Maximizing Impact and Tax Benefits: Charitable Giving for High Earners

May 9, 2024

In this episode, hosts Matt Blocki and Jamison Smith discuss the world of charitable giving for high net worth and high-income earners. The discussion opens with a crucial insight: many individuals miss out on potential tax savings from charitable donations due to incorrect structuring. Matt and Jamison argue that while the intent to help is paramount, optimizing tax benefits can significantly enhance the impact of your generosity.

The conversation digs into complexities of tax deductions, highlighting the difference between standard and itemized deductions and their implications for charitable giving. They clarify the math behind deduction caps and how these can influence your charitable strategy, emphasizing the underutilized power of donor-advised funds (DAFs) and the strategic gifting of appreciated stock to maximize tax advantages.Particularly relevant for Pennsylvania residents, the episode also explores the Educational Improvement Tax Credit (EITC) program, demonstrating how directing state tax liabilities to approved schools can yield significant tax benefits while supporting underserved communities.

The episode concludes with real-life examples, underscoring the importance of strategic beneficiary designations and the potential tax pitfalls of not aligning your estate plan with your charitable intentions. Through a combination of detailed explanations and practical advice, this episode offers listeners a guide to making the most of their charitable contributions while aligning with both financial and philanthropic goals.

Episode Transcript

Welcome to Ewa’s finlit podcast. Ewa is a fee only RAA based out of Pittsburgh, Pennsylvania. We hope all listeners of this podcast will benefit as we deep dive into complex financial topics that we will make simplified for you. And we hope that this really serves as a catalyst so that you can make the best financial planning decisions for your family and also save time. Welcome, everyone, to this week’s Finlit by EWA podcast, joined here by Jameson Smith. We’re talking about charity for high net worth income, high income earners, high net worth clients. One of the perspectives we have is not just tax savings. And believe it or not, a lot of people don’t have any tax savings when they give it a charity because it’s not structured correctly. So that’s going to be one way that we addressed.

 

Obviously, give the charity because you want to help or believe in some kind of impact. That’s going to be after you give the money. But our job as a financial advisor is being stewards of your money is make sure you’re getting the best benefit tax from a tax perspective as well. We’re also going to then give perspective of mistakes. We’ve seen one to be public about your gifts, one to be private about your gifts. This can be huge. And some options give you the ability to be anonymous. Some options do not. Jameson, first, to get into this, let’s talk first about just the lay of the land, about why some people are just not getting any tax benefits from their charitable gifts. So when someone goes and files their taxes, they basically have two options.

 

Can you explain that and then how that piggybacks into charitable giving?

 

Yeah. So 2024, if you’re a married couple filing your taxes jointly, when you get to take some deductions, you either choose the standard deduction or you itemize your deductions. So the standard deductions, the freebie that the IR’s gives you, 2024, that’s $29,200. And so if your itemized deductions, which are comprised of a few things, are greater than that standard deduction, you can take a larger deduction and itemize what makes up the itemized deduction. The first thing is what is people call salt state and local taxes, that’s capped at $10,000. So if you’re making half a million dollars, 3% state tax, if you’re inside, I guess we’ll use Pittsburgh, for example. You’re in city limits, another 3% for local taxes. So 6%, that’s $30,000, is going towards your state and local taxes.

 

So that in that scenario, that with the or, sorry, that’s capped at 10,000. So in this scenario you have 10,000, even though you’re paying 30,000 in state local taxes, you can deduct 10,002nd component’s mortgage interest. So we’ll assume million dollar mortgage, only the first 750,000 is deductible. So if you have a 5% interest on the mortgage, back the napkin math, that’s $50,000 and 37,000.

 

Basically you can deduct $37,500.

 

Yeah, $37,500. So you add those two up, in this scenario you’re at 47,500. That’s greater than the standard deduction of 29,200. Plus any charitable contributions could get stacked on top of that. Yeah.

 

For that example, if you’re maxed out on that stand, if you’re above the standard option, you can get money straight to charity and it’ll all be deductible.

 

Yeah, exactly.

 

Which is great. So now there’s a way to get double benefits, which we’re going to talk about if you gift the right stuff. But for someone like that the standard deduction in the way would not be an issue. So let’s go through another example of, let’s just say someone making, well, we’ll.

 

Just say that 10,000, you’re capped at Stanley at ten. Let’s just say you don’t have a mortgage or something. Maybe you have a. Yeah, let’s say you have no mortgage.

