Episode 6: Tax Efficient Ways to Support Your Favorite Charities

Benjamin Brandt:         Welcome back to The Retirement Tax Podcast. I’m your humble co-host as always, Benjamin Brandt and joining me today as always, is the handsome Steven Jarvis.

Steven Jarvis:     That’s so nice of you to say Ben, so glad to be here.

Benjamin Brandt:         Steven, I’ve got a question for you.

Steven Jarvis:     Yeah.

Benjamin Brandt:         Is there a sure fire away that every person over the age of 70 and a half can save money with charitable contributions?

Steven Jarvis:     Well, I am a CPA, so I do shy away from definitive statements, but this is probably about as close as I’m going to get to saying yeah. For just about anyone over 70 and a half who is giving to charity, there’s a better way to do it as far as being tax efficient.

Benjamin Brandt:         I love it, so if you are not yet 70 and a half, but your parents are, stay tuned to the very end and you will find ways that we can just about for sure, save them some money on their income taxes. Because we’re publishing this during the season of giving, during Christmas, so our aptly titled episode: Tax Efficient Charitable Giving.

Steven Jarvis:     Yeah. And we talked a little bit about this on our last episode for people who have been listening along, as far as charitable giving and how the tax deductions related to that actually work. And so, we want to spend today talking about some different ways to give to charity as tax efficiently as possible. And I’m going to start with the disclaimer I always give around this of, we’re going to talk about the tax piece, but obviously you should be giving to charities that you care about, organizations that you support. That’s the primary reason for giving all we’re doing here is saying that if you are giving anyways, let’s be as efficient, as tax efficient as we can, if nothing else, so that you can give more to that organization. If you’re not interested in the tax savings for you personally, just think of how much more you could give to that local charity, your local church, wherever it is that you give, how much more could you give if we were doing this tax efficiently?

Benjamin Brandt:         Right. So give because you want to give, because something calls to you specifically, but the tax savings is going to be the charity on top.

Steven Jarvis:     Yeah. And for a lot of us, this was more of the last episode, go back and give it a listen. A lot us end up with the standard deduction anymore, and by a lot of us, I mean around 90% of taxpayers take the standard deduction and are not actually getting any sort of tax benefit from charitable giving, unless they’re being intentional. Because there’s proactive things we can do to make sure that we get this tax benefit from our charitable giving.

Benjamin Brandt:         Excellent. Well, let’s go through some of that.

Steven Jarvis:     Yeah. So let’s start with what I’ll refer to as bunching or grouping of charitable deductions. And to recap just a little bit what we were talking about the last episode, really when you itemize your deductions, you’re only getting a tax benefit for that portion that’s above and beyond the standard deduction, which for married filing jointly folks out there, for 2021 is $25,100. And so, only our deductions above that actually get us any sort of benefit. And so, what we can do if we’re intentional about this, if we’re proactive, if we look at more than one year at a time, is we can be strategic about the timing of our deductions so that we can capture some benefit there.

                           So, here’s an actual tax return I was just recently looking at. This tax payer was getting a $10,000 state, local tax deduction. And then they were giving about $15,000 to charity. And it was 15,000 and change because they were just barely over the standard deduction. And this was consistent, every year they were giving about $15,000 to charity, getting them right up to that standard deduction limit, and they were getting no tax benefit from it. And so, they’re just taking the standard deduction every year.

                           So, a really easy thing for them to do to maximize the tax efficiency, is to instead of giving $15,000 every year, give $30,000 every other year. Because you still get the standard deduction, so if we take away the $15,000 charitable contribution this year, and now we’ve only got the $10,000 state and local, great, we take the standard deduction, still $25,100. And now next year when we give 30,000, now instead of just being right at that standard deduction, we’re up to $40,000 in itemized deductions. Now, we’ve got this extra $15,000 that we are getting a tax benefit from. And like we said before, if nothing else, there’s just about another $3,000 you can give to chair because of what you’re saving from being tax efficient.

