.Should You Maximize Your Charitable Donation This Year?

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Should You Maximize Your Charitable Donation This Year?

Should you take advantage of the CARES Act’s 100% deduction against your AGI for a cash charitable contribution? Maybe not.

Published by Motley Fool Wealth ManagementWed, Nov 17, 2021

read time 5 min read

The CARES Act allows individuals to take up to a 100% deduction against their adjusted gross income (AGI) for a cash charitable contribution just for 2021. In other words, individuals could theoretically use philanthropic gifts to wipe out their tax liability this year. Sounds like an opportunity that you might want to jump on…right? Not so fast.

Tax planning is based on two broad principles.

There are two sides to the tax equation—income and deductions.

  1. Getting a tax bargain on the income. Recognize income as efficiently as possible by doing so at the lowest rate possible.
  2. Getting “bang for your buck” through deductions. Recognize deductions at the highest rate possible. That’s the reason charitable giving generally increases in high-income years.

Giving a cash contribution to match 100% of AGI may not always make sense.

The CARES Act provision caught the eye of many taxpayers. But is it worth it from a financial perspective? Maybe not. The reason may lie in the benefit received for every dollar contributed.

For example, federal plus state tax rates can be upwards of 50% at the highest tax bracket in 2021. That means every dollar contributed to a charity would have a $0.50 tax benefit. Some may consider that a great deal.

Conversely, the effective tax rate at the lowest bracket is roughly 10% (depending on state taxes). Thus, when cash contributions reduce AGI to fall within the lowest tax bracket, taxpayers receive far less for their donation compared to higher tax brackets. In other words, instead of receiving $0.50 for every dollar contributed, now they’re only getting a $ 0.10 tax benefit.

Let’s walk through an example.

Sam and Veronica expect to earn a combined $350,000 in 2021. They wish to contribute 100% of their income in 2021 to charity, so they don’t have to pay taxes this year. But since they are increasing their donation this year, they do not expect to make any charitable contributions next year, in 2022.

Their Wealth Advisor analyzed two potential scenarios: 100% charitable contribution this year versus splitting their contribution over two years.

email-chart-charitableThis example illustrates the importance of timing. By employing an all-in approach (Scenario 1) where the charitable contribution was made in a single year, Sam and Veronica—despite paying zero taxes in year 1—paid a higher effective tax rate over two years compared to Scenario 2. As a result, they did not maximize their potential deduction value.

Alternatively, by splitting their gift over two years (Scenario 2), they could take full advantage of their benefit and realize an effective tax rate that was less than half of the all-in approach of Scenario 1.

In the end, Sam and Veronica elected Scenario 2. It was a win-win for the charity (which still received an aggregate $350,000) and the couple, as they maximized their charitable benefit by lowering their overall taxes over a two-year period.

Consider the whole picture.

This CARES Act provision encourages donors to give generous gifts this year—an admirable push to help the disadvantaged and reward givers. But the incentive can be short-sighted.

Instead of falling for an attention-grabbing headline, look at the whole picture. For some, that may mean that consolidating philanthropy in one year may not be the best option. Instead, it may make sense to spread it over several years.

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