Bigger Gifts to Charities, Bigger Tax Deductions in 2021
Charitable giving feels good. So does reducing your tax bill. The CARES Act provides an opportunity to do more of both in 2021.
Charitable giving feels good. So does reducing your tax bill. The CARES Act provides an opportunity to do more of both in 2021.
Tax rules can be complex, but taking the time to understand them can help you maximize your savings. And given temporarily higher limits for qualified contributions, knowing the rules is even more valuable than before. So we’re going to spare you the complexity and serve up the key points every charitable investor should know. Don’t worry, this won’t hurt a bit.
Know your limits
Charitable deduction limits are expressed as a percentage of an individual’s adjusted gross income (AGI). The limits are different for public vs. private charities, and they vary by the type of property donated, but we’ll just focus on the rules and strategies that are relevant for most investors: contributions to public charities1 in the forms of cash and long-term appreciated securities (those you’ve held more than one year),2 which from here on, we’ll simply refer to as “securities.”
Under normal circumstances (that is, when we’re not in a pandemic), if you make all of your donations in cash, the maximum amount that you may deduct against your taxable income is 60% of your AGI. If you donate securities instead of cash, you may deduct an amount that is equal to 30% of your AGI. Pretty simple so far, right?
Now, what if you want to donate a combination of both cash and securities? For this scenario, the rule maintains the limit for cash donations at 60% of AGI but limits the deduction for securities donations to the lesser of 30% of AGI or 50% of AGI minus the amount of cash that is deducted. If you work through the math, you will conclude that the maximum amount you can deduct for cash and securities combined is 50% of AGI.
Why you should “CARE” about temporarily higher limits
As part of the CARES Act, individuals who itemize deductions on their tax returns can deduct up to 100% of their AGI for donations of cash made to public charities during 2020 and 2021. Individuals who donate both securities and cash are allowed a combined deduction of up to 100% of AGI as well. The 30% limit on securities donations still applies but can be supplemented with deductions for cash donations up to 70%.3
Maximize your tax savings by donating securities
When you donate cash to a public charity, you get one tax benefit: a deduction, for the gift portion, against your taxable income. But when you donate long-term appreciated securities, there are more ways to save on taxes:
You can deduct the fair market value of the securities against your taxable income.
You do not pay the long-term capital gains tax on the securities you donate.
Replenishing your portfolio results in a higher cost basis, creating the potential to harvest more tax losses to offset gains in future years.
If you plan to make donations to public charities that total 100% of your AGI this year, consider donating 30% of that in the form of securities. If you plan to make donations that total 30% of your AGI, consider donating entirely in the form of securities.
Maximizing your securities donations will maximize your savings by avoiding the 23.8% tax on capital gains,4 and the adjustment to your cost basis allows you to reap additional savings in future years. A tax professional can help you determine the most tax-efficient strategy for your situation.
Excess contributions? Keep calm and carry forward.
Individuals who donate amounts beyond the deduction limits can carry forward the excess contributions. Put simply, if you donate more than you can deduct for the current year, you can deduct the excess amount against your AGI in a future tax year. Here’s what you need to know:
You can carry forward your excess charitable contributions up to five years.
Contributions you carry forward are subject to the same percentage limits in the year to which they are carried.
You must deduct the contributions you made during the current year before you may apply contributions that you’ve carried over from prior years.
If you accumulate carryover contributions from multiple years, you must apply them chronologically, i.e., beginning with the earliest year.
Take opportunities, not opportunity costs
The opportunity to eliminate your 2021 tax bill may sound too good to pass up, but it might not always be the most tax-efficient strategy. Consider the graduated tax rate system, which applies higher rates only to the additional income earned within each bracket. Choosing to deduct 100% of AGI generally means that a portion of the deduction is being used to offset income that would have been subject to lower tax rates.
Rather than incurring this opportunity cost, you might consider spreading out the timing of your charitable contributions in order to limit the amount you donate in any given year to the portion of your income that is subject to higher tax bracket(s). A tax professional can help you determine the most tax-efficient strategy for your situation.
The bottom line
Taxpayers who itemize their deductions have an opportunity to increase their tax savings for 2021 by making the qualified contribution election, which allows the deduction of up to 100% of AGI for cash donations made to public charities (versus 60% in “normal” tax years).
Donating appreciated securities can provide additional tax advantages versus cash and still provide the charity with equivalent value. The deduction limit for the donation of long-term appreciated securities to a public charity is 30% of an individual’s AGI.
Investors who hold appreciated securities can achieve even higher savings for 2021. After deducting up to 30% of their AGI for securities donations, the qualified contribution election permits the deduction of an additional 70% of AGI for cash donations (versus just 20%, as combined, without the election).
A tax-conscious advisor can help investors fulfill their charitable inclinations while taking advantage of opportunities to achieve greater tax savings.