assets, but sometimes there’s no other option. And you need to give cash if you want to max out your charitable deduction. You can use cash to make up the remainder of your charitable deduction to max out at 60% of your adjusted gross income (remember that your limit drops to 50% any time you donate any capital gains property with your cash donation). Do this only after you’ve exhausted your appreciated assets.
If you’ve already maxed out at 50% (or 60% with a cash-only donation) or you’re not able to itemize, then you might also consider charitable causes that don’t provide a tax deduction, such as a 501(c)4. If you’ve maxed out your charitable giving deductions within a year, then you might also consider using the carryover rule.
Going Beyond The Limits: The Carryover Rule
Perhaps you’re looking at your desired giving and thinking about how you’d like to give more than 60% of your adjusted gross income (50% if you included any capital gains property gifts). Or perhaps you’re past the 30% limit for your capital gains giving (property you’ve held longer than a year).
First, let’s talk about cash since it’s easier. If your cash-only gift puts your total giving over the 60% marker, then you can carry over the remainder for up to the next five years until your deduction is exhausted.
Carrying over a capital gains property gift is more complicated. There’s still the five-year window, but in later years you no longer get to deduct the appreciation. Here’s an example.
You make $100K this year (year 1). You give $50,000 in appreciated stock ($50K fair market value, $35K cost basis). You also give $25K in cash. This is all going to a public charity with a 50% limit (not 60% because you’re giving appreciate stock).
Year one, you can deduct only $30K in stock because of the 30% capital gains giving limit. You can deduct another $20K (from the cash donation) to max out this year’s 50% limit.
It’s year two. You still make $100K. You give another $10K in appreciated stock. You give another $20K in cash. You have a rollover of $5K from your capital gains gift ($35K cost basis — $30K capital gains gift deduction from year one). Your $5K capital gains gift rollover plus your new $10K appreciated stock gift totals to $15K in capital gains giving for year two. You’re under the 30% cap for capital gains gifts, so there’s no more rollover here. You rolled over $5K in cash gifts from year one plus you gave $20K in cash this year in year two placing you at $25K total in cash gifts for year two. Your total gifts for year two add up to $40k ($15K in capital gains plus $25K in cash).
The $40K in charitable gifts for year two is below the 50% threshold of your $100K income, so there’s nothing to carry over into a third year.
Was that a pain? Kinda, but only once we start getting into carrying over capital gains gifts. The cash part was more straightforward. The takeaway here is that in most cases you probably don’t want to carry over capital gains gifts because you no longer get to deduct their appreciation in carryover years. If you do make capital gains gifts that carry over, then the capital gains property probably shouldn’t be highly appreciated. Save the highly appreciated stuff for when you get the full benefit of a deduction.
Note that you cannot use the carryover rule to give to private foundations. You can only use it for public charities. Also, the carryover rule applies to a longer time frame for some particular (probably don’t apply to you but maybe they do) nonprofits. You can read all the fun details here.
Giving Through Your IRA
If you have an IRA and are over 70 ½, then you have to make a minimum distribution to yourself (though not with a Roth IRA). But what if you don’t need the money? If you turn 70 ½ within the applicable tax year, then you can make your distribution directly to a nonprofit and not realize any of the income. Note that this doesn’t count as a deduction. You can do this for up to $100K per year.
A special rule when giving through your IRA is that it has to go directly to a nonprofit and not a donor-advised fund (discussed later). Your bank can help you make this distribution correctly.
Tax-Loss Harvesting (Including for those who don’t itemize)
We’ve talked quite a bit about appreciated assets. For most people, this means stock in a brokerage account or perhaps cryptocurrency for some. Broad index funds are a common way to invest and are generally part of a well-balanced retirement account. But in some cases, such as a semi-liquid emergency fund (in addition to a savings account), it may be useful to have volatile investments. Volatile investments are good for donating appreciated assets and — when those assets lose value — harvesting for a loss. Cryptocurrency’s volatility actually fits well here.
When you sell an asset held less than a year at a loss, then you can deduct it off your regular gross income, which is taxed at a higher rate. You can deduct up to $3,000 as an above-the-line deduction (the convenient deduction type that applies to everyone). Plus, if you have losses above that limit, then you can carry them over as long as you want into future years (called a capital loss carryover).
If you’re selling an asset that you’ve held more than a year at a loss, then your deduction cap is still $3,000 but it starts at capital gains taxes (taxes on realized gains from assets you’ve held over a year). If you don’t have enough capital gains income, then it goes as a deduction to your regular gross income. If it carries over to future years, then it also applies to regular gross income.
