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A Little Known Tax Saving Strategy

Contributed by Pence Wealth Management

As a Financial Advisor, one of the largest client issues uncovered is that people are making charitable contributions with after-tax money and not receiving a tax deduction. That is, they are taking cash out of their savings or checking and donating directly to their favorite charity, religious group, or other non-profit. This is one of the least tax-efficient methods in making charitable contributions given the recent changes to federal tax laws under the Tax Cuts and Jobs Act of 2017 (TCJA).

Under the new tax law, most people will now use the Standard Deduction versus the Itemized Deduction on their tax forms. For 2018, the Standard Deduction for a single person under the age of 65 is $12,000 and doubles to $24,000 if married. This means the taxpayer will need to exceed the Standard Deduction to obtain a higher tax break. It is projected the majority of taxpayers will not exceed the Standard Deduction and therefore, will not receive a tax break for their charitable giving.

Donor-Advised Funds

However, there are methods to ensure you are able to still receive a tax break and continue your philanthropic giving by using a Donor-Advised Fund (DAF). Clients can donate assets today, receive a tax deduction now, and allow those donated assets to be granted to the chosen charity at some point in the future. The key to understanding the DAF is the type of asset used to fund the account to get the maximum tax deduction.

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Example 1, Bob and Susie Smith are married and file a joint tax return. Bob is a Boeing director with an annual salary of $220,000 and is in the 24% federal tax bracket and 9.3% California state tax bracket for a combined top marginal bracket of 33.3%. Bob has been working at Boeing for over 30 years and has acquired Boeing stock since he began working there. Bob owns 1,000 shares of Boeing stock at a cost of $25 per share (cost basis) and with a current market value of approximately $350 per share. Bob has a Long-Term Capital Gain of $325 per share or $325,000.

Bob wants to make an annual $6,000 cash charitable contribution and wants to know if he will obtain a tax deduction. Their current deductions include $6,500 in state and local taxes, $8,000 in interest, and $6,000 to their favorite charity for a total of $20,500 in Itemized Deductions. Since the Standard Deduction of $24,000 exceeds their Itemized Deductions of $20,500, there are no tax savings and they will choose the Standard Deduction.

Given Bob has a savvy financial advisor, the advisor discussed the use of a Donor-Advised Fund to meet all his charitable giving and reduce his concentrated position in Boeing. Bob is very intrigued and asks his Financial Advisor to explain.

Example 2, Bob will aggregate the next 5 years' worth of giving not in cash, but in highly appreciated stock. Bob donates 85 shares of Boeing stock with a market value of $29,750 (85*$350) to a Donor-Advised Fund. He will immediately receive a $29,750 charitable deduction. Adding in his other Itemized Deductions of state and local taxes of $6,500 and interest of $8,000, his new total is now $44,250 of Itemized Deductions. In this case, the Itemized Deduction of $44,250 exceeds the Standard Deduction of $24,000, Bob will use the Itemized Deduction.

Bob was able to maximize his deduction by gifting highly appreciated Boeing stock and receiving market value for his deduction. Bob reduced his taxable income by an additional $20,250 ($44,250-$24,000) compared to the Standard Deduction. Given Bob was in the 33.3% combined marginal tax bracket, he saved an additional $6,643 ($20,250*.333).

Additionally, Bob gets to choose when he makes his charitable contribution, as he controls the Donor-Advised Fund. As long as it is a 501(c)(3) he can make as much or how many donations as he wants in any year or future years.

Four Common Misconceptions about Donor-Advised Funds (DAFs)

1. Donor-Advised Funds are only for the Rich

2. Donor-Advised Funds must all be given away in the same year of contribution

3. Donor-Advised Funds leave me with less control and are less flexible than a foundation

4. Donor-Advised Funds cannot grow in value

#1. In our practice, we see many clients who thought DAFs were only for people with millions in the bank and they were not eligible to set up DAFs. They are amazed that they too can set one up very quickly and operates as their own "foundation" of the sort with minimal cost.

#2. A DAF contribution can be given away in a time period of the client's choosing. It could be a set amount each year and carry forward to future years.

#3. DAFs leave the donor with lots of control. The donor can change or add more charitable groups, as long as they are 501(c)(3) charitable organizations.

#4. When a donor funds a DAF, they can choose to select a type of investment model for their contribution based on their risk tolerance. For example, a donor can select a balanced 50% equity and 50% bond portfolio, thus increasing the likelihood of the investment to grow over time.

Summary

It is imperative one meets with a qualified and reputable financial and or tax advisor. Everyone's situation will be different and one wants to make sure they are getting the best advice to their current situation. The above examples were simplified for illustrative purposes only. Each state may impose their own limitations on how much one can deduct in any particular year against the taxpayers Adjusted Gross Income (AGI). Additionally, the federal government has self-imposed limits on the percentage deductible against AGI above certain levels.

For a free Pence advisor consultation, call 800.731.3623. Or attend a Special Seminar.

Content in the material is for general information only and not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. Pence Wealth Management offers securities thru LPL Financial, Member FINRA/SIPC. Pence Wealth Management & LPL Financial do not provide tax advice or services.

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