It’s Not What You Do, It’s When You Do It: Timing Your Charitable Contributions to Reduce Taxes
Updated: Oct 5, 2021
In my experience as a financial counselor and planner, charitable giving is a super red-hot button. I remember giving a presentation a couple years ago where I provided several model household budgets. One of those models included an oft-used standard of giving 10% of income. There was a participant who was shocked that a financial planner would suggest it to be responsible to give away money. Across the room was an equally shocked participant that someone would even consider not sharing their earnings with someone less fortunate.
My conversations with other financial professionals have also yielded tremendous differences in opinion. One financial planner might advise that charitable giving be delayed until every bit of debt is paid off and retirement is fully funded. Another planner might advise that charitable giving occur in some sort of balance alongside those things and yet another may say that charity ought to be one of the highest priorities even if it’s at the expense of not paying off debt or saving. I certainly have my own beliefs about charitable giving, but today’s post is going to focus not on how much to give, but when to give for those who are intentional givers.
Knowing that this topic is super-red-hot, I want to clarify one point in advance. The strategy I’m going to describe involves an attempt to time charitable gifts with the goal of reducing a household’s federal tax liability. Some givers may believe that tax implications ought to have no impact on when or how charitable gifts are given. I appreciate that perspective, but have found many givers appreciate the opportunity to pay less in taxes when possible and might even give the net difference to charity as well!
The implementation of the Tax Cuts and Jobs Act (TCJA) in 2018 raised the federal standard deduction. For 2019, the standard deduction is $12,200 for individuals and $24,400 for married couples filing jointly. Put simply, itemized deductions such as home mortgage interest (subject to limitations), state and local taxes (also subject to limitations), charitable contributions, and other less common deductions need to be greater than the standard $12,200 or $24,400 amounts to have any impact on tax liability.
Meet Gary and Liz. Gary and Liz carry a mortgage of $300,000. Their monthly mortgage payment is about $2,000 and they expect to pay $11,000 in mortgage interest this year. Their state and local income taxes are about $8,000. Charitable giving is $350/month or $4,200/year. The total of these three common federal tax deductions is $23,200, which is JUST under the standard deduction of $24,400. Their marginal tax bracket is 22%, which means that they will pay 22% federal tax on their next dollar earned. It also means that any additional deductions beyond the standard deduction saves them 22% on the amount over $24,400.
Gary and Liz don’t give to charity for the tax deduction, but they do feel a little slighted that their giving doesn’t help them on their taxes at all. With a little bit of foresight, Gary and Liz can make their charitable giving reduce their tax liability. Assuming that they have a fully-funded emergency reserve, Gary and Liz could pre-gift their donations for next year sometime in late December. As long as the charity has “constructive receipt” on or prior to December 31 the donation counts for the current year. What is “constructive receipt?” Constructive receipt is when a party has unfettered access to funds with no restrictions. Dropping off a donation minutes before a charitable organization closes on New Year’s Eve gives the organization constructive receipt and you an itemized deduction. If you are mailing a donation, the postmark must be Dec 31 or earlier. A receipt showing the postmark date may be necessary if there is a question during an audit.
Back to Gary and Liz. By making their 2020 contribution early, they have increased their current year itemized deductions from $23,200 to $27,400. They now have $3,000 less income subject to the 22% federal tax bracket resulting in a savings of $660! They might even turn and give that $660 directly to their charity of choice resulting in a donation 15% larger than the original amount.
Households with fairly significant charitable contributions may consider using a Donor Advised Fund which allows for a tax-deduction in the year that contributions are made to the fund even though the actual distribution to charity is delayed to a future year. This can make particular sense when receiving lump sums of taxable income.
I encourage anyone who chooses to begin bunching deductions to discuss their plans with the charity’s financial leaders if the gift is size-able enough to impact the organizational budget. For example, a household may decide to pre-gift $20,000 to their place of worship after receiving an end-of-year bonus. The budget leaders may believe the donation is a special offering without realizing that regular monthly donations won’t flow throughout the next year.
Pregifting or bunching deductions together allows intentional givers who are just under the standard deduction amount to reduce their tax liability and even increase their charitable donations. Contact me or comment below with questions!