Benjamin Brandt:         Excellent. So in this case, this client is going to file itemized this year, standard next year, itemized the year after that, standard the year after that. Okay, that’s not something I’d considered outside of a donor advised fund, but that’s a great strategy is just to double up. Maybe you want to run that by the charity, because some charities that I’ve been involved in might not be able to parse that out over two years. But yeah, that’s a great idea doubling up. I’ve heard people do that with their property taxes and things like that, doubling up, but that’s a great idea with the charitable, double it up.

Steven Jarvis:     That’s a great reminder, Ben, of you still want to start with what’s impactful for the organization you’re giving to. It’s good to have a proactive conversation, especially if you’re consistently giving to the same organization, if they count on that or plan on that every year, make sure it fits for them, because that’s still got to be the primary motivation is supporting these great organizations. But if you take that strategy over the next 10 years and every other year there’s an extra $3,000, now 10 years later we’ve given an extra $15,000 to this organization. So, it can become really powerful.

Benjamin Brandt:         It can. And that is a little bit of a pushback that I’ve gotten from some clients on this area when we’re talking about bunching, is clients would say, “Well, I know that the church needs my X dollars at this time of year for this exact purpose.” So, you kind of want to keep that in your mind, but some of the strategies that we’re going to talk about, you can work around that. So, if we put something in the middle, like a middle man, like a donor advised fund so that we can recapture a lot of these deductions, you can still give at the same cadence that you were giving to, because that’s how your charity expects it. So yeah, give first, let’s get the tax deductions where we can. But also, we want to keep you in your old habits and, we want to keep you in the habits of the cadence that you’re normally giving to. For the benefit of that charity, because that’s where we’re starting from in the first place.

Steven Jarvis:     Yeah. So, really we’re starting with the simplest idea here, of this would be one way that really on your own, you could strategically do this. And you can consider years where you have other high itemized deductions to tack on your charitable contributions as well. But so, that’s really starting on the basic end of things, but Ben, you already mentioned, you kind of slipped in there donor-advised funds, which is taking this a step further, as far as the control and flexibility we get when we’re giving. So, why don’t you talk a little bit more about that?

Benjamin Brandt:         Yeah. So donor-advised funds, I think really start to shine in retirement because we’ve got access to so many of our investments. We’re in de-cumulation mode, we’re living off of our savings. When we talk about doubling up one year or doubling up every other year, we could think about our income and say, “Okay, I could probably swing that cash-wise.” But when we’re thinking about three years at a time, five years, 10 years at a time, on our normal income while we’re accumulating our assets that might be difficult. But when we’re in retirement, we have access to all of our savings, then we can really start to think about what the tax bill is of those 30 years.

                           And a donor-advised fund, making sure that we’re recapturing the deduction on all those charitable contributions, I think the donor-advised fund can really shine, because we’ve got so much access to cash that we could contribute to this donor-advised fund, accumulated, brokerage, securities, things with long term capital gains, things like that. So I think that’s really where the donor-advised fund shines. So we talked about bunching, every other year was Steven’s idea. The donor-advised fund would be, what if I took three years, or four years, or five years of charitable contributions, and I put them in this middleman called a donor-advised fund? So, rather than giving 5,000 a year, which is not going to get me beyond the standard deduction, it’s not going to get me to be able to itemize, what if I did every fifth year, I did $25,000 into this donor-advised fund?

                           Now, I’m still going to give out of the donor-advised fund 5,000 a year, so I’m still giving at the same cadence, the charity is still receiving it at the same cadence, but because I’m doing this extra step of opening up the donor-advised fund and I’m proactively planning, then every fifth year I’m going to get that deduction. So I’m giving it, like I normally do, 5,000 every year, but because we’re grouping it together in five year increments, the money that I’m giving next year, I’m getting the tax deduction this year, and the year after that, this year. So there isn’t a single charitable contribution that falls through the deductibility gap, because I’m being super proactive about how I’m giving this money away.

