Please note: This article may contain outdated information about RMDs and retirement accounts due to the SECURE Act 2.0, a law governing retirement savings (e.g., the age at which individuals must begin taking required minimum distributions (RMDs) from their retirement account will change from 72 to 73 beginning January 1, 2023). For more information about the SECURE Act 2.0, please read this article or speak with your financial consultant. (1222-2NLK)
Remember the adage "It's better to give than to receive"? If your financial goals include giving to causes that are important to you, you can strategize to make the greatest impact while potentially receiving tax savings, too.
Ground rules for giving
The tax aspects of charitable giving can be complex. It's always a good idea to consult a tax professional about your giving strategy. That said, here are a few ground rules:
- Request a receipt if you donate $250 or more to a single charity. If the donation is in cash, regardless of amount, you'll need a receipt or supporting bank records.
- Get an independent, written appraisal for gifts of property in excess of $5,000 ($10,000 for closely held stock). You won't need an appraisal for exchange-traded stocks, bonds, or mutual funds.
- Subtract the value of any benefits you received for your charitable donation (for example books, tapes, meals, entertainment, and so on) before you deduct it.
- Itemize your deductions on your tax return if you think your total donations will exceed your standard deduction1 and you want to receive a tax benefit for your charitable donations. If your standard deduction is higher, your donations won't reduce your tax bill, but you'll still be supporting your favorite charity—which is a good reason on its own to give.
- Be aware of the annual deduction limits for donations to public charities, including donor-advised funds. For contributions of non-cash assets held more than one year, the limit is 30% of your adjusted gross income (AGI). Your deduction limit will be 60% of your AGI for cash gifts. Note that if you're planning a large donation that's close to or exceeds your AGI limit, you may carry over the excess contribution amounts up to five subsequent tax years. Consider talking to a tax professional before making your donation.
Tax treatments by type of gift
The tax advantages of a charitable contribution generally depend on three factors: the recipient (only donations to qualified charities are deductible), how you structure the gift, and the type of property you choose to give. Different types of property donations—whether its cash, business assets, or investments—offer different tax advantages and drawbacks:
Cash donations are simple, but as previously mentioned, make sure you keep a receipt from the charity or a bank record (such as a canceled check or statement) to substantiate your cash gift—no matter how small.
You can deduct transportation costs and other expenses related to volunteering. However, the value of volunteer time isn't deductible.
Tangible personal property
You can donate almost any item—including old clothing, household goods, or vehicles—as long as it's in "good" used condition or better under IRS tax rules. If the property doesn't relate to the charity's mission, you may deduct the amount you paid for the property or the property's current reasonable value—whichever is less. If the property is related to the charity's mission—old clothes donated to the Salvation Army, for example—it's usually fully deductible based on its current reasonable value. Some charities will provide guidance, but it's ultimately up to you to determine the property's worth for tax purposes.
Ordinary income property and short-term capital property
Ordinary income property normally includes assets like inventory held for sale by a business, artwork created by you, or manufactured items you produced. In addition, any short-term capital assets, such as stock, are considered to be ordinary income property if held for less than a year.
Typically, if the donated assets would have generated ordinary income if sold on the day of contribution, then the IRS limits your deduction to the asset's cost basis (the fair market value reduced by the amount of ordinary income or short-term capital gain that would have been realized). However, you may be able to take the full deduction if you include the appreciated value of the asset in your gross income on your tax return. If the property has decreased in value, your deduction could be further limited (see "Property or assets that have decreased in value").
Appreciated long-term capital property
You can usually deduct the full fair market value of appreciated long-term assets that you've held for more than one year and a day—such as stocks, bonds, mutual funds, or other personal assets like real estate that have appreciated in value. An additional benefit is you don't have to recognize any gains on the donation, which means you pay no capital gains tax on that property.
Donating long-term assets—especially highly appreciated securities—instead of cash can be a very effective and tax-efficient way to support a charity. If your assets have appreciated in value, you can generally increase the amount of your potential deduction as well as your gift by contributing the securities directly to the charity instead of the cash generated by selling them.
