How to donate to charities tax-efficiently
If you’re charitably inclined, there are some tax-efficiency tips to keep in mind to help you make the most of the potential tax benefits of your charitable donations.
Before we start, I want to say that deciding to donate to charity should always first and foremost be because you’re truly charitably included and want to help the organization(s) to whom you’re giving.
Yes, there can be tax benefits available to you for making donations. But unless you’re genuinely charitably inclined, don’t make donations just to try to save yourself some tax. Even with the most generous of charity-related tax benefits, you’ll still end up with less money than you had.
For example, assume your all-in effective tax rate is 30%. If you donate $1,000, you may be able to reduce your tax bill by $300. But, even with the tax savings, you’ll still have $700 less than you did before making the donation.
I’m in no way saying people shouldn’t donate to charities. I’m simply saying that people who aren’t charitably inclined and are just looking save themselves some money won’t actually make themselves financially better off by making charitable donations, even if they’re SUPER tax-efficient about it.
So, to sum up: If you’re charitably inclined and want to make donations to charitable organizations, that’s fantastic. A secondary consideration with regards to how much you donate, what you donate and when you donate is the tax implications around trying to maximize the potential tax-efficiency of it all.
Before we really get into it, I want to make you aware of IRS Publication 526, which is about Charitable Contributions. It’s tremendously helpful in understanding the tax implications of making donations. And, it’s straight for the horse’s mouth (where the “horse” is the IRS). For those interested in digging more into the topic of tax-efficient charitable giving, I highly recommend giving it a read.
Also, it’s important to be aware that, in the eyes of the IRS, charitable donations are only eligible for potential tax benefits if they’re made to qualified charitable organizations. If, on the other hand, you give money or other things to individuals (not formal charitable organizations), that is considered a “gift” as far a the IRS is concerned. And gifts aren’t eligible for any potential tax deductions or any of the other benefits I’ll be talking about below.
Even if you give someone money because they need it for good reasons that are arguably charitable in nature, it’s still not a charitable donation in the eyes of the IRS. For example, if you buy a $20 meal and give it directly to a homeless person, that’s just a gift, not a donation. If you instead give $20 to the local homeless shelter that in turn uses the money to buy a meal for that same person, then the $20 would be considered a donation.
One final comment before we get into it: most of this article will be in reference to donating “non-qualified” assets. This means donating cash from your bank accounts, securities from your brokerage account, physical possessions such as cars or household furnishings, etc. Only one of the points below will be in reference to using “qualified” assets to make charitable donations. Specifically, qualified assets refers to IRAs (or SEP or SIMPLE IRAs).
Okay, let’s now talk about how to make your charitable donations as tax-efficient as possible:
Understand the standard deduction vs itemized deductions – Without getting in too much detail about the form and function of tax returns, know that the amount of income on which you have to pay income tax isn’t just the total amount of income you have for the year.
At a super high level, most of your sources of income get added together on your tax return to arrive at your “Total Income.”
Then there are some adjustments you can make to your total income to arrive at your “Adjusted Gross Income,” or “AGI.”
Then you can deduct certain things from your AGI to arrive at your “Taxable Income.” That’s the amount on which you have to pay income tax.
In going from your AGI to your Taxable Income, the IRS lets you deduct the larger of 1) the standard deduction or 2) your itemized deductions.
For 2024, the standard deduction is $14,600 for Single filers, or $29,200 for Married Filing Joint filers.
Additionally, if you’re 65 or older as of the end of the year, there’s an additional $1,950 standard deduction if you’re single, or $1,550 per person 65 or older if you’re married and file a joint return.
Also, if you’re blind or disabled, there is another $1,950 extra standard deduction for single filers, or an extra $1,550 per person blind or disabled if you’re married and file a joint return.
All taxpayers are entitled to take the standard deduction(s), with no questions asked. Basically, the IRS lets you take that amount right off your AGI just for showing up. For the majority of taxpayers - approximately 90% - the standard deduction is taken.
However, for the remaining 10% of taxpayers, their itemized deductions are larger than the standard deduction, so they instead use their itemized deductions to arrive at their Taxable Income.
