Christine Benz: Hi, I am Christine Benz for Morningstar. The clock is ticking if you want to make a charitable contribution and have it count on your 2022 tax return. Joining me to discuss what you need to know about charitable giving this year is tax and retirement planning specialist Ed Slott. Ed, thank you so much for being here.
Ed Slott: Great to be back with you Christine. Thanks.
Benz: It's great to have you here. I want to talk a little bit about charitable giving, and I'm hoping you can outline the rules around taking a deduction for charitable contributions. What should people know about that?
Slott: Oh, that's easy. Probably you can't take a deduction anymore. Ninety percent of people no longer itemize deductions due to the new--it's not even that new, it's a few years old already--higher standard deductions, especially for older people of 65 or older who get actually extra standard deductions. So, most people get no tax benefit of the gifts they give to charity because they don't itemize deductions anymore. There are some ways to do it and one of them involves IRAs, one of my favorite. Now just before we get into this discussion, I'm not saying to make charitable gifts solely for tax purposes. If that was the case, give all your money away, and you'll never pay any taxes. That's not what we're talking about here. We're talking about making the gifts you are already giving but doing them in a better way to get some tax benefit out of it.
Benz: You just referenced the qualified charitable contribution, the QCD, the qualified charitable deduction. Who can take advantage of that, and what do they need to save and hold on to to prove that they've made these contributions?
Slott: Well, QCD, qualified charitable distributions, is a great provision. It allows you to make a direct transfer from your IRA to the charity, and why that's such a great provision? The best assets to give during life or even after death is our IRAs. They're the best assets to give because they're loaded with taxes, and charities don't pay the taxes. If you think about it, if you're in a giving mood or you want to give and you have an IRA, that should go to charity, that leaves more of non-IRA funds to say your family, your children beneficiaries who can inherit better assets like stock portfolios that receive a step-up in basis. IRAs never receive a step-up in basis, and under the Secure Act, inherited IRAs almost always have to be withdrawn now within 10 years after death. So, IRAs are great to give to charity.
Like I said, you could leave it to them if you want to, if you're charitably inclined in death. But during life you can make some of your lifetime gifts with this great provision, a qualified charitable distribution. Now, the only downside is to me is that it's not available to enough people. It's only available to IRA owners and IRA beneficiaries who are at least 70 and a half years old, and you must actually be 70 and a half. For example, if you'll turn 70 and a half tomorrow, you don't qualify today, and it's 70 and a half, because I know somebody's thinking this and they'll say, "Wait a minute, I thought the RMD age is 72. Yes, the Secure Act raised the RMD age to 72, but they left the QCD age at 70 and a half.
So, you can actually take advantage of it even before RMDs begin. That's a great way to bring down your IRA balance and do the charitable gifting you wanted to do anyway and get that money out of your IRA at zero tax costs. Now you don't get an itemized deduction, but you get something much better, an exclusion from income, because that lowers adjusted gross income, AGI, a key item on any tax return because it determines the availability of many tax deductions, benefits, and credits, even taxation and Social Security, those Medicare IRMAA charges, all of that. So, anytime you can reduce what we call as accountants above the line, deductions, reduce AGI, this is an exclusion from income. So, it's a great provision if you qualify. It's not available from 401(k)s or company plans, only from IRAs.
Benz: That's great to know. So, getting back to this idea of deductible charitable contributions, if people are in a position to take a deduction on a charitable contribution and they are going to be itemizing their deductions, what kinds of documentations do they need to have?
Slott: Well, that's a big area. Let's just talk about bigger gifts. Say $250,000 or more. There's been several cases, this comes up all the time and there was a huge case, you may have seen the big story in The Wall Street Journal. Some family lost a $400,000 tax deduction because they didn't have a piece of paper that's technically known as a CWA, contemporaneous written acknowledgement. Translation: That's that letter you get every year when you give to charity that tells you how much you gave, the fair market value, and if you received anything back in return. You have to have that letter. And I couldn't believe it in this case, and I'm talking about with some artwork, very expensive, like $400,000 deductions, you would think they had attorneys working on it, the charity. And they never issued the letter and the whole deduction, even though they truly gave the gift, was knocked out.