Donating appreciated investments can increase tax savings
Let's say Sarah and Steve are married, file a joint tax return, and want to donate $100,000 worth of stock to their local animal shelter. They are in the 37% federal ordinary income tax bracket and are subject to the 20% long-term capital gains tax rate, plus the 3.8% net investment income tax. They have two options: They could sell the stock and donate the cash, or they could just donate the stock directly to the charity.
- Option #1: Sell the stock and donate cash
- Option #2: Donate the stock to the charity
Current fair market value of stocks (1,000 shares x $100 per share)>Option #1: Sell the stock and donate cash$100,000>Option #2: Donate the stock to the charity$100,000>
Amount donated to the charity1>Option #1: Sell the stock and donate cash$100,000 (in cash)>Option #2: Donate the stock to the charity$100,000 (in stock)>
Income-tax deduction from donation2 (0.37 x amount donated to charity)>Option #1: Sell the stock and donate cash$37,000>Option #2: Donate the stock to the charity$37,000>
Capital gains tax owed>Option #1: Sell the stock and donate cash$22,610>Option #2: Donate the stock to the charity$0>
Net tax savings from charitable donation>Option #1: Sell the stock and donate cash$14,390>Option #2: Donate the stock to the charity$37,000>
Property that has decreased in value
For property that has decreased in value below its cost basis, the IRS has a special rule that says you can only take a donation deduction for the fair market value of that asset. In some situations, such as when you have shares of stock that have decreased in value to the point where you have losses, it may be better to sell that asset first and then donate the cash proceeds. By doing so, you may be able to reduce your tax liability by using your capital losses to offset any capital gains (known as tax-loss harvesting) and then donate the remaining cash to potentially get a deduction on your contribution.
Giving through specialized charitable vehicles
While gifts of cash or appreciated investments can be given directly to a charity, it often makes sense to consider specialized charitable vehicles to make giving easier and to manage the tax benefits. If you give regularly, certain giving vehicles such as donor-advised funds or private foundations can make sense.
Donor-advised funds, for example, allow you to make a donation of appreciated stock held long-term and to receive a current-year tax deduction. You can then grant those assets out over time and have the remaining assets invested so they can potentially grow for future grants to worthwhile charities.
If you prefer to leave assets to charity but also earn income for a period of time, a charitable remainder trust (CRT) or pooled income fund is worth exploring. If you're age 70½ or older, you can donate a qualified charitable distribution (QCD) tax-free from an IRA directly to a qualified charity. A QCD can be used to meet up to $100,000 of the required minimum distribution for your IRA, and you don't have to include that distribution in your taxable income. However, you should note that there is no tax deduction for a QCD.
The bottom line
Each of these donation strategies and vehicles offers different benefits, but in the end, what really matters is helping an organization that matters to you—the tax benefits from a donation are just icing on the cake. So, compare your options and talk with a financial planner, tax advisor, and/or a philanthropic advisor to help determine the best way to give for your particular situation.
1For 2022, the standard deduction is $12,950 for single taxpayers and married couples filing separately, $19,400 for heads of households, and $25,900 for joint filers. In 2023, the limits increase to $13,850, $20,800, and $27,700, respectively.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
This information does not constitute and is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, or investment manager.
A donor's ability to claim itemized deductions is subject to a variety of limitations depending on the donor's specific tax situation. Consult your tax advisor for more information.
Market fluctuations may cause the value of investment fund shares held in a donor-advised account to be worth more or less than the value of the original contribution to the funds
Contributions of securities held for longer than one year are generally deductible at fair market value (FMV); securities held for one year or less have the same AGI limits as cash contributions (60%), but the valuation is based on the lesser of the cost basis or FMV. Contributions that exceed AGI limitations may be carried forward and deducted for five years. An account holder's ability to claim itemized deductions may be subject to further limitations depending upon the donor's specific tax situation and account holders should consult their tax advisors.1222-2SLX