There is still time to potentially reduce your 2020 federal income taxes, but you'll need to act soon. There are several tax minimization strategies for individuals including timing your income and deductions, making the most of your retirement and health savings accounts, being smart about charitable donations, keeping taxes to a minimum on the investments in your taxable accounts, and minimizing taxes on your estate and inherited retirement accounts. Many of these strategies need to be completed by the end of the year to be effective, and not all of the strategies may be appropriate for you. Let’s review how to be smart about your donations.
Claim and Above-the-Line Deduction for Cash Contributions up to $300
Normally, only those taxpayers who itemize deductions on their tax returns can deduct the contributions they make to charity during the year. For 2020, however, Washington created an above-the-line deduction for cash contributions, making it possible for those people who do not itemize deductions to deduct up to $300 of the cash contributions they make in 2020.
This means that if you claim the standard deduction instead of itemizing deductions, you can still receive a reduction in your taxable income for up to $300 of the cash you donate to charity during 2020. This new tax provision was created in response to the COVID-19 pandemic to encourage taxpayers to support their favorite charities during this difficult period. It is in effect only through 2020.
The AGI Limit on Cash Contributions is Suspended for 2020
Washington also tweaked the tax rules this year to incentivize taxpayers who itemize deductions to give more to charity in 2020.
If you itemize deductions, the amount you can deduct per year for cash contributions to charity is normally limited to 60% of your AGI. For 2020, however, the AGI limit for cash contributions made in 2020 is suspended, enabling very generous individuals to deduct more of their 2020 cash contributions this year.
This new provision and the above-the-line deduction described earlier do not apply to contributions to donor-advised funds and supporting organizations.
Time Your Charitable Contributions
Tis the season to give, but before you pull out your checkbook, consider whether it is more advantageous to give this year or next.
If you expect to be in a higher tax bracket next year, you may want to wait until 2021 to contribute. Why’s that? Because the higher your tax bracket, the greater your potential tax savings from a charitable deduction. For example, let’s say you are in the 24% tax bracket this year and expect to be in the 35% tax bracket next year. A $10,000 charitable contribution this year would reduce your federal taxes by about $2,400. But if you make the contribution next year, the tax reduction would be about $3,500.
This tip only applies if you itemize deductions. If you claim the standard deduction, consider making your cash contributions this year because the above-the-line charitable deduction is set to expire at the end of 2020.
Consider Bunching Your Charitable Contributions if it Allows you to Itemize Deductions
Bunching the charitable contributions you normally make over two or more years into one year may benefit you taxwise if it boosts your itemized deduction amount over your standard deduction amount.
To illustrate this point, let’s say a married couple who files jointly typically donates $10,000 to charity every year, but their only other deductible expense is $10,000 for the state and local taxes they pay. In this scenario, the couple is better off claiming the $24,800 standard deduction rather than itemizing deductions and claiming their $20,000 worth of deductible expenses. But what if the couple doubles up on their charitable contributions this year and skips making contributions next year? If they do that, they can itemize deductions this year and deduct $30,000 ($20,000 for charitable contributions + $10,000 for state and local taxes). Then next year, when they are not making charitable contributions, the couple simply claims the standard deduction.
If you want to bunch your charitable contributions this year, but prefer to spread out your gifts to charity over time, consider using a donor-advised fund. The organizations that sponsor donor-advised funds are charities themselves, so contributions you make to your donor-advised fund account this year are tax deductible this year, even if you do not recommend grants to specific charities until later years.
Consider Donating from Your Traditional IRA if you are Over Age 70½
Even though required minimum distributions (RMDs) are suspended for 2020, a taxpayer who is age 70 ½ or older can still transfer up to $100,000 from his or her traditional IRA directly to a charity this year and avoid paying income tax on all or part of the distribution.
Normally, a qualified charitable contribution from a traditional IRA counts toward your RMD for the year. For example, if your IRA’s RMD for the year is $10,000 and you make an $8,000 qualified charitable distribution, you would generally only have to withdraw $2,000 to meet your RMD requirement for the year.
But even in this year when RMDs are suspended, there are still benefits to be gained by making a charitable distribution from a traditional IRA. First, a qualified charitable distribution allows you to make a charitable contribution with pre-tax dollars. Second, it reduces your IRA balance—the amount on which next year’s RMD is calculated. In other words, reducing your traditional IRA balance this year may help reduce your RMDs in future years.
Before making a charitable distribution, be sure to consider the impact that any deductible IRA contributions you make after 70 ½ may have on it. Beginning in 2020, deductible IRA contributions made after 70 ½ reduce the amount of a charitable distribution that can be excluded from income. This new rule was put in place by the recent SECURE Act, which also removed the age limit (formerly 70 ½) on contributing to a traditional IRA.
Please consult one of our financial professionals for more information and advice on maximizing your tax benefits before making significant contributions to charity.