Despite the poor stock market, some readers have had a good enough year where they are looking at year-end giving to charity. While this is a blog post, you should investigate more before deciding if a strategy will work for you. Here are some ideas you may consider:
Income from an IRA you don’t need and don’t want to be taxed on can go to charity
This helpful reminder comes from the IRS. You can make tax-free distributions of up to $100,000 per person from your IRA if you are more than 70 ½ years old. This kind of distribution is not an option for reducing people’s tax burden now for income already received, but it is a great planning tool for future years. For example:
Bilal is 73 years old and retired with a high income from his pension, rental income, and IRA. His IRA income comes from a “mandatory minimum distribution” he does not need, but the government forces him to withdraw some of it yearly because that’s how IRAs work.
Bilal can give up to $100,000 of this IRA income to charity. He cannot deduct the donations from his taxes, but it does count against the mandatory minimum distributions, so he has that much less income. The government does not force Bilal to take the distribution, pay taxes, and give it to charity. I am describing a Qualified Charitable Distribution (QCD), and you can read about it here.
Cash gifts tend to be inefficient.
The value of your deduction is your donation times your highest marginal tax rate. So, if Bilal donates $100 to charity and has a marginal tax rate of 35%, he saves $35. However, suppose Bilal donated $100 in appreciated stock purchased for $10. In that case, that is a savings of having to pay income tax on the $90 appreciation, plus he gets the deduction for the complete donation. That is just the start. It would help if you generally planned charitable gifting, the who, why, and how.
Huge income years may have a charitable solution.
Many people have years where they receive a significant income they usually don’t expect yearly. For example, on the sale of a business, or a building, certain kinds of lawsuit judgments and a big bonus can result in a rather extreme uptick in income for a specific year and, thus, a more significant than the ordinary income tax bill. It’s possible to get a tax deduction for giving to a charity that year for an amount substantially more significant than the charitable gift for that year; this is through a charitable lead trust.
Example: Bilquis owns restricted stock in a startup she works at. Someone purchased the company, and her HR tells her she will receive a taxable income of 2.3 million dollars. Bilquis knows payments like this are unusual, and she would like to keep as much money as possible for her family, retirement, and other priorities.
She creates a “charitable lead trust” (CLT) that allows her to give a percentage of the $2.3 million while investing it every year for the next 20 years. She can spread her deduction for the next five years.
Bilquis could get a deduction with a CLT trust, like an outright donation. With a CLT, Bilquis gets to keep nearly all the money. Twenty years later, she may have much more if she invests wisely while donating.
Some charitable-tax planning increases income.
One of the more common charitable planning techniques, a “charitable remainder trust,” is a kind of “split-interest trust” where the person who creates a trust gets several tax benefits. The result may still be more taxation overall, but because there is more to tax.
Hamza sells an office building owned by his charitable remainder trust for a profit of $4 million.
He is not immediately taxed on the capital gain of nearly $4,000,000 and can reinvest whatever he wants, supercharging his returns.
Hamza also gets an immediate tax deduction. It’s for the value of the future interest in charity.
Income from the trust that goes to Hamza is taxed but on more favorable terms than other investments. When setting up the trust, Hamza has various options regarding when he starts to take distributions and under what terms (there are a detailed set of rules, however). He can decide to take a “unitrust” – say 6% of the account value, an annuity trust, which is fixed income (but it’s not interest), net income, or a variety of other options.
The entire trust ends up going to charity eventually. That’s the bargain with this kind of trust. An illustration can show people who invest through charitable remainder trusts can do substantially better financially than those not having such plans.
A Charitable Gift Annuity is a horrible idea.
Many nonprofits will try to sell donors, especially the elderly, something called a “Charitable Gift Annuity.” It works like this:
Khadija is 80 years old. A local nonprofit offers her a charitable gift annuity. It’s a way to earn a fixed income, guaranteed by an organization’s assets for the rest of her life. She decides to donate $3 million, which will generate a guaranteed $120,000 per year for the rest of her life. Khadija figures she can retire and not worry about the stock market. She will get a tax deduction for the value of the charitable contribution.
Annuities are often a bad deal and are often exploitative to the elderly. They are not as safe as you might think. This device likely violates rules on Islamic Inheritance as well as interest. As we are dealing with nonprofits, consumer protections in the law often melt away, but they are the same product.
Please stay away from them and discourage Muslim organizations from marketing them.
Always Research Charities
The charitable sector has many organizations that do good work. The industry is lightly (if at all) regulated by state and federal governments and has tended to attract more than its fair share of corrupt operators. Religious nonprofits are the least regulated by design and tend to have almost no accountability.
Having social ties to an organization, hearing a good speech at a fundraiser, or being subjected to brand advertising is not a substitute for due diligence. Organizations often figure you would be less careful about the money you give than what you invest for your family. They may be correct, but why should that be?
You should care about the money you spend for the benefit of your brother just as much as you care about the money you keep for yourself. As Muhammad (sws) is reported to have said, “none of you will believe until you love for your brother what you love for yourself.”
Charity is more than just a tax benefit. It’s an act of love.