As the name implies, itemized deductions are a few different potential deductions you can “itemize” and add up. If the total of your itemized deductions is larger than your standard deduction, you’ll want to use your itemized deductions on your tax return, as it will result in a lower Taxable Income.
There are a few things that can potentially be itemized on your tax return:
- Qualified medical expenses in excess of 7.5% of AGI
- State and local taxes (aka “SaLT”) including property tax, state income tax and personal property tax, collectively subject to maximum deduction of $10,000
- Interest paid on the mortgage of a primary residence
- Casualty and theft losses from a federally declared disaster
- Charitable donations
As you can see above, charitable donations are one of the few potential itemizable deductions. To the extent the sum of your deductible charitable donations and other itemizable deductions exceeds your standard deduction, you will benefit from itemizing your deductions on your tax return.
Let’s look at a quick example of comparing the standard deduction vs itemized deductions.
We’ll first assume your AGI for the year is $100,000.
Let’s assume you’re single and 65 or older. Your standard deduction for 2024 will be the $14,600 base standard deduction, plus another $1,950 for being 65 or older. That’s a total 2024 standard deduction of $16,550. Unless you have at least $16,550 of itemized deductions, you’ll be using the standard deduction on your tax return.
So now let’s start adding together your potential itemizable deductions:
We’ll assume you had $9,500 of qualified medical expenses. You can only itemize qualified medical expenses to the extent they exceed 7.5% of your AGI. Since your AGI is $100,000, you can only itemize qualified medical expenses in excess of $7,500 (as 7.5% of $100,000 is $7,500). That means you can itemize $2,000 of your medical expenses.
We’ll assume you paid $7,000 of property taxes on your house. And let’s assume you live in Florida, so you have no state income tax. Therefore your total state and local taxes are the $7,000 of property taxes paid, all of which are deductible, as they’re less than the $10,000 maximum.
We’ll assume you own your house outright and have no mortgage and therefore no interest to itemize.
We’ll assume you donated $4,000 of cash to a charity.
Your total itemized deductions for 2024 would be:
$2,000 of medical expenses +
$7,000 of state and local taxes +
$4,000 of charitable donations
In total, your itemized deductions for the year would be $13,000. This is less than the $16,550 of standard deduction your eligible to use. Which means you’ll be taking the standard deduction. That also means you receive no tax benefits for having made the donations, since you would’ve gotten the standard deduction anyway, even without the donations.
Keep this example in mind; we’ll come back to it later.
Understand deductibility limits – Not all donations are created equal in terms of how much you’re able to potentially deduct. Different types of assets have different deductibility limits, based on your AGI.
Cash– when donating cash (which could be actual physical bills, bank ACH transfers, credit card donations, bank wires, etc.), you can only potentially deduct up to 60% of your AGI in any given year.
For example, assume your AGI is $100,000 this year. And assume you donate $70,000 of cash to a charity. You can only deduct up to $60,000 this year (I’ll later talk about what happens to the other $10,000 you can’t currently deduct).
Capital Gain assets – when donating securities (stocks, bonds, mutual funds, exchange traded funds, etc.) whose market values are higher than the prices at which you acquired them AND you held them for more than 12 months, you can only potentially deduct the market value of those donations up to 30% of your AGI. Or, if you instead choose to deduct the securities at their original costs, you can only deduct them up to 50% of your AGI. I’ll later work through an example of this.
Ordinary Income assets – when donating securities whose market values are lower than the prices at which you acquired them OR the market values are higher than the original costs but you haven’t owned the securities for at least 12 months, you can only deduct the market values of those donations up to 50% of your AGI.
Other property – when donating other property such as card, clothing, household goods, etc. you can only deduct their fair market values up to 50% of your AGI. However, depending on the asset, there could be some wrinkles. For example, if you donate a car, the value you can deduct is generally the lower of 1) the fair market value of the car at the time of the donation or 2) the price for which the charity sells the car.
Understanding the above deductibility limits is important if you’ll be making donations that are large relative to your AGI.