So, you have to have the documentation by the time you file your return, and it's simply that letter. Years ago I was doing a tax return. In tax season ,I got a letter from, I think it was like a Girl Scout troupe or something. They asked me for some gifts or something and I forgot all about it. And I got this little handwritten letter from these girls, even they knew about the CWA, "No goods or services were given in return. Thank you for your gift." I kept the letter. And matter of fact, I ran into the person who was the head of that group just a few weeks ago because I talked about the story, and she said, "I'm the one who did that, who told them to write that letter." So, you need that letter, whatever the amount is to make sure that you're giving a net deduction.
For example, let's say you gave $1,000 but $150 of that, they said, "Well, we gave you that back at tickets to a show or a dinner or something." So, the net deduction is only $850. But you need that same documentation, believe it or not, for a QCD, even though that's not an itemized deduction. The difference is in an itemized deduction, if it's a large enough gift and you have enough to itemize, you would get the net deduction. With a QCD, you would lose the whole thing because for a QCD you can't get anything back. The gift under the tax law for a QCD, if it was taken as an itemized deduction, it would've had to be entirely tax deductible, with no quid pro quo or benefit back. Other than religious, intangible, or notable honoree type benefits, you're not allowed to get anything back. So be careful of that. If you're using the QCD, you'll need that letter and it must show that there was nothing received in return. And also QCDs do have limitations. You're limited to $100,000 a year per person, not per IRA, per person. But that should be enough to do some serious gifting and bringing down your IRA balance in chunks at 0% tax cost, if you qualify.
Benz: Ed, you referenced earlier the fact that more taxpayers are taking the standard deduction, they're not itemizing. And we've been hearing more about this strategy of what's called bunching deductions together, in an effort to get over that hurdle of the standard deduction and have more itemizations, can you talk about that and how that might fit within the context of charitable giving?
Slott: Right. So, you would take deductions, you would make your charitable gifts say all in one year. Say we're now in 2022 and maybe you didn't make gifts in '21 or '20, or maybe you were going to make gifts in '23 or '24, but now let's do it all in one shot. As long as you're giving anyway and you're comfortable with that, make all the gifts now to kind of bunch them, that's why we call them bunching, into one year, so it pushes you up over the standard deduction amount and allows you to itemize. Once you've opened that door and you're allowed to itemize, other things may become deductible even though the taxes are limited, say to $10,000, but maybe medical expenses, they can do the same thing with the bunching of medical expenses. So, once you've opened that door, you can kind of pile on and get some benefit.
But if you're also doing the QCD that I talked about earlier, the transfers from your IRA to charity, that's still better done from the IRA to the charity as a QCD because again, that's an exclusion from income better than an itemized deduction, you can do both. What you can't do is take an itemized deduction, even if you're over the threshold to allow itemizing, for the amount you claimed as a QCD, you can't double-dip like that. But yes, the bunching strategy, which lots of people are doing because so many are not getting the standard deduction, or are getting the standard deduction and are not able to itemize. At least every two or three years, maybe you can itemize by bunching, not only charitable items but other expenses like medical bills.
Benz: My last question, Ed, relates to timing and investment portfolios. I think investors had been feeling very charitably inclined kind of going through 2021 as balances were elevated. This year has been not such a great year for many investors. So, I guess the question is, do charitable contributions tend to be more advantageous for the giver as well as for the charity itself when the market is up and when balances are elevated?
Slott: Well, I think so. I don't really have statistics. I can only tell you from my own experience with clients. I found that the gifts they gave to the charities, and this is back in the years when everybody itemized, so I saw all the deductions. They tend to give to the causes they believe in, whether the market's up or down, in general. Maybe if the market's down, they might not give extra, but the core gifting they do, it doesn't seem to change with the market because they believe in these causes, and a lot of them would make the gifts even if they didn't get a deduction.
Benz: Ed, always great to get your insights. Thank you so much for being here.
Slott: Thanks, Christine.
Benz: Thanks for watching. I’m Christine Benz for Morningstar.
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