 

So you have $300,000 left in your mortgage and you’re stuck with a low interest rate from like years ago, 3%. So now you’re at, you have 10,000 in state and local taxes, you have 9000 in.

 

Perfect. Yeah.

 

So that’s 19 interest and you’re given 10,000 a year to charity. So how much benefit does someone get in that scenario?

 

Zero, because you’re at 19 from the salt taxes plus the mortgage interest. So if you give ten, your itemized deduction would be $29,000. You’re dollar 200 short of the standard deduction.

 

At that point you’re taking the standard deduction, you’re getting that benefit anyway. So the charity literally gave you zero, literally zero tax benefits.

 

Yeah.

 

So it’s great that you gave the 10,000. Maybe you’re giving that to, you know, an underserved school, maybe that’s a religious affiliation, you know, whatever that is, that’s great. But there’s zero tax benefits for that, because that standard deduction is so high. And that’s where the majority of the population does file standard deductions.

 

Yeah.

 

So.

 

So, yeah. Let’s talk about one easy solution that we help clients with is a donor advise fund. What’s the difference between that and, like a. What’s the other option? Like a foundation creating, like a foundation for. Yeah.

 

The donor advised fund. The nice thing about this is it’s. It’s simple in the fact sometimes the private foundation, like, there’s. There’s gonna be a lot of. And so this would be like, if you’re putting millions of dollars in specifically for charity, there are some. Some cool benefits, but a lot of times, yet, there’s like, minimum distributions have to occur. There’s a lot of rules, regulations, filings, etcetera. So don’t revise fund. You can literally. It’s like a 529 account. You can open it up right on, like, fidelity or schwab. And it’s just an account. And the nice thing about this account is you can front load it. So let’s just go through example. And you can also use stock. So I’m just going to use a really simple example. Let’s say someone’s in the top tax bracket of 37% federal taxes.

 

So let’s just say that someone is in that scenario that you just described. So they’re giving 10,000 a year away into charity over ten years. So they just gave $100,000 to charity over ten years, and they got zero tax benefits for it. If we utilize a donor advise fund the right way to this client, I would say, you know what? Let’s. Let’s put $100,000 upfront. But you have this $10,000 Apple stock. You put $10,000 in Apple stock from 15 years ago. That’s now worth 100,000. So what we do is we gift $100,000 of Apple stock into the donor advised fund. That $90,000 gain that normally they would have paid federal taxes of 23.8, plus state taxes of 3.07, so that they have a 26.87% capital gain. They’re avoiding a 90,000. So we just avoided.

 

If they sold this apple stock by themselves, they would have paid a 24,183 tax on top of that. In that example you gave, the first 10,000 we put in isn’t going to be deductible because they’re just utilizing the standard deduction. But anything above that another 90,000 is full right off of. Off of the 37% tax rate. So that’s another 33,300 we saved. So, all in all, if. Let’s just say you were giving 10,000 a year to your church, in that example, under the standard deduction, after ten years, you got zero tax benefit. If I put $100,000 upfront into a donor advice fund from an appreciated stock, I would avoid 24,183 and capital gain taxes, I’d save an additional 33,300 in federal taxes. I would have saved 57,000, almost 57,500. Just rounding up a couple. A couple hundred bucks.

 

So 57 and a half percent of my. The money I put in is I get right back in taxes. So, you know, more than half of what I put in, I got right back in taxes because of that strategy. And then, by the way, once the $100,000 is in that donor advice fund, my charity doesn’t notice a difference. Cause that donor advice fund, once it’s in there, it grows tax free and distributes tax free. It just has to be used for charity. So I’m still utilizing the 10,000 a year. So the charitable organization I’m giving to, if they’re used to my 10,000 and kind of relying on that for cash flow purposes, they’re still getting their ten. But instead of getting zero benefit for me, I just saved, you know, $57,500 in taxes. Yeah, but, yeah, go ahead.

 

I would say, yeah, this donating. So there’s basically two. You can donate stock or you can donate cash. One of the benefits of the stock. Some charities can’t receive stock, so you would have to sell the stock and then donate it. You’re missing the tax benefit.

 

Yeah.

 

Nice thing is donor advised fund. It goes in, and then the charity is getting a cash distribution.

 

And you can name as many charities as you want on the donor advice fund. You can switch what charity is on the donor advice fund. The lots of flexibility. So let’s get nerdy for a second. Jameson, what are the, like, how much could someone put into a donor advise fund?