For example, if you have $100,000 of AGI and donate $15,000 of cash and $5,000 of securities, the above limits won’t come into play as both of these donations are well under their respective % of AGI deductibility limits. But if your AGI is instead only $20,000, for example, then the above limits will definitely come into play.
So, what happens if you donate more than what you’re allowed to deduct in the current year because of the respective % of AGI limits? The amount that isn’t able to be deducted in the current year will carry over for up to five additional years and apply toward those years’ deductibility limits.
As an example, assume your AGI this year is $100,000 and you donate $70,000 of cash. You will only be able to deduct $60,000 of that donation, because cash donation deductibility is limited to 60% of AGI.
That means the other $10,000 of non-deductibility will carry over to next year. Let’s assume you’ll again have $100,000 of AGI next year. You’ll be able to deduct the $10,000 of carry over next year, as that will be under 60% of next year’s AGI. But keep in mind if you make additional donations next year, those will additionally use up some or all of your deductibility limits for the year (where again any excess not deducted will carry over for five more years after the year of the donation).
If you aren’t able to soak up the carried over deductibility of a donation within the five years after the year of donation, the remaining amount not deducted is unfortunately lost at that point. So, plan accordingly if/when making really large donations!
One final note about how the deductibility limits work before moving on: if you donate different types of assets that have different % of AGI deductibility limits, the limits are first used up by the assets with the highest deductibility percentage. And that can crowd out some or all of the amount you can deduct of the donated assets with the lower deductibility limit.
For example, if you donate enough cash that you hit the 60% of AGI deductibility limit for that cash donation, you won't additionally be able to deduct any capital gain assets that year; the 30% of AGI deductibility for those is NOT on top of the 60% of AGI deductibility of the cash donation in this case.
Bunching donations – Let’s revisit the itemized deduction example from before, where you have $100,000 of AGI, donated $4,000 but didn’t get any tax benefit for it because your itemized deductions were only $13,000, which was lower than your standard deduction of $16,550.
One way to get some tax benefit for donations in a scenario like this is to “bunch” multiple years worth of donations together into a single year (and then not make donations in the other years).
For example, instead of donating $4,000 every year, perhaps instead donate $20,000 every five years, assuming you have the cash flow and budget to make that large of a donation every fifth year.
Assuming you’d still have the same $2,000 of deductible medical expenses and $7,000 of property taxes, you’d now have $20,000 (not $4,000) of charitable donations. Now, in the year of the “bunched” donation, you’d have $29,000 of itemized deductions. For 2024, this is $12,450 larger than your $16,550 standard deduction. Which means your taxable income in the year of the bunched donation will be $12,450 lower than it would have been had you not bunched your donations.
Granted, you’re not getting a deduction on all$20,000 of donations (because, again, your total itemized deductions are only $12.450 higher than the standard deduction you would have gotten anyway). But you’re nonetheless getting a tax benefit for at least some of the bunched donations, whereas you would get no tax benefit if you continued donating $4,000 per year.
If you’re going to consider bunching donations, keep in mind the % of AGI deductibility limits previously mentioned. Depending how large your bunched donation is going to be, you may not be able to deduct it all in the year of the donation. However, you’ll have the following five years to soak up the carried over non-deductible amounts.
Consider donating appreciated securities – if you have stocks, mutual funds, exchange traded funds, etc. in a brokerage account and the positions are highly appreciated (i.e. you have a lot of unrealized gains on them), those can be good candidates to donate to meet your charitable goals.
If/when you were to eventually sell those positions (assuming you didn’t donate them), you’ll have to pay tax on the gains. Granted, if they’ve been held for more than 12 months, they’ll be taxed at the lower federal capital gains tax rates as opposed to the higher ordinary income tax rates. But still, if you’re going to be making donations, it could be worth it to donate appreciated securities and get rid of that pending tax obligation as opposed to donating cash.
However, this assumes the recipient charitable organization is able to accept securities as donations. Not all charities can. Most larger or more established charities and organizations can. But smaller places may not, as they may not have wanted to go through the extra process and operations of establishing and maintaining a brokerage account.
Another thing to keep in mind with donating appreciated securities is the % of AGI deductibility limits mentioned before. Recall that “Capital Gain” assets can only be deducted up to 30% of AGI if you’re deducting the positions’ market values, or 50% of AGI if you’re deducting the positions’ original costs.