Steven Jarvis:     Yeah, it’s all about that intentionality. There’s some really powerful things that we can do here. And so, whether you’re more of a DIY type person or work with a professional, these are things to think about, of if I’m giving already, if I’m already charitable minded or that’s part of the legacy I want to leave, how do I do that in the most efficient way possible so I can maximize the impact on that organization? That’s ultimately what we’re trying to solve for.

Benjamin Brandt:         All right. So, we talked about bunching, that’s every other year. Qualified charitable distributions, or excuse me, donor-advised funds would be if we’re doing something that every other year wouldn’t quite get us there, maybe we’re doing every third year or fifth year, or something beyond, but let’s talk about qualified charitable distributions. This is where I think just about everybody, and I’m sure you could find some cases where it wouldn’t be, but just about everybody over 70 and a half, if you’re giving to charity and you’ve got an IRA, there could be a little bit of magic here.

Steven Jarvis:     Yeah. Qualified charitable distributions are great, or we call them QCDs for short, these are so great because they do a couple of different things for us. So, the general idea is that it allows us to make charitable contributions directly from an IRA, so that we can use our pre-tax money to donate directly to charity. So, since we’re using pre-tax money, we don’t even have to worry about itemized versus standard deduction. This comes out before we even get to that point, it never hits our adjusted gross income, which our adjusted gross income has a lot of other impacts on our tax return and things like IRMAA, and how much our social security is taxable. And so, keeping dollars out of adjusted gross income is huge all on its own, but being able to approach this and use a QCD to do our charitable giving, it’s just a great way to approach this. So Ben, what are some other benefits that you talk to your clients about when using QCDs?

Benjamin Brandt:         Well, so just to explain a little bit further, so the way that we used to be before we were 70 and a half, or before we learned about qualified charitable distributions, we would take a distribution out of our IRA, it would go into our checking account and then we would write a check to the charity. And when standard deduction doubled, and some of these things changed, that’s not deductible to us anymore. So, how can we re-engineer that? Well, we’re zapping, let’s call it a thousand dollars, we’re zapping a thousand dollars out of our IRA. We’re not taking it ourselves, it’s a third party distribution, it’s going right from the IRA to the charity. It does not pass go, it does not collect $200. So that doesn’t come back on our income, we’re not going to see that at all.

                           Now one thing, and Steven maybe you could talk to this, one thing that I’ve seen confuse people in the past, is that distribution will still show up on our income taxes but it won’t be taxable to us. So, I’ve had to in the past for clients that are self preparers, we’ve had to work through this, how do we teach the software what it is that we did? So, maybe you could explain what that is and how it works.

Steven Jarvis:     Yeah. This is a great time to reinforce that just because something goes through a software does not make it perfect. It’s really easy to fall into this false sense of security, that since we put it into a tax software, it must be right. But the IRS hasn’t actually given custodians a way to report QCDs. So, if you give $10,000 to a charity directly out of your IRA, you are still going to get a 1099R at the end of the year that says you had a taxable distribution of $10,000. Which can be incredibly confusing, because the whole reason you gave it to charity was so that it wouldn’t be taxable, but that’s what the 1099 is going to say is, “Here’s this taxable distribution.”

                           And then when we go into the tax software, we have to depending on the software you’re using, you essentially have to override it. But you have to, you have to very intentionally mark, okay, this was a QCD, and so that it doesn’t get taxed. It’ll still show up on the face of your 1040, but not in the taxable column. But if you’re not aware of that nuance, this the gets messed up all the time. And not just by DIYers, this gets messed up by tax preparers quite often, because the document coming from the custodian just says, “Hey, there was a taxable distribution.”

Benjamin Brandt:         Right, so we might have technically taken, removed $10,000 from our IRA, maybe we spent ourselves 9,000 and gave a thousand as a QCD. So, it should say 10,000 in IRA distributions, 9,000 taxable distributions. Am I understanding that right?