 

So if you’re doing cash, 60% of your adjusted gross income. And if you’re donating appreciated stock, 30% of your adjusted gross income.

 

So if I’m making half a million. So, hypothetically, clients making half a million dollars a year, they could put 60% all at once, $300,000 of cash. But we would tell them, you should put stock, if you have an appreciated stock, not in an IRA, an appreciated stock in a brokerage account. That’s the only way this works. So we would say you could put up to 150 and throw it in there. Or we could do a Roth conversion of 100,000, bump your income up to 600. Now we can do 30% of 600. So we can do 180 in the donor advise fund and eliminate the tax on that Roth conversion and save all the capital gains and whatever stock that we’re gifting over.

 

Yeah, it’s a really good way, too. Like, if you are doing something like a Roth conversion or anything, you’re going to have a taxable event intentionally in a year. You can offset it with the donor advice fund contribution.

 

Awesome. Okay, so that is one amazing strategy. I would say that’s the most common strategy. That’s why we. We obviously mentioned it first. For retirees, there’s a very common strategy called a QCD. What does a QCD stand for and how does this work?

 

Qualified charitable distribution. So when you have to start taking requirement distributions from an IRA, anything that’s pre tax, 73 and a half, depending on what age you are. But it just got bumped back to 75. If you’re young enough. Anyway, between 73 and a half and 75, you’ll have to start taking distributions from a pre tax IRA. And so if you have a million bucks, it’s a calculation based on life expectancy, like a mortality table, but surround numbers. It’s approximately 5%. As you get older, it gets higher. But let’s just say you have a million dollar IRA, 5% of that. IRS says, you know, you have to start taking $50,000 a year out because none of that money has been taxed before. With a QCD, you could take.

 

You still have to take that money out, but you could just send it right to a charity and then you avoid showing income that year of that. So you basically just avoid the taxes.

 

Absolutely. So one of the nice things about the QCD as well is that it doesn’t show up as. As income. So, for example, if you’re right on the cuff of like, a Medicare limit. So I’m just pulling these up right now. So if you’re married filing jointly, that’s last year’s. There we go. Yes. If you’re married filing jointly, let’s just say hypothetically, your income is above 306. You’re in the one, two, three fourth Medicare tier. So you’re paying $428 in Medicare cost per month per spouse versus, let’s say your RMD, like you said, is 100,000. Well, not like you said. Each spouse has a 50,000. Well, we could do 100,000 as a QCD. That wouldn’t show up as income. And so now instead of the income being, you know, over 306, we get it down to 206.

 

And now we’re in the 230 a month. So now we’re saving over $200 a month. We’re saving $5,000 a year in Medicare cost. We’ve also lowered our marginal tax bracket as well. So a QCD can really be efficient. If you’re planning on giving some money to charity, if you want to front load that it can be a really efficient way to navigate tax rates and Medicare rates and retirement.

 

Yeah, no question. Then we’ll get into actual case example. But you wanna talk through. We don’t really do a lot of this, but a charitable remainder annuity trust, the difference between that and a donor advice fund. So I’ve gotten a lot of questions.

 

Yeah, go ahead.

 

A lot of times fund, give a.

 

High level on it. I mean, this is also one, I would say that the donor advised fund and the QCD are super safe, easy IR’s is going to bless them right off the bat, because once it’s done, it’s like done with these kind of trusts, like crafts, crutz, etcetera. They are highly scrutinized by the IR’s. So our advice is only do them if your intention is first and foremost charity. Now there are some flexibility where you can keep some money here, keep some family wealth here, but you’re mixing the charity with it. So generally speaking, the IR’s is going to test and say, was this for the purpose that the IR’s created? The rules of why you could do this?

 

Did this person do it for this reason or did they do this because they’re trying to avoid taxes that they should be paying. So I’d recommend, make sure that whatever charity you’re doing, it’s got to be for the reason of charity first, and then save as much tax as you can given the tax law. But we can’t skirt that because there can be some gray areas. So with that being said, let’s talk. Let’s talk through that. Give us a high level.

 

Yeah, similar to a donor advise fund. You put the money into this trust, but you have to take distributions each year. So I believe it’s around like 5%. So you put a million dollars in it, you basically create an income stream. It’s annuity. So you’re getting $50,000 a year back out of it, but then the balance at the end goes to charity. So it’s similar to donor advise fund. It’s just, you can get some of the money back out of it. But like you said, it’s scrutinized by IR’s. It’s a lot more complicated. There’s attorney fees involved, there’s filing, reporting every year. Basically, the IR’s has to test it each year to make sure that you’re not taking too much money out, that there’s going to be enough money at the end left for the charity.