For example, assume you’re donating $90,000 worth of stocks that you originally bought for $10,000 20 years ago. And assume your AGI in the year of the donation is $100,000.
If you deduct the positions at their $90,000 market value, you can only deduct up to 30% of AGI. Which means you can only deduct up to $30,000 in the year of the donation. The remaining $60,000 will carry over for up to five years.
Or, if instead of using the market value you choose to deduct the stocks at their original cost of $10,000, then you can deduct that up to 50% of AGI. BUT, you’d only be able to deduct $10,000, since you’d be deducting their cost. Yes, in this example, you can deduct all of the cost in the year of the donation instead of having to worry about carrying any over. But it’s only a total deduction of $10,000. Clearly in this case you’d be better off deducting the positions at their market value instead of their cost.
Consider opening and funding a Donor Advised Fund, or “DAF” – a Donor Advised Fund isn’t a tax-efficient donation strategy in and of itself. Instead, it’s a tool to help potentially carry out some of the previously mentioned strategies such as bunching donations and donating appreciated securities.
A Donor Advised Fund, or DAF, is an investable account that you can donate cash or securities into, invest it and then later make distributions to charities from the fund.
The major financial custodians such as Vanguard, Fidelity and Schwab all offer DAFs. What’s nice about using these firms is that they act as both the administrator of the DAF and the financial custodian that holds the DAF’s assets.
There are other independent DAF administrators who run and administer DAFs, but separately require the opening of the DAF’s investment account at a financial custodian.
When you put money into a DAF, the donation is made at the time you contribute money or securities to the fund. At that point, you no longer own the assets; you formally and irrevocably donated them to charity. In the case of a DAF, the DAF is technically the charity to which you make the donation.
The DAF administrator will generally let you invest the money in the DAF as you choose, though they may place certain restrictions on what you can invest in. For example, there are some religion-based DAF organizations that restrict donors from investing the funds in companies involved in alcohol, tobacco, gambling, etc. While it may sound odd that the DAF administrator restricts how you can invest the money, you have to keep in mind that you no longer own the assets; the DAF does.
Anyway, the intention of the DAF is that you put money or securities into, invest it, let it grow (hopefully) and then later send money out from the DAF to underlying charities of your choice. But, as the technical owner of the fund and assets in it, the DAF administrator may not allow distributions to be made to certain charities. For example, religion-based DAFs may not allow distributions to organizations that help or fund causes which the religion does not support.
However, generally speaking, DAF administrators are rather flexible and accommodating with regards to 1) what they’ll let the DAF invest in and 2) what charities they’ll let you make distributions to from the DAF.
Because the DAF is technically the charity to which you make a contribution, the DAF administrator will formally be a charitable organization and will be the entity that’s responsible for administering the DAF accordingly. As such, there are costs to having a DAF. While there may be exceptions, my experience and research is such that the lowest cost DAFs charge 0.60% of assets per year to run and administer.
For example, if you donate $100,000 to a DAF run by Vanguard, Fidelity or Schwab, they will deduct roughly $600 per year from the account. As the account size increases or decreases, the dollar amount of fee will increase or decrease. And there is often a minimum dollar amount of fee, such as $100 per year.
A DAF can make sense if you want to make a large donation and/or bunch donations but don’t necessarily want the underlying charity to get the money all in one shot. Maybe you want to spread out the timing of when the underlying charity actually gets the money, but you want to maximize the tax benefit of making a large donation in one year. Donating a large amount to a DAF and then instructing the DAF administrator to make annual distributions to the underlying charity could be a good solution.
Also, most (all?) DAFs accept securities as donations. As such, if you want to make a large donation to a charity, and you want/need to make it via donating highly appreciated securities but the charity can’t accept securities, using a DAF as an intermediary could make sense. You can donate the securities to the DAF, and then liquidate them within the DAF and have the DAF administrator then distribute the cash proceeds out to the underlying charity. However, be sure to check to see if the DAF you’re looking into would allow for such a short-term usage of the DAF.
