Client Success Stories: Maximizing the Value of Charitable Gifts

There’s an old story about an experienced engineer who was called on to fix a nagging issue with