Steven Jarvis:     Yep, you’re exactly right.

Benjamin Brandt:         Love it, excellent. Anything to add about bunching qualified charitable distributions or donor-advised funds?

Steven Jarvis:     Well, one other thing on qualified charitable distributions, is that you can use this to meet your required minimum distribution when you hit 72. And the reason QCD started 70 and a half and not 72, is because when they moved the RMD age, they didn’t move the QCD age, just because that’s how the IRS works.

Benjamin Brandt:         That makes perfect sense.

Steven Jarvis:     Perfect sense. And so, that’s just one of those additional benefits of using a QCD. Again, if you’re already charitably minded, if you already have organizations who care about and support, this is a great way to take care of your RMD without having to pay additional taxes, if you have other sources of income that you’re using, that you don’t need all of your RMD.

Benjamin Brandt:         So, if you’re 70 and a half we can do QCDs, even though RMDs don’t apply yet, required minimum distributions start at 72. Is there a certain time of the year that you prefer? I think the custodians sort of default towards end of the year, if you don’t have something specifically on file that says, “I’d like my RMD in May,” they’re going to send it to you probably between Thanksgiving and Christmas, somewhere in there. But we tend to do our QCDs for clients early on in the year, so that we have that documented that they’re using it to specifically offset their RMD, and then take that RMD later on in the year. But is there any other science other than convenience to that?

Steven Jarvis:     No, a lot of times I’ll work with clients on them later in the year, but you want to make sure that you don’t get too late. Because you need the charity to have cashed the check, so that the contribution was actually recognized by them before the end of the year. And so, you don’t want to put yourself in a situation where you’re trying to mail them a check on December 30th, and then it doesn’t get cashed until the next year, and then we’ve got timing issues that can be hard to resolve. We also want to make sure that these QCDs are only going towards supporting the overall mission or the program of the organization.

                           The way I always explain this is with the Girl Scouts, your QCDs can go for supporting the Girl Scouts, don’t use your QCD to buy Girl Scout cookies. Because the IRS is going to assign a value to the product you’ve got, and that piece is going to be taxable. And so, if you really care about the Girl Scouts, go ahead and do a QCD to the organization itself, and then use cash or your checkbook, your personal checkbook to buy the Girl Scout cookies, so we keep those really distinct and we don’t accidentally create a taxable event.

Benjamin Brandt:         I see, so we’re giving a gift, we’re not getting something in return. So, I suppose something like a charity auction also wouldn’t really work.

Steven Jarvis:     Yeah, you technically could, but whatever the value of what you got in return, that piece of it would be a taxable event. It just gets murky. And so yeah, if we’re buying Girl Scout cookies, if we’re going to a charity auction, going to a charity golf event, things like that, that it’s better to keep separate, just to keep those real clear lines.

Benjamin Brandt:         So, we’re giving a gift expecting nothing in return. That’s maybe a good rule of thumb.

Steven Jarvis:     Yep, yep. When it comes to QCDs.

Benjamin Brandt:         Excellent. Do you want to move on to our listener questions?

Steven Jarvis:     I’ll just add one other quick thing on the topic of charity, just to keep in mind. Also consider whether it makes sense to donate appreciated stocks instead of cash to charities, because then we don’t have to worry about paying the capital gains on that appreciation. So again, if you’re planning on giving anyways, that might just be another way to really leverage the tax efficiency of giving.

Benjamin Brandt:         And can we double that up with the donor-advised fund as well? Can we give appreciated securities to the donor-advised fund, so we’re saving on the capital gains and we’re getting the deduction for the donor-advised fund?

Steven Jarvis:     Yeah, definitely.

