As the 2022 tax year draws to a close and the holiday season is upon us, many people are feeling especially generous. The end of the year is the perfect time to support your favorite charities and nonprofits. Not only will you be changing the lives of those whom your donation benefits, but you can also improve your own life by making taxes less of a headache.
Below are brief descriptions of five common problems faced by taxpayers and how end-of-year giving can help solve them.
Itemized Deductions Not Surpassing Standard Deduction Threshold
In order to obtain tax deductions for charitable giving, you’ll need to itemize your deductions. But what should you do if your itemized deductions don’t quite surpass the standard deduction threshold? This is where a tax strategy known as “bunching” comes into play.
Bunching Your Donations
Bunching involves moving as many itemized expenses as possible into the current tax year while taking the standard deduction for the following year. If you proactively make all your charitable contributions for 2022 and 2023 before the end of 2022, you can itemize those deductions on you current-year tax return. When it’s time to do your taxes for 2023, you’ll simply take the standard deduction and not have to worry about itemization.
High Capital Gains Tax on Appreciated Assets
Selling non-cash assets that have risen in value often results in having to pay long-term capital gains tax, which can be as high as 20%. If you want to avoid this, you can instead donate any appreciated stocks, bonds, mutual funds or real estate that you’ve held for longer than a year to a recognized charitable organization. You’ll save up to 20% on taxes, and the charity you support will receive the full value of the asset.
Donating Non-Cash Assets
As an example, let’s say you purchased stock for $100 a few years ago, and that stock has now risen to a value of $1,000. If you sold the stock and then donate the proceeds, you’d need to pay as much as $200 in taxes. This would then leave you with only $800 to contribute to charity. If you instead donated the stock directly, the charity would receive the full $1,000 stock value without $200 skimmed off the top.
Need to Satisfy IRA Required Minimum Distribution (RMD)
Traditional IRA owners who have no need for additional income in the current year but have yet to meet their required minimum distribution (RMD) have the ability to bypass income tax on part or all of their RMD. The IRS allows for something called a “qualified charitable distribution (QCD),” which is essentially when you donate directly from your IRA without first withdrawing income from it.
Making a Qualified Charitable Distribution (QCD)
If you are age 70 ½ or older and have a traditional IRA, you’re eligible to make a QCD of up to $100,000 per year (couples who are married filing jointly can give up to $200,000 per year). By using this method to contribute to charity, you’ll avoid paying income taxes on your IRA distribution.
Significant Tax Liability When Converting From a Traditional IRA to a Roth IRA
If you plan on retiring soon but don’t want to have to worry about paying taxes on future IRA distributions, converting to a Roth IRA is a great option. However, doing so will require you to pay taxes on the total amount withdrawn from the traditional IRA. You may want to consider making a charitable contribution to offset part or all of the liability generated by this taxable event.
Offsetting Taxes With Charitable Deductions
Let’s say you want to move $100,000 from a traditional IRA to a Roth IRA. Under normal circumstances, you’d be required to pay taxes on the full $100,000. Alternatively, you could make a charitable contribution of $100,000 in the same year that you make the IRA transfer, generating a charitable deduction to offset your withdrawal and transfer tax liability.
Uncertainty About Where to Direct Future Donations
Want to make your tax-deductible donation before the end of the year but unsure of where the money should go? A donor-advised fund (DAF) is exactly what you need. Offered by investment companies, universities, community foundations and various charities, DAFs enable individuals to contribute irrevocable lump sums to be parceled out as grants in future years.
Contributing to a Donor-Advised Fund (DAF)
You can contribute however much you’d like in 2022 (taking the applicable charitable deduction on your tax returns) and then start recommending grants to charities in 2023. You’ll have plenty of time to research causes that are important to you and decide how to best direct your donations—but you won’t have to wait to take the tax deduction for them.
These tax-saving strategies often work best when used in conjunction with one another. For example, you might bunch your deductions, contribute to a DAF and convert to a Roth IRA all in the same year. Hypothetically, you could make your all usual charitable contributions for 2022 and 2023 before the end of the year (bunching). To simplify things for yourself, you could invest those contributions in a DAF to ensure plenty of future opportunities to decide how the money gets used. You could then convert the same amount of money that you donated to the DAF from your traditional IRA to a Roth IRA, helping to offset the resulting tax liability.
As you can see, there are numerous possibilities to consider. No matter what charitable giving tax strategies you decide to employ, be sure to consult with a tax expert first to make sure everything goes smoothly. A knowledgeable CPA or tax consultant will be able to advise you on your best course of action.