How Do Charitable Tax Deductions Work?

Written by: David Elder, Wealth Manager & Partner

It is a question that millions of giving Americans ask around tax season. Fortunately, donating to charities and getting a tax write-off for it is not as complicated as it seems. That said, there are a few important rules you should know before filling out your taxes.

How Do Charitable Tax Deductions Work?

Essentially, giving to charity often allows you to reduce your taxable income. However, this does not mean that charitable donations will automatically save you a lot of money when tax season rolls around. How much you can write off will depend on how you choose to fill out your returns.

There are two basic ways to deduct charitable donations: standard tax deduction or itemization. As of 2022, for tax year 2021, individuals who use standard tax deduction (the vast majority of tax filers) can write off up to $300 per year for cash donations to qualifying charities or up to $600 for couples. This is the simplest method as you are not required to do any extra calculations, but it could end up leaving a lot of money on the table. For example, you and your spouse may donate $2,000 to qualifying charities during a given tax year, but if you use standard deductions, you can only get up to $600 in deducted taxable income.
Alternatively, if you itemize your charitable tax deductions, you could get a dollar-for-dollar deduction on much larger donations. If you choose to donate in cash, you could theoretically donate up to 100% of your taxable income and still have it written off. However, you should keep in mind that the types of charities you choose can affect this percentage as well, as some organizations put limits on the amount of income that can be deducted.

Which Types of Charities & Donations Can Be Deducted?

It is extremely important to remember that not every form of charity is tax-deductible. Generally speaking, you will have to donate to a registered 501c3 organization (sometimes incorrectly called a 401c3) to have it deducted from your taxable income. This is a type of U.S. organization that is exempt from federal income tax. Popular charities like these include the Salvation Army or the American Red Cross. However, there are plenty of smaller 501c3 organizations out there, including the vast majority of public and private universities.

When you are choosing where to donate, you should always make a choice based on the cause(s) you want to support. However, if you want to donate and save some money on your taxes, you should make sure that you donate to a 501c3 or similar organization that qualifies for charitable tax deductions. Many people think they are donating to a qualifying charity simply because it is a good cause. For example, many tax filers try to deduct contributions to GoFundMe campaigns, but unless the recipient is a 501c3, this kind of contribution will not be tax-deductible.

Maximizing Your Charitable Tax Deduction With Merit

Charitable giving is not a tax mitigation strategy. Ultimately, you need to have the desire to give to a cause or organization. Using charities to offset tax obligations doesn’t really save you money; it simply gives you more power to choose where your money goes.

But if you do want to give, you can maximize your tax benefit and help the cause of your choice at the same time. At Merit, we generally recommend itemizing your tax deductions, as this will allow you to deduct much more than standard deductions. However, if you are over the age of 72 and have an IRA, you also have the option to do a Qualified Charitable Donation (QCD). You can use a QCD whether you itemize or not, allowing you to get charitable tax deductions while also working toward satisfying your minimum required distributions.

There are also some more specific planned giving strategies that you can implement to help maximize your charitable tax deductions, including:

  • University Benefits – In addition to being tax-exempt in most cases, donating to a university can also give you access to additional benefits like free sporting event tickets.
  • State-Specific Rules – Every state has its own rules related to charitable tax deductions. Be sure to research how charitable tax deductions work in your state of residence. For example, in Georgia, you can give money to a private school and still get most of the contributed amount back through a tax credit.
  • Documentation – While saving receipts and letters of contribution may not literally save you money on your taxes, it can help ensure that you record all of your tax deductions. Moreover, having supporting documentation is extremely important if the IRS audits you.
  • Appreciated Assets vs. Cash – If you give appreciated assets to charity rather than cash, you can avoid paying capital gains taxes and still get charitable tax deductions.
  • Donor-Advised Fund – A donor-advised fund allows you to take advantage of charitable tax deductions now while delaying the payment until later. You have up to 10 years to make the donation using this method.
  • Changing Tax Rates – Timing your giving can also be important, as your tax rate now could be far different from your tax rate 10 years from now. So, if you anticipate higher taxes in the future, consider waiting to donate until it could reduce your tax burden the most.
  • Pooled Income Fund – A Pooled Income Fund is a type of trust that invests your contributions and pays out a regular income based on your gains. Once you have passed on, all of the accumulated donations in the fund are contributed to the charities of your choice.

For professional help navigating charitable tax deductions, be sure to contact Merit Financial Advisors today!