Managing Money Well Through Tax Deductions
Using wisdom in paying less taxes means that more money is available to bless your family, friends, church and other organizations.
Some may choose to not even consider the tax implications when they contribute. Many are motivated by spiritual commitments and closely held values that will cause them to see that the money they manage is ultimately God’s provision to them to be managed for good purposes.
Part of managing money well is an understanding the tax benefits of giving.
We don’t only give to church and charity because of tax benefits (that is peculiar to the modern American context). And, those benefits may go away some day. But for now, it is worth understanding the opportunity.
The money saved by wise tax planning can be considered as either:
1) A secondary benefit or blessing to a life of generosity (not the main reason to give, but a nice benefit)
2) A practice of excellent money management (managing what we’ve been given effectively)
3) A way to have even more resources for good purposes (being smart about money enables us to retain more of what we earn)
Though this is not an exhaustive explanation of tax code, the following terms and explanation is a quick reference guide. On a practical level, the below concepts get more complex from the first to the last. For instance, the Charitable Remainder Trust tends to apply to older individuals who have had time to accumulate assets.
1) CHARITABLE DEDUCTION - making a financial contribution to a church and reducing the amount of income the federal government will tax.
Simple Version:
Very simply, if you make $50,000 annually and write a check to your church for $5,000, the government will require that income tax be paid on $45,000.
The law and logic:
The standard deduction for people in the United States in 2019 is $24,400.
In an attempt to simplify taxes, this means that you reduce your income by $24,400 and pay taxes on the rest. (this is a simple explanation – there are exceptions, of course)
This means, that unless the combination of a few things you can deduct is greater than $24,400, then there is no “extra benefit” to giving more from a tax incentive standpoint.
(i.e. – when you combine state and local taxes and mortgage interest paid and your charitable giving, your generosity to church and charity may actually cause you to go beyond the $24,000 and get even more tax benefit)
EXAMPLE:
State and Local Taxes 10,000
Mortgage Interest 10,000
Charitable Gifts 10,000
Deduction 30,000
Limitations to consider:
There is a part of US tax code called AGI or Adjusted Gross Income. Your AGI refers to all of your sources of income in any given year minus the things you are allowed to deduct (e.g. certain business, medical, tuition and other costs). This is what you report when you file taxes every year.
What is important to the discussion of charitable giving is that once we give 60% of AGI in 2019, anything given beyond that does not help to reduce the amount of taxes we pay. In other words, your tax benefit on charitable giving is limited. For most people, however, this does not create a problem.
2) CARRY OVER DEDUCTION – allowing the giving that exceeded this year’s limit to help with next year’s tax burden.
Simple Version:
Very simply, if you gave $65,000 this year, but were limited to $60,000 (because of the current limit of 60% of AGI), then the $5,000 that didn’t get you any tax benefit this year can be applied to next year’s tax burden.
Law and logic:
Though it is rare, when someone exceeds the giving amount they are “allowed” for tax deduction purposes, the federal government will recognize the extra giving in the following year or years.
EXAMPLE:
60% of your AGI 60,000
Charitable Giving this year 65,000
Amount to add to your deductions next year 5,000
Limitations to consider:
An overage can only be claimed within five years of its original appearance on to the income tax radar.
3) BUNCHING DEDUCTIONS – reducing taxes by loading up deductions one year instead of spreading them over two.
Simple Version:
You give $20,000 to your church inside one year (e.g. 10,000 in January and 10,000 in December) and nothing the next year instead of $10,000 each year for two years. The tax benefit is greater in total (over the two years) but it the church still gets the amount you intended to give.
Law and logic:
Because you will get the $24,400 deduction regardless, you can bunch up giving in a prior year to get a lot more than the standard. So if you can get a large deduction one year and the standard deduction the next, this will often (when added all together) be a higher tax benefit to you.
EXAMPLE:
Instead of this
Tax Year 2018 2019
State & Local Tax 10,000 10,000
Mortgage Interest 10,000 10,000
Charitable Gifts 10,000 10,000
ANNUAL DEDUCTION 30,000 30,000
Total Deductions Over 2 years: $60,000
You can do this
Tax Year 2018 2019
State & Local Tax 10,000 10,000
Mortgage Interest 10,000 10,000
Charitable Gifts 20,000 - 0 -
ANNUAL DEDUCTION 40,000 24,400
(Standard Deduction)
Total Deductions Over 2 years: $64,400
Limitations to consider:
There is a cap on deductions related to AGI (as mentioned before). In 2019, you will need plan for your best deduction without going over 60% of AGI, or be ready to apply the overage to next year’s deductions. This is where tax planning professionals are extremely helpful.
4) IRA Distribution – distributing from a Retirement Account can reduce tax burden.
Simple Version:
You distribute $50,000 from your IRA directly to the church and avoid the tax on income or appreciation (capital gains).
Law and logic:
There is actually a Required Minimum Distribution (RMD) for individuals who hold retirement accounts and are 70 ½ years old. There is a calculation table provided by the government that shows the amount necessary to distribute without being penalized (it is a formula that factors in life expectancy and determines an amount based on a percentage of the balance of the account).
An individual can distribute up to $100,000 from an IRA, after which there is no longer a tax reduction benefit.
5) DONOR ADVISED FUNDS – depositing funds into an account that can receive and hold charitable giving to distribute proceeds at a later date.
Simple Version:
A family opens a Donor Advised Fund account and deposits $50,000 in it this year because they needed to reduce their tax burden. They get to decide later when and to what charity these funds will be distributed.
EXAMPLE:
2018 2018
Money Deposited in DAF Tax Deduction
$50,000 $50,000
2019 2019
Money Given to Church from DAF Tax Deduction
$25,000 - 0 -
Law and logic:
This is a giving vehicle that is like a “savings account for generosity” and it managed by a third party. The donor retains the right to dictate when and where the charitable giving gets distributed but surrender ownership of what they put into the account. The charitable gift deduction applies to any year deposits are made into the DAF regardless of when the money leaves the account to be given to a charity.
6) CHARITABLE REMAINDER TRUST – investing in a trust fund, the principal of which is owned by a charity, but the income it produces accrues to the donor until death.
Simple version:
A donor wants to eventually give away $1M of the family wealth, but would like to gain both a tax benefit and a source of income now and going forward. This donor also would like to “give away the tree” ($1M) but retain the right to “pick the fruit from the tree” (interest income) for the rest of their life.
EXAMPLE:
Family deposits $1M in a CRT ($900,000 of which are appreciate stocks for which no capital gains tax is paid)
Family retains income interest of 5% or $50,000/year
Family accrues a $460,000 tax deduction
Law and logic:
This donor names CHARITY “A” as the beneficiary of the $1M CRT and sets up terms for the income distribution. The CRT produces a certain amount of interest income for the donor who can choose to have that income distributed in that year or as an “IOU” for future years when the income is preferred or needed. The donor family can change the beneficiaries over time and are not locked in. When the donor passes away, the remaining principal goes to the charity.
DISCLAIMER:
This is meant to be a quick reference guide and is therefore not exhaustive or universally applicable in every situation. It is up-to-date and accurate as of June 2019, but does not substitute as professional or legal tax advice. Tax laws change regularly. Please consult your Tax Return Preparer, Financial Advisor or Attorney for advice on anything regarding the implications of charitable giving decisions on your taxation.