 

This is a much more complex way. There are certain situations where it could make sense. I’ve analyzed a couple times with, like, putting real estate in a crat when there’s gonna be income coming from the real estate. That could make sense. But it’s a. Yeah, not as common as a donor advice, so not as simple.

 

I’m gonna make a general statement and say, usually the crat would make sense. If you’re above the estate tax limits, which right now, or, you know, for married filing jointly, it’s like 14. It’s like 14 each, right? Almost 14 to 28. Yeah, yeah, I’m just rounding up. So if you’re. If your net worth’s above 28, crat. Great. Awesome. It’s a way to be flexible. If you’re under that, probably not the best tool. We’d want to stick to more traditional ways. And then, by the way, those limits get cut in half in January 2026. So then if your net worth above 14, that could be a strategy to look at. But generally speaking, that’s for the super high net worth, eight figure plus crowd. Okay, well, before we talk through the case example, I wanted to also talk about one specific to Pennsylvania.

 

It’s called the EITC. So essentially, if you have a under school score, underserved school k through twelve, and they get approved through the state to receive this kind of funding, you can direct your state tax liability of Pennsylvania to this school and then get 90% of that back. So, for example, let’s just say someone’s making. Keep the math really simple. So, 310,000. So your state tax liability for making 310,000 as family is going to be about ten grand flat to Pennsylvania state. So if you were to redirect that $10,000 to an underserved school that’s approved for the EITC and make a two year commitment, which is the 90%, then your state taxes would drop by 9000. So in this example, let’s say option one, you just want to pay your state tax, you pay 10,000. Let’s say option b, I want to.

 

This is a school I’m very passionate about it. Cost me just a little bit more because I pay 10,000 to the underserved school and then I owe, I get 90% of that back against my state tax. Instead of owning ten, I owe one. So now I pay the state 1000, so it cost me eleven. So you pay the state ten. I paid a school ten and paid the state one, so it cost me eleven. But what greater way? It’s a 90% on the dollar way. If I’m passionate about a school that, you know, the mission or helping an underserved community, what a better way to do that and get a humongous tax benefit? I mean, 90% is absurd. The donor advised fund, we can get close to 60, maybe 70%, depending on how low of a basis you have in a stock.

 

But the EITC allows us to get that full 90% against the state tax, which is really cool. So that’s a specific to Pennsylvania rule. There may be some other states that do it, but just wanted to speak about that for our Pennsylvania clients. And we know a lot of the schools that are eligible for that in the greater Pittsburgh area. So if you’re interested in that, some schools have set up, like joineder agreements, they have llcs already. Some schools are eligible. You maybe you need to set up your own llc to be able to do it. But we’ve helped countless clients through this process. If you’re interested in that, please reach out to us and we’re happy to help. So. Okay, well, let’s talk, for example, of estate planning.

 

So a lot of times, like, we’ll meet someone, maybe their spouse has already passed or they’re single, and then they were like, well, you know what? I want to give maybe two thirds of my money to my siblings. I’ve got a brother and sister, and I want to give the other third to charity. And so then they’ll write in a will, like, I want two thirds of my money going to my siblings and one third of my money going to charity. And then they’ll put the beneficiary as, like, the trust created of the will of whoever’s name that is. This is a huge mistake that could cost millions of dollars. And the reason for that is a charity, upon death can receive literally anything tax free.

 

So, for example, if I have a million dollar IRA and a million dollar Roth Ira, and my beneficiary was 50% a person and 50% a charity, and it would just all got split up. Well, first of all, if I give the million dollars of Roth to the charity, and then a million dollars in IRA to the person. That person was in the highest tax, they would pay $370,000 a federal taxes. They take that money out in the ten years window, plus they would pay an inheritance tax. Pennsylvania, that’s 4.5% if it’s a, you know, a child, that could be, you know, much higher if it’s not a child. So they’re gonna pay, you know, up to some cases over 50% in taxes. However, if I were to redirect the Roth to that person, they would at least avoid the federal tax of 37%.

