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Are you trying to learn how to deliver massive tax value to your clients? Then look no further. Retirement Tax Services Podcast, Financial Professional’s Edition is a show hosted by Steven Jarvis, CPA. Steven aims to bridge the gap between tax professionals, financial advisors and their mutual clients in their quest for reducing tax expenses in retirement.
As a matter of fact, the short answer is, “Yes, we’d be happy to.”
However, don’t waste the time if they aren’t. These accounts aren’t worthwhile for clients in that case.
DAF Donors can take multiple years of charitable giving and get the tax benefit all at once. Meanwhile, they retain control of how and when that money is distributed.
Many donors aren’t getting as much of a tax break as they believe. In fact, only amounts above the standard deduction count as genuine benefits.
For example, let’s say that charitable contributions are your only itemized deductions: If you give $26,000 to charity in 2021, you’re not getting $26,000’s worth of tax benefit.
Only the portion given above the standard deduction counts. As a matter of fact, you have to multiply that by your marginal rate to determine the actual savings.
If a taxpayer who is married filing jointly has a marginal tax rate of 24%, the tax benefit from donating $26,000 only comes out to $216.
We’re not out to discourage charitable giving! At the same time, pull back the curtain. Add value by explaining these details.
Review the client’s spending before you recommend a DAF. Where does it line up against the standard deduction?
Taxpayers who consistently give while falling below the standard total itemized deductions are ideal candidates.
Contributions to donor-advised funds are included in itemized deductions. Consequently, the same limitations and phaseouts apply. In other words, this isn’t an endless benefit.
Look at the amounts and timing of these contributions when you do an overall tax planning analysis. Try to offset income during the client’s higher tax rate years.
Additionally, make sure that the amounts are meaningful. Review how far beyond the standard deduction each contribution could push the client.
Likewise, note how much income needs to be offset within the current year. These factors are like moving parts. They have to be considered in combination with each other.
The IRS doesn’t allow donor-advised funds in order to be nice. As a matter of fact, the reason why they support them is that they’re irrevocable.
Once funds are contributed, they have to be used for charity. However, they can still be invested. Better yet, any growth is tax-free.
As the name implies, all distributions are made under the advisement of the donor. These contributions are irrevocable. Regardless, the client retains extensive control over them.
Review clients’ tax returns every year. Use this to learn who’s charitably-inclined. Additionally, there’s a level of value you cannot provide to clients without them.
Study the logistics of contributing to a donor-advised fund with the custodian. Likewise, learn what using them entails. Expect them when you deal with larger custodians. Set clear expectations for your clients, too.
Hello everyone! And welcome to the next episode of the Retirement Tax Services Podcast: Financial Professionals Edition. I am your host, Steven Jarvis, CPA. In this show, I teach financial advisors how to deliver massive value to their clients through tax planning. We are back to a Q&A Friday, and today’s question comes from Jim an advisor who reached out on LinkedIn. So, great reminder to be sure and follow Retirement Tax Services on LinkedIn to stay up to date on the content we’re putting out. And you can also reach out to firstname.lastname@example.org – to give us feedback and submit your questions for future episodes. So, Jim reached out because he is considering multiple client situations, where a donor advised fund might make sense. And he asked if we could do an episode talking about donor advised funds. And the answer of course is, we’d be happy to.
So, donor advised funds are just one of many vehicles we can use for charitable giving. And one of many vehicles we should be considering for our clients who are charitably inclined, because like any charitable giving opportunity using a donor advised fund only makes sense for those taxpayers or those clients, who are already charitably minded. The math is never going to come out in your favor if you had no intentions of giving money to charity otherwise. So, a donor advised fund allows us to take multiple years of charitable giving and take the tax benefit all at once while maintaining control over how and when the funds are actually distributed. This option became a lot more popular with the ‘Tax Cuts and Jobs Act’, when the standard deduction increased so much. For many taxpayers they’re likely getting far less, if any tax benefit from charitable giving than they might think. Only the amounts above the standard deduction, which for 2021 is $25,100 for taxpayers who are married, filing jointly.
So only the amounts above that represent a tax benefit since all taxpayers get the standard deduction regardless of their charitable giving or other itemized deductions. So if charitable contributions are your only source of itemized deductions and in 2021, you give $26,000 to charity. You don’t get $26,000 of tax benefit. It’s only the portion of the giving above the standard deduction. That is an added benefit. And then you have to multiply that by your marginal rate to get to your actual tax savings. So, in this example, if we assume a 24% marginal tax rate, the taxpayer would get a tax benefit of only $216 from donating $26,000 to charity. This is definitely one of those areas that we can help just pull back that curtain a little bit for our clients and help them understand how these things work. By making sure they know where the benefit may or may not be coming from, and that they understand how their charitable giving or other itemized deductions are impacting their tax return in a given year. Understanding where a taxpayer is compared to the standard deduction in a typical year is an important starting point for deciding if a donor advised fund makes sense from a tax standpoint for them.