Benjamin Brandt:         Excellent, excellent. Yeah, so if you made some good stock picks over the last few years, and you’re looking to realize some of those gains, you could offset some of those gains by funding. And it isn’t necessarily something that you have to give to a donor-advised fund and then take the money out next year, you could be giving multiple years. So if you’re approaching retirement and you have a large gain, you could say, “I’m accounting for, through the donor-advised fund, I’m accounting for my gift of in 2022, 2023, for a decade.” If you know that you’re going to be giving some part of your income, you’re essentially saying that, “This is income I’m going to earn in future years by selling this stock,” or whatever it is, “I’m also assigning part of what I would have given to charity anyway, but because I want to recapture, essentially capture all of what that deduction would be, I’m putting that long term capital gain in my donor-advised fund and then making those gifts over the course of my retirement.”

Steven Jarvis:     Yeah, lots of ways for these strategies to overlap.

Benjamin Brandt:         Excellent, excellent. Well, let’s dive right into our listener questions.

Steven Jarvis:     Yeah, here we go. So the first listener question, which these all come from Ben’s other podcast, Retirement Starts Today, and we’re really grateful for his audience’s active participation. This one says, “If you start a donor-advised fund to bunch deductions, how much can you deduct compared to your earned income? I’ve heard 50% and 60%.”

Benjamin Brandt:         Okay. And there’s a sub-question that we’ll get to, but yeah, can I offset a hundred percent of my income through charitable deductions?

Steven Jarvis:     Yeah, unfortunately the IRS is only so charitable to us, as much as they want us to be charitable to others. So in general, 50% of your adjusted gross income is how this gets limited. Now, there are certain types of charities where this can be actually as low as 30%, but in general, your public charities, it’s going to be 50% of your adjusted gross income that this gets limited to.

Benjamin Brandt:         So the best I can do is 50% of the total? 50% of total income.

Steven Jarvis:     Yep, so you’re not going to be able to offset your entire income with charitable contributions. But we can still have a pretty big impact.

Benjamin Brandt:         Right, so to answer the listener’s question, that’s going to be 50%. Sub question to that, “Does a Roth conversion count as earned income? If so, can I take a larger deduction and put more in a donor-advised fund?” So to give that question body, I think he or she is asking, let’s say I do 50,000 as a Roth conversion, could I take out an additional 30,000 out of my IRA and fund a donor-advised fund? Can these sort of cancel each other out in some way?

Steven Jarvis:     Yeah. So, they ask if it counts as earned income, but really for that charitable giving limitation, it’s adjusted gross income. We’re probably talking about the same thing, but I want to have that nuance there. And yes, Roth conversions do go into adjusted gross income, and so this would increase the total amount you’re able to give. And combining strategies where we’re trying to accelerate deductions, which is what we were doing with those charitable giving strategies, and strategies where we’re accelerating income, which is essentially what we’re doing with Roth conversions, can be very powerful. Because then in the years where we’ve intentionally increased our income, we’ve also been proactive about offsetting some of that income.

Benjamin Brandt:         And I did, I’m noticing now that she said earned income. It’s not earned income the way that you’d be able to do IRA contributions or Roth IRA contributions, it’s not something you’ll be paying like payroll tax on. But yeah, so earned income I guess can be a little bit of a loaded term, but yeah, it is income that you’ll have to pay income tax on.

Steven Jarvis:     Yeah. That’s why I want to make that clarification about adjusted gross income, because their earned income does get defined differently by the IRS.

Benjamin Brandt:         Okay, excellent. Question number two, “I’d like to hear more opinions on taxes in retirement. My tax CPA is telling me not to worry about doing Roth conversions, and let the next generation pay tax.” Boy, this is a bit of a loaded question, CPA versus CFP, we might get into some trouble. But he or she did ask, “I’d like to hear more opinions about taxes in retirement.” So my opinion would be we pay whatever taxes we owe, but we don’t want to leave the government any gratuity, no tip. So, I would say that whether you are giving to charity or you’re passing this onto the next generation, being clever about how we pay taxes, simply maximizes that gift. It’s like Steven had the example of if we double up these charitable contributions every other year, standard, itemized, standard, itemized, over 10 years that’s an extra 3,000 we could have given to that charity, just because we’re being very intentional about how we structure these things and how we pay the taxes. We’re clearly paying everything that we owe, we’re just making sure we don’t pay any extra.