 

And guess what? The charity, if they get a million dollars in a traditional IRA, or a million dollars in a Roth IRA, they get to keep all million dollars. There’s no taxes to them from an inheritance level, from a federal tax level, from a state tax level. All that money goes to them tax free if they’re a 501 c three. So it’s really important to align direct beneficiaries on, hey, I want the charity to receive the stuff that’s going to present a tax problem, which would be, you know, low basis stock. If you’re. If you don’t have a child, the child would obviously get a step up in basis, or a spouse, that wouldn’t matter. But like for a charity, a low basis stock, perfect. A traditional IRA or pre tax 401k, perfect. Any individual, you’re much better.

 

Passing a Roth IRA, tax free life insurance proceeds, tax free life insurance actually avoids estate taxes as well. In Pennsylvania, Roth Ira does not. But at least you avoid the high federal taxes. So, extra attention to your beneficiary arrangements or how what accounts are directed where can literally save millions of dollars upon your passing, and more money gets put into your loved ones hands. And obviously the charity is going to keep whatever they get, no matter what.

 

Yeah, I have actually a specific example. I did this for a client that I can. I can talk through, but round numbers, it was like a million dollars of assets, and it was exactly what you said. A third to single person to. So it was a third to daughter and one kid, a third to niece, and then a third to charity. And so it was essentially split evenly between Roth Ira, traditional IRA, and taxable investment account. And there was a variable annuity as well that had a pretty big gain. And we didn’t want to start taking any money out of the variable annuity because we would have bumped his income up in retirement. He would have get hit with Medicare charges. So what we did was exactly what you just said. The Roth Ira.

 

His niece was in a higher, is a much higher tax bracket than his daughter. So the Roth Ira we just put outright to the niece. So she received that tax free. The traditional IRA and the variable annuity. We opened a donor advice funded fidelity, put the donor advice fund as the beneficiary to each of those. So now what we did, we’re going to let the variable annuity ride. He’s never going touch it. He’s never going to pay any taxes on it in his death. Traditional IRA, variable annuity, going to the donor advise fund. No taxes are paid that goes to charity tax free. And then we intentionally did the taxable investment account that has a gain outright to his daughter because she’ll get the step up in basis.

 

Then we have trust in place to protect that for when she can take it and things like that.

 

But that’s so important to set it to be proactive where you’re living. Because if you just waited till, didn’t set up the donor advise fund again, the charity’s gonna get the money tax free. If you know that’s your intention, do that while you’re living. Cause you’re gonna save a ton of taxes while you’re living still. The charity’s gonna get the money tax free. But then you can set up your other loved ones or yourself hyper efficient if you know for sure that you want a percentage of stuff going to charity.

 

Yeah. And the attorney had, he already had this set up to do a third, a third. And the attorney had given. It’s not bad advice. It’s just not as like detailed as it could be. Yeah.

 

Just would have cost him a couple hundred thousand, but. Okay, perfect. Well, that’s a high level. And then just to close out, want to discuss, you know, things like a donor advice fund. You can put your name on it if you’re part of a religious affiliation, which is like tithe 10%. And there’s like accountability in your church, for example. Obviously want to keep your name on it. But there’s other views of that we’ve seen where it’s like, no, a true gift should be private, anonymous from the heart. Not to get into that too philosophically, but I will say this. Our super high net worth clients that have gifted a lot publicly, they’ve given the feedback where they just. They kind of feel like a paycheck year by year. Because then once they. Maybe they intend to do it one.

 

One time, they get pounded with solicitations and calls, etcetera. Really, for the rest of their retirement. I’m thinking one example, for example, and so one spouse, the wife, she’s like, if there was a way we could give anonymously, that would be a dream come true. That’s what a donor advice fund does, give you the flexibility where you can make your, you put the money in, it’s your donor advise fund. You control it, how it’s invested, et cetera. But what you distribute, you may not want to distribute it all and just pass it to a charity when you die, it has to go to a charity once it’s in there. But you can make those gifts anonymous, which is really cool.

 

And you can title. You have to give the donor advice on a name. A lot of times, if it was yours, it’d say the blocky family charitable fund or something. But you could name it something that has nothing to do with.

 

Could name it the T Rex charity fund.

 

Yeah. And while they might be able to figure that out.

 

True.

 

Yeah. You could do anything. And then when they’re getting that distribution, they have no clue where it’s coming from.

 

Good point. Good point. Well, thanks for joining and everybody. Look forward to catching you next week. Thanks for tuning in to our podcast. Hopefully you found this helpful. Really hope this is as beneficial and impactful to as many people across the nation as possible. So hit the follow button, make sure to rate the podcast, and please share with any friends or family members that would also find this beneficial. Thank you very much.

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