Qualified Charitable Distributions (“QCDs”) – This one only applies if you’re at least 70 ½ years old and you have pre-tax money in an IRA (including a SEP or SIMPLE IRA).
The IRS will let you do a distribution of pre-tax money from your IRA directly to a qualified charitable organization, place of worship, etc. This is called a Qualified Charitable Distribution, or QCD. And it can only be done from IRAs (or inherited IRAs, SEP or SIMPLE IRAs); not employer plans like 401(k)s, 403(b)s, 457s or the federal Thrift Savings Plan.
Donating via QCD instead of giving cash from your bank account is arguably the most tax-efficient way to make cash donations, and here’s why:
If you take a normal distribution out of your IRA, that will increase your AGI. However, assume you then you turn around and donate that cash to a charity. Assuming the donation is large enough to itemize on your tax return, the donation will reduce your Taxable Income thereby offsetting the increase in AGI caused by the distribution. All said and done, the tax impact appears to be zero because the itemized deduction of the donation reduces your Taxable Income by the amount of the IRA distribution.
However, the distribution nonetheless increases your AGI, and AGI is what’s used to determine whether other hidden or knock-on taxes come into play.
For example, income-based Medicare premium surcharges are keyed off of your AGI, not your Taxable Income. The Net Investment Income Tax is also keyed off your AGI.
As such, one of the main benefits of QCDs is that the money donated this way does NOT show up in your AGI in the first place.
But, at tax return time, you’ll need to remember you did QCDs during the year and manually account for it on your return. When you receive the 1099-R from your IRA custodian at the end of the year, it won’t make any mention of how much of your total distribution(s) was QCD vs normal outright distribution(s). The burden is on you to remember you did QCDs and manually reflect it on your tax return. If you don’t, the QCD will flow into your tax return as if it was a fully taxable distribution.
The other main benefit of QCDs is that they can take the place of RMDs. If you’re charitably inclined, of RMD age and don’t especially need the money from the RMDs from your IRA(s), you can do QCDs to satisfy at least some of those RMDs, thus not having to realize them as taxable.
For example, assume you have $50,000 of RMDs this year. Perhaps you do a QCD for $30,000 and then take the remaining $20,000 as a normal distribution. This way, only $20,000 of taxable income will actually show up on your tax return (again assuming you properly account for the QCD on your return). The $30,000 of QCDs will go right to the charity and stay out of your AGI and Taxable Income.
The amount of QCD you can do in any given year is rather large. For 2024, it’s $105,000 per person. Which means a married couple could do up to $210,000 of QCDs in 2024.
The annual QCD limit is indexed for inflation and will increase each year going forward.
Other, more complicated, charitable giving strategies – I figure the rest of the stuff I’m about to mention is more complicated and involved than would be beneficial for the vast majority of those of you reading this. But I didn’t want to completely ignore them, in case they may be relevant or of interest to you, in which case you can separately seek out more information.
Some people may choose to formally start their own charity, such as through starting a private foundation and making donations to it. For most people, this will be much more cost and operational burden than is prudent. You can sort of think of a DAF as a stripped down more cost-effective foundation in the sense that you can you donate money or securities to it, recognize the tax benefit of the donation at the time, invest it and then later have the money go out to underlying charities.
There are also a few different forms of charity-specific trusts that can be set up, such as Charitable Remainder Annuity Trusts, or CRATs, and Charitable Remainder Unitrusts, or CRUTs. In both cases, you put money into a trust, get some pre-determined amount of income for life out of the trust, and then eventually whatever is left in the trust after you pass goes to charity. There are strict IRS rules about how much income you can get each year and how much needs to go to charity at the end.
Similar to CRATs and CRUTs are Charitable Gift Annuities, or CGAs. They are functionally like CRATs or CRUTs in that you donate to it, get some amount of income for life out of it, and then the remainder goes to charity after you’re gone. The difference is that with a CGA, you directly donate the money to the charity, not a trust, and that charity is the one who pays you the income during your life, and then keeps the remainder after you pass.
That’s a wrap for my thoughts on how to tax-efficiently donate to charities. I hope you found this helpful!