There are lots of reasons to donate to charitable organizations, not the least of which is that, well, it just makes you feel good. But there are other reasons, too. The IRS has long realized the merits of making charitable donations and has rewarded taxpayers or their businesses with charitable giving deductions on annual tax forms.
There are a number of specific ways you can optimize the charitable giving deductions you take for yourself or your business in order to lower your tax bill in any given year. Here are three:
1. Make Sure You Have the Proper Documentation
We’ve all had the experience of someone showing up at our door, asking for a donation to some worthy cause. Maybe our business partner’s daughter wants to help clean up Hudson Bay. Or the collection plate comes around in church, and we have the opportunity to give a little something extra to support schools for kids in India. It’s tempting to just grab our wallets and throw in a few bucks – or a lot of bucks, if we really believe in the cause – toward that charitable organization.
But what you need to know is that it’s no longer okay to simply record the amount of cash you donate on your tax form. You must have verifiable documentation of any giving you make. The IRS requires images of processed checks, clear transactions on credit card or bank statements, payroll deductions, or a written receipt from a qualified 501(c)3 organization containing the name of the organization and the date and amount of the contribution. For text message donations, a telephone bill meets the recordkeeping requirement, as long as it shows the same information. For the full IRS rules on charitable giving, click here.
2. Donate Appreciated Securities
Another way to take better advantage of your charitable giving deductions is to transfer appreciated stock or mutual funds to a charitable organization. Donations of stock or other noncash property are usually valued at the fair market value of the property. By donating appreciated securities, you avoid paying capital gains taxes on the amount of the appreciation, as long as you’ve held the securities for more than a year.
It’s important to note, however, that you wouldn’t want to donate depreciated securities, since the amount of the depreciation could be used to offset gains elsewhere in your taxes. For more info on donating stocks and mutual funds, see the IRS publication Determining the Value of Donated Property, which includes securities valuations.
3. Take Advantage of a Donor-Advised Fund
Sometimes it makes sense to accelerate your charitable giving deductions by giving more now than later. This is especially true if you’re anticipating a drop-off in income next year, or if you’re nearing retirement and planning to move to a place where tax rates are lower. In such a case, you can front-end load your deductions by using a donor-advised fund.
Donor-advised funds, sometimes called charitable gift funds, allow you to set aside money now for an immediate charitable deduction, while disbursing the cash to the charities you select over a period of years. Charles Schwab, Fidelity Investments and Vanguard all offer such donor-advised funds.
Here’s how it might work for you: Instead of donating $1,000 a year over the next decade, you could contribute $10,000 to a donor-advised fund now. Your money is invested in a mutual fund, which earns tax-free interest. You do pay an annual fee for fund administration (typically 0.6%, in addition to the usual expense ratio), and you can’t get your donation back, ever. But you get to choose which organizations get the money, how much and when.
There are a number of potential tax benefits to contributing to a donor-advised fund. Your donation qualifies for maximum income tax benefits (with a few restrictions, of course) for the year in which you make the contribution. You incur no capital gains tax on gifts of appreciated assets, and your contribution isn’t subject to estate taxes. If you’re required to pay an alternative minimum tax (AMT), your contribution reduces your AMT impact. For more on how the IRS addresses donor-advised funds, click here.