When it’s near the end of the year, it’s a good time to rebalance your portfolio through giving. If you have one stock that’s appreciated by a lot, it may be good to give that stock so you can diversify. Its appreciation could have messed up your diversification. If you’ve held a stock for so long that it’s too far away from its original price (cost basis), then it can be hard to sell at a loss. Because of this, there’s a case to rebalance your portfolio annually (to the extent that you can) so that you can take advantage of losses.
There is a legal caveat for selling assets at a loss and deducting the loss. If you do sell and deduct a loss, you cannot repurchase the same (or substantially similar) stock within a 30-day window. The window is both 30 days before the sale and 30 days after the sale. Repurchasing within the window is called a wash sale, and it’s prohibited. You’ll get some fines and lose your deduction.
If you could do a wash sale, then everyone would be constantly racking up losses throughout the year every time a stock went down a point and then repurchasing the stock a second later. But you can’t do that, so be careful and don’t violate this rule.
If you give, then you need to get yourself a donor-advised fund. They’re great, and they count as public charities. They’re so good, I wrote a whole essay just about donor-advised funds. You should read that, too. Donor-advised funds are kind of like a checking account where you can only give to charities.
This essay talks a lot about giving assets beyond just cash. You don’t want to give your favorite nonprofits more work to do. To make their lives easier, give to the donor-advised fund and make the bank do all the work. When you give to the donor-advised fund first, you get all the great tax benefits and the nonprofit just gets a check. Plus, with a donor-advised fund, you get the tax benefits within the year of your giving. This means that you can take a big deduction one year but spread out your giving in future years.
The other thing about a donor-advised fund is that it makes your paperwork easier. You just go to one area to see what you’ve given. Plus, you can also use it to simplify your planned giving (another topic I wrote on). Some banks will let you point to a donor-advised fund as a beneficiary. That way, you only have to change the charitable beneficiary for your donor-advised fund. Whether you’re able to point your charitable beneficiary to a donor-advised fund or not, you should still set up charitable beneficiaries for all your accounts.
There is a small fee with donor-advised funds, but even conservative investments are enough to take care of the fee. Also, donor-advised funds aren’t really the place to look for investments. One reason is that you don’t get good investment options unless you have a whole lot in your donor-advised fund. Secondly, even if you were to get gains in your donor-advised fund, you’re past the time when you can get a tax benefit. The best strategy is to just not wait too long before distributing funds from your donor-advised fund to charity.
Where To Give
You work hard for the money. So you better treat it right.
There are lots of charitable causes out there, they have different levels of outcomes per dollar received, and you have a limited amount to give. Because of this, your decision of where to give is more important than how much you give or how efficient your taxes get.
Most charitable giving goes to churches (like the Mormon church that has amassed over $100B in anticipation of the Second Coming) and universities (which often already have billions in endowments). By far, these are not your best giving opportunities if you care about metrics like quality-adjusted life years saved (QALY) and other important factors.
When looking at a nonprofit’s cause area, you should also consider factors like (1) importance, (2) neglectedness, and (3) tractability. Importance tells you how much beneficial impact there would be if the cause was solved. Neglectedness tells you how much attention the particular cause area gets. Tractability tells you how likely the cause area is to be solved given a particular intervention.
One area that looks at such metrics is Givewell. You could do far, far worse. Most people do. Givewell gives to causes that have been vigorously evaluated according to these metrics. You should check them out. One of the reasons Givewell is great is that it falls under effective altruism. Effective altruism is about using reason to do the most good you can do with limited resources and recognizing that not all actions have the same impact.
And here’s a plug for the charity I run, The Center for Election Science (CES). CES is also a grant recipient of the Open Philanthropy Project, a funder within the effective altruism space. You can also read our year-end appeal to the effective altruism community.
The Center for Election Science studies and advocates for better voting methods beyond our terrible choose-one voting method. By having a better voting method, we can elect better people to office so that we have policies and spending that actually reflect our interests. You can donate and learn more about CES on its website.
A Brief Advisory
The tax code is notoriously complicated, and it changes quite frequently. What I’ve shared here has been (mostly but not always) relatively stable over recent years. That said, it’s anyone’s guess what Congress’ next whims will be.
Also, you may have an issue where there’s some weird exception I’m not familiar with. Or perhaps despite my best efforts of consolidating this information for you, I’ve overlooked something or missed a detail that’s important to you. Investing, taxes, and giving is often highly personalized, and some of this advice may not fit your needs. Still, feel free to use this as a starting point when talking with your financial planner or accountant.
Good luck, and thanks for giving!
Liked what you saw here? You can find more of my writing on philanthropy, nonprofits, and other useful topics on my website.