Most often you are going to be looking for taxpayers who consistently give to charity, but are also consistently below their standard deduction, with their total itemized deductions. Contributions to donor advised funds are included in your itemized deductions just like any other charitable contributions. The same limitations and phase outs apply. So, this isn’t an endless benefit you can take advantage of. The amount of, and when to make contributions to a donor advice fund should be part of your overall tax planning analysis. You should be looking at offsetting income in relatively high-income years for the taxpayer, and in amounts that are meaningful after considering both the amount in excess of the standard deduction, the contribution will push the taxpayer to, and how much income there is to offset in that tax year. It’s just like the other tax planning strategies we talk about. So many of these things have to be considered in combination.
Most of our tax planning strategies aren’t considered on a standalone basis because of the inner workings between all these different pieces of a client’s tax situation. It’s important to know and understand the contributions to a donor advised fund are irrevocable, which really is why the IRS allows a tax benefit from them. Once the funds are contributed, they have to be used for charitable purposes, but they can still be invested with any growth being tax-free and the distributions are made under the advisement of the donor, hence the name. Even though the contributions are irrevocable, the donor, the taxpayer or clients still maintain a great deal of control over what happens. A taxpayer can of course, just group their charitable donations and contribute to their favorite charity once every three years, for example, but that may not fit the giving plan of the donor or the organization receiving the funds.
So, a donor advise fund gives us more flexibility over time than simply giving larger amounts, less frequently to those same charities. So, a donor advise fund allows the taxpayer to still give a certain amount each year, but take the tax benefit all at once.
So, let’s go through an example of how you would quantify the potential benefit of using a donor advised fund. If you have a taxpayer who is married, filing jointly, and consistently has itemized deductions of $20,000, which includes $10,000 of charitable giving, they aren’t actually getting any tax benefit from the charitable donations they’re making each year. The standard deduction is currently 25,100 for married, filing jointly taxpayers. So, they are going to take the standard deduction every year. So based on current tax law over the next five years, they will donate a total of $50,000 with zero tax benefit. You might have clients who say ‘the tax benefit is not the reason I give to charity’, to which I would say, ‘well, of course not, you are giving to organizations who have missions you care about and want to support, but Mr. and Mrs. client, would it be all right if we took some proactive planning steps that would allow you to give even more to those organizations?’
The answer is rarely no. So, if this next year, instead of donating $10,000 to charity, the client set up a donor advisee fund and made a $50,000 contribution. They now have a reduction in current year taxable income of $34,900, which we got to by taking the total itemized deductions for the year of $60,000 and subtracting the standard deduction of $25,100. So now they’ve reduced their taxable income and the current year by $34,900 and have not impacted their deductions in the next four years, because they would have been taking the standard deduction anyways. If we assume a marginal tax rate of 24%, that is almost $8,400 in tax savings this year, that is of course assuming their AGI is high enough to allow the full contribution to be deductible. Taxpayers can use appreciated investments to contribute to the donor advice fund and avoid capital gains as well, which is important to keep in mind when considering where the funding for the contribution will come from.
Now, the taxpayer can use the donor advised fund to continue to contribute to their favorite charities potentially for longer than the five years, they were attempting to fund depending on investment returns. And if they were making their annual charitable contributions from cash, they could use that cash instead to invest and replenish the assets they use to fund the donor advice fund to begin with. So, to make accurate recommendations around using donor advised funds. You absolutely have to be doing multi-year projections, so you can see the impact on each of the years, including in the analysis. It is not as simple as taking the total contribution multiplied by the marginal tax rate for your client. You need to look at each year included and project what the tax liability will be with and without the contribution to the donor advice fund. So, when you’re considering which clients this might be applicable for, you’re looking for taxpayers who consistently come in below the standard deduction, $25,100 for married filing jointly and $12,550 for single filers for 2021.
But, you’re looking for those taxpayers who still give enough to charity, that lumping multiple years of giving into a single year will push them meaningfully over the standard deduction threshold. And there isn’t a set dollar amount you’re looking for. You really have got to do the projections and see what the potential benefit would be and how that fits with the client’s other tax planning opportunities. It’s important to remember for your retired clients that you’re also going to want to consider qualified charitable distributions or QCDs in your planning around charitable giving, because the added advantage of QCDs is that they reduce adjusted gross income, not just taxable income and adjustable gross income is used in several places in the tax return to determine phase outs and limits and even additional taxes. So, that added benefit of reducing adjusted gross income through a qualified charitable distribution can be significant depending on the taxpayer situation.
All right, so to wrap up, let’s talk about action items. ‘Course, the first action item is to make sure you are reviewing your client’s tax returns. This can be a great way to see if clients are charitably inclined, even though many taxpayers take the standard deduction, which gives us less visibility into what they might otherwise itemize. It can still be a great conversation starter to understand whether your clients are charitably inclined and what other itemized deductions they might be getting.
The second action item is to make sure you understand the logistics of contributing to, and using a donor advised fund with your custodian. Donor advice funds are fairly common with the big custodians, but you want to be able to set clear expectations for your clients and make sure they understand how the process works. Both when they’re contributing to the donor advice fund and the ongoing investment and distribution decisions.
Last action item is to make sure you follow retirement tax services on social media and keep letting us know topics you’d like to hear covered in future episodes or guests you would like us to have on an interview. Thanks for listening everyone! Good luck out there, and remember to tip your server, not the IRS!
The information on this site is for education only and should not be considered tax advice. Retirement Tax Services is not affiliated with Shilanski & Associates, Jarvis Financial Services or any other financial services firms.