                           I would say the same works with leaving money to your kids. Why would we intentionally avoid a strategy, because our kids can just pay the taxes? Any gift to them, they should be happy with the gift, don’t look a gift horse in the mouth. But how I look at it, is I’m able to magnify and maximize that gift by using some of these strategies. So, if I’m giving a gift, I want to give a gift first. If I can make that gift bigger by using a clever strategy, why wouldn’t I do that? Because my attention is to give the gift. So, while I congratulate you on your patriotism, if you don’t want to use these strategies to fund the government further, I guess I applaud that, but for me and for my clients, I want to make sure we’re not paying any more than we have to pay.

Steven Jarvis:     Yeah. And with all due love and respect to all of my fellow CPAs, most CPAs are very focused on how much tax are you paying this year? And in fairness to them, it’s usually because that’s what their clients are coming to them and saying is, “I want to pay as little to the IRS right now as possible,” and so that’s what they get really focused on. But so, this idea that let’s not worry about Roth conversions and let the next generation pay it, that would certainly not be my opinion. Ben, I think you’re really just hitting on the head, of let’s be proactive, let’s be intentional, let’s take control of when we are paying these taxes whenever it’s possible for us to do that.

Benjamin Brandt:         I would also add, let the next generation pay the tax, you might not make it that far. If we get stuck in deferral mode for too long, and now we’re 72 and we’ve got to take out four or five percent of our IRA every single year, I’ve got bad news for you: you will be paying those taxes, not the next generation. So, if you blow up your taxability of your social security, if you blow up your income-based Medicare premium payments, you yourself will be paying those taxes. And sometimes that can show up as kind of a rude surprise, when you get a letter from the social security department that said, “Hey, remember two years ago when you started RMDs? Well, now you’ve got to pay a lot more for your health insurance, your Medicare.”

                           So, it’s one thing to think about. Yeah, they should be happy with any gift they get, whether they pay taxes on it or not. But there are a lot of situations where your income will spike if we don’t pay close attention to this, and you’ll be paying taxes that we could have otherwise avoided with some proactive planning. So yeah, I don’t want to throw any shade on the CPA community, financial advisors and certain CPAs of a certain ilk, we’re solving for different things. And like Steven said, a lot of times the job of the accountant is, “This number at the bottom of my tax return, get that as close to zero as possible.” But as advisors that are focused on retirement, we know that we’re paying a six or seven figure tax bill over the course of our retirement, sometimes that means voluntarily paying more taxes now in order to pay, hopefully, a lot less later. If our account balances go up, if taxes go up, there’s a lot of different ways we can make it make sense to pay more taxes now, to pay less later.

                           So, we’re solving for totally different things. One is looking out 30 years, one is saying, “We have just this year to deal with, how can you get this number as close to zero as possible?” Which would make sense if you have that mindset, why you would never do Roth conversion, because you’re intentionally making that number bigger, not smaller, so you’re swimming upstream. So, we love all of our accountant friends, especially Steven, but you just have to understand that we’ve been given different marching orders, so the thing that we’re trying to solve for is totally different. So, it’s not right versus wrong, it’s what is your outlook and what are you solving for?

Steven Jarvis:     Yeah. What I try to stay focused on is, how do we minimize the tax over the lifetime of your wealth?

Benjamin Brandt:         That’s exactly right, I think it’s the biggest bill most of our listeners will pay in their retirement. I think that’s probably a good note to end on, so Steven, I had a lot of fun. Thank you for your time. Until next time, don’t let the tax man hit you where the good Lord split you.