Updates on 2021 Year End Tax Planning Using Charitable Contributions

November 2023: This information has been updated based on new information. Read our most recent charitable giving yead-end tax planning insights. 

2021 Tax Savings Opportunities for Executives and Entrepreneurs

In our summer article on charitable contribution tax planning, we highlighted several tax savings opportunities for executives and entrepreneurs. As the year draws to a close, we provide an update on how to leverage charitable giving in order to reduce your taxable income for 2021. For many individual taxpayers, the use of charitable contribution planning may be one of the few discretionary planning methods left to help reduce their tax liability.

Charitable Contributions: Bunching into One Tax Year

Beginning with tax year 2018, the Tax Cuts and Jobs Act (TCJA) roughly doubled the standard deduction for all taxpayers (for joint filers in 2021 the deduction is $25,100). This change, coupled with the $10,000 deduction limit for state and local taxes, means many more taxpayers will find they are no longer itemizing, but rather claiming the standard deduction. It is estimated that for 2021 only 15% of taxpayers will itemize, whereas before TCJA the percentage of itemizers was about 31%.

With the increase in the standard deduction, one strategy to maximize the tax benefits from charitable giving is to pay two, three or even several years’ worth of contributions in one tax year, so that your itemized deductions in that tax year exceed the amount of the standard deduction. In the years that follow, you would not make any charitable contributions but again claim the standard deduction.

Tax Savings with a Donor Advised Fund

Many taxpayers may not be comfortable with the above bunching strategy because they do not like the idea of paying more than one year’s worth of contributions to charity at one time. In addition, taxpayers’ philanthropic interests often change from year to year.

If this is the case, to accomplish the bunching strategy, taxpayers should consider setting up and contributing to a donor advised fund (DAF). A DAF is a fund sponsored by a public charity that allows donors to make one (often sizable) contribution to the DAF, receive a current year tax deduction for the contribution, and then recommend grants from the DAF to their favorite charities over time, often over many years.

DAFs are an especially efficient tax planning vehicle when there is a year in which you have unexpectedly high earnings and even more so when that income is considered ordinary and taxed in the highest tax brackets.

There is a stacking rule built into our current tax code which means that itemized deductions first shelter ordinary income items such as interest income and wages, and then second they offset qualified dividends and long term capital gains. With proper planning, a taxpayer could potentially offset all ordinary income items and just pay tax on their qualified dividends and long term capital gains at the current 0%, 15% and 20% federal tax rates.

Give Appreciated Long Term Securities

Whether or not you give directly to the charity or to a DAF, keep in mind one of the most tax efficient methods for making a charitable contribution is to make the contribution using long term appreciated securities. Stock market values are at all-time highs, and as a result, 2021 could be great year to make contributions using appreciated securities.

If the security has been held for more than 12 months, a taxpayer that makes a charitable contribution using appreciated securities receives a tax deduction for the FULL fair market value of the security and does not have to pay income tax on the built in appreciation contained in the security. Keep in mind the deduction for contributions of appreciated securities is limited to 30% of adjusted gross income (AGI), while contributions of cash have higher AGI limits. For donations of appreciated securities made to a private foundation, the donation is limited to 20% of your AGI. If your donation exceeds the AGI limits, the excess charitable deduction can be carried forward for up to 5 years.

COVID Relief Legislation Increases Contribution Deduction Limits

The CARES ACT was passed by Congress in March 2020 to combat the negative economic impact of the Coronavirus. This bill contained several taxpayer friendly changes to the tax code, with two in particular designed to encourage taxpayers to make charitable contributions in 2020.

COVID relief legislation passed in December 2020 extended these charitable contribution provisions for 2021.

First, and for 2021 only, the AGI limit for CASH contributions was increased to 100% of AGI from 60%. This new limit applies only to cash contributions and not to contributions of appreciated securities. In addition, it is important to note that cash contributions to Donor Advised Funds (DAFs) and private foundations do not qualify for the increased limits.

To take advantage of this higher AGI limit, taxpayers should consider not only making their annual charitable contributions in 2021, but also pre-paying future contributions in 2021 so as to use this increased AGI limit to shelter a large part of 2021 taxable income.

Taxpayers who are considering converting their traditional IRA to a ROTH IRA in 2021, could potentially shelter up to 100% of the additional taxable income arising from the conversion.

Second, for taxpayers that plan to claim the standard deduction in 2021, the COVID relief legislation allows an “above the line” deduction of up to $600 for cash contributions made in 2021 by married taxpayers filing jointly. A $300 limit applies to single taxpayers.

Use Your IRA Account to Manage Charitable Contributions

With the increase in the standard deduction amounts discussed earlier, Qualified Charitable Distributions (QCDs) from IRA accounts have become an even more important tool for qualifying individuals to manage their charitable contributions.

A QCD is an otherwise taxable distribution from an IRA owned by an individual that is over the age of 70 ½ that is instead directed to a qualified charity. The amount directed to the charity is not taxable income to the individual. Taxpayers over 70 ½ can make QCDs of up to $100,000 per tax year. QCDs also reduce the amount of the Required Minimum Distribution (RMD) in a given tax year.

For qualifying individuals, making a qualified distribution allows those who are now taking the standard deduction to still reap a direct tax savings by giving to charity. It should be noted that QCDs cannot be used to make contributions to DAFs.

Even though the SECURES Act (enacted as of January 1, 2020) increased the age at which taxpayers must take their RMD from their IRA from age 70 ½ to age 72 (for those taxpayers that had not reached age 70 ½ by December 31, 2019), qualifying taxpayers may still want to make use of QCDs for 2021. Making a QCD in 2021 will have the effect of reducing the IRA account balance as of December 31, 2021, which will in turn reduce the RMD amount required for 2022 and future tax years.

QCDs can also be a source of income to aid in the implementation of the contribution bunching strategy discussed above.

Keep in mind that the $100,000 limit is an annual limit and any unused amount cannot be carried forward to a future year.

Charitable Contributions Tax Considerations: 2021 vs. 2022

Throughout 2021, there has been much discussion about Congress and President Biden’s plans to increase tax rates for those individuals with taxable income over $400,000. Many taxpayers may have considered postponing contributions to 2022 in order to shelter income that could be taxed at a higher rate in 2022.

While this strategy could have some merit, it should be noted that tax rates for taxpayers with income over $400,000 are still fairly high, with the top bracket reaching 37%. As a result, taking into account the time value of money, it might still make sense to go ahead and make the contributions in 2021. This is especially the case if the amount and type (ordinary vs qualified rates) of taxable income for 2021 is expected to be higher than 2022.

Each person’s tax situation is unique. We can help you narrow down the specific actions that you can take to fit your needs for successful tax planning this year. Contact your Keiter Opportunity Advisor or Email | Call: 804.747.0000 for advice on charitable deduction tax planning opportunities.