In a world where every act of kindness can make a difference, tax-efficient giving can empower you to support causes you care about while optimizing tax benefits. As a Certified Financial Planner™ professional and a Certified Tax Specialist™ with over a decade of experience, I’m here to guide you through the art of giving wisely. Let’s explore the top ways to impact nonprofit organizations meaningfully while being tax-efficient.
Tax-Efficient Giving: Simply
Cash is the most straightforward form of giving. What it lacks in tax efficiency, it makes up for in ease. Cash donations immediately support charities, whether a one-time gift or a recurring contribution and can be made anytime, anywhere, in just about any way.
Using beneficiary designations doesn’t mean you have to give the entire account to the nonprofit. You can set a percentage of how much you would like to go to the nonprofit(s) and how much you may want to pass on to heirs. If you are considering gifting to both charitable causes and heirs, the type of accounts you leave to each matter.
By gifting to a nonprofit from your tax-deferred retirement plans (rather than a taxable account), your heirs avoid the tax liability of inheriting that account – typically a traditional IRA. Withdrawals from traditional IRAs are taxable at ordinary income rates, among the highest you pay. That is true for those who inherit traditional IRAs, too. Add to that the requirement to liquidate the inherited IRAs over a five to ten-year period (in most cases), and this could mean a great deal of that inheritance is going to the IRS. Nonprofit organizations don’t pay taxes, so by receiving a traditional IRA account, they get the full value gifted vs the after-tax amount. (It’s important to note this example applies to tax-deferred retirement accounts like traditional IRAs. Roth IRAs do not have the same tax consequences.)
For your heirs, inheriting a taxable account comes with a step-up in basis, which removes embedded gain from the account that’s accumulated over your life, and inheriting insurance policies and Roth IRAs are tax-free events. This makes all three strategies the keys to tax-efficient giving when leaving money to your heirs.
Jane has amassed a well-diversified portfolio, including a $500,000 taxable account, a $500,000 traditional IRA and a $500,000 life insurance policy. She wants to leave money to her two adult children and her favorite charity, The Boys and Girls Club. What is her most tax-efficient move when it comes to beneficiary designations?
Jane designates her adult children as beneficiaries of the taxable account and the life insurance policy. By doing so, she ensures that her children benefit from the step-up in basis of the taxable account, minimizing their capital gains tax burden upon inheriting the assets. Additionally, the life insurance proceeds will be received income tax-free. She opts to name The Boys and Girls Club as the beneficiary of her IRA. The organization can receive the full value of the IRA without incurring income tax.
Donating appreciated stock is tax-efficient giving that benefits donors and charitable organizations. When you contribute stocks that have appreciated in value to a nonprofit, you support your chosen cause and enjoy significant tax advantages. By bypassing the sale of the appreciated stock, you can avoid capital gains taxes that would have been incurred had you sold the stock yourself. Furthermore, you can claim a charitable deduction for the stock’s full market value at the time of donation, potentially reducing your overall taxable income (again, only of tax benefit if you have the overall deductions to itemize).
Over the years, Sarah has purchased shares in a pharmaceutical company, and the stock’s value significantly appreciated. Rather than selling the stock and incurring capital gains taxes, Sarah supports The Oregon Food Bank by donating the appreciated shares directly to the organization. The stock, originally purchased for $5,000, is now valued at $20,000. By contributing the stock to The Oregon Food Bank, Sarah avoids capital gains taxes on the $15,000 appreciation and qualifies for a charitable deduction for the full $20,000 market value of the stock.
Tax-Efficient Giving: More Involved
Donor Advised Funds (DAFs) & Bunching Donations
Donor Advised Funds (DAFs)
Put succinctly, a Donor Advised Fund (DAF) is a powerful philanthropic tool that allows you to make charitable contributions, receive an immediate tax deduction, and strategically distribute funds to nonprofits over time.
Put in more detail, when you contribute to a DAF, you can deduct the full value of the donation in the year of contribution, even if the funds are distributed to charities gradually. This can be a great way to offset a particularly high tax year while still planning your giving strategically. A DAF operates as a separate account, managed by a sponsoring organization, where donors can recommend grants to qualified charities.
Donor-Advised Fund + Appreciated Assets
One notable benefit of DAFs is that you can contribute to them using appreciated assets, as discussed above, and bypass capital gains taxes.
You can learn more about this trifecta of tax-efficient charitable gifting by watching our video:
Donor Advised Fund + Appreciated Assets + Bunching Donations
Qualified Charitable Distributions (QCDs)
A Qualified Charitable Distribution (QCD) is tax-efficient giving available to individuals 70.5 or older with individual retirement accounts (IRAs). If this describes you, this provision allows you to make direct charitable contributions from your IRA to qualified nonprofit organizations, up to a maximum of $100,000 annually (indexed for inflation starting in 2024). By sending funds directly from the IRA to the charity, the distribution is excluded from your taxable income. This can go toward fulfilling your required minimum distribution (RMD) and reducing your overall taxable income.
This strategy is particularly advantageous for those of you who may not need the entirety of your RMD for living expenses and want to minimize your taxable income. QCDs not only reduce your taxable income, they may also reduce the taxation of your Social Security benefits, Medicare IRRMA surcharges and more. Want to learn more about QCDs? Check our blog: What is a Qualified Charitable Distribution (QCD)?
Robert is 75 years old and has a $500,000 Traditional IRA. He is required to take a minimum distribution from his IRA, and instead of receiving the distribution as taxable income, he opts to make a QCD.
Robert’s annual RMD is $20,000, and he directs the entire amount as a QCD to the Oregon Historical Society. By doing so, the $20,000 distribution is excluded from Robert’s taxable income. Not only does this fulfill his RMD obligation, but it also allows him to make a meaningful contribution to the organization without incurring additional taxes.
Tax-Efficient Giving: Complex
Charitable trusts are sophisticated estate planning tools that allow you to contribute assets to benefit both charitable organizations and their beneficiaries. One common type of charitable trust is the Charitable Remainder Trust (CRT). In a CRT, the donor transfers assets—often appreciated stocks or real estate—into an irrevocable trust. The trust then pays you or your beneficiaries an income stream for a specified period, after which the remaining assets are directed to a charitable organization. This tax-efficient giving provides immediate tax benefits, such as an income tax deduction for the present value of the charitable remainder, and ensures ongoing income during the trust’s term.
Conversely, the Charitable Lead Trust (CLT) provides income to a charitable organization for a set period, with the remaining assets ultimately passed to your beneficiaries. This structure allows you to support a cause during your lifetime while transferring assets to heirs with potential estate tax benefits.
The complexity and nuances of charitable trusts make them particularly suitable for those seeking to create a lasting legacy with both charitable impact and financial advantages. Consulting with legal, tax, and financial professionals is essential to tailor these trusts to your individual goals and circumstances.
James initiated a Charitable Lead Trust (CLT) with an initial deposit of $500,000 to support his favorite organization, The United Way. The CLT is invested in a moderate portfolio and appreciates at 5%/year. James lives another 20 years happily watching his CLT distribute 5% of its value each year to The United Way. When he passes, the total amount that was directed to The United Way is roughly $819,500.
The remaining assets in the CLT, made up of principal and appreciation over 20 years, total just under $470,000. This passes on to his two children. This amount is just under his initial contribution of $500,000. The CLT allowed James to leverage the initial gift to, in essence, give from the same pool of money twice.
Charitable Gift Annuities
Private foundations are philanthropic entities established by individuals, families, or corporations to contribute to charitable causes. Unlike public charities, private foundations typically do not rely on public fundraising and are funded by a single source or a small group of donors. These foundations are endowed with substantial assets, which are invested to generate income that can be distributed to support various charitable activities.
One notable characteristic of private foundations is the ability to support various charitable initiatives. Donors who establish private foundations often have a specific vision or mission they wish to advance, and these foundations serve as a means to channel resources toward causes aligned with their values. While private foundations offer a high degree of control and flexibility, they are subject to certain regulations to ensure transparency, accountability, and compliance with tax laws.
The Thompson family decided to leave a lasting impact on their community by establishing the Thompson Family Foundation through the Oregon Community Foundation (OCF). The family’s foundation was created with a substantial endowment to support local arts and education initiatives. Collaborating with OCF, the Thompson Family Foundation strategically defined its grantmaking priorities, focusing on projects that enhance school arts education and provide resources for emerging artists within the community. OCF played a crucial role in managing the foundation’s investments, ensuring compliance with legal regulations, and facilitating effective philanthropy.
The most tax-efficient giving plan is empty without clarity around your intrinsic motivations behind giving. If you’re looking for guidance, check out our blog, which walks you through the steps to create your philanthropic philosophy.
In smart philanthropy, finding the right strategy that aligns with your financial goals and charitable aspirations is key. Whether you prefer the simplicity of beneficiary designations or the complexity of creating a private foundation, there’s a tax-efficient option for everyone. Remember, giving wisely benefits the causes you care about and maximizes your financial impact while minimizing your tax liability. If you’re looking for a thought partner to talk through your philanthropic goals, I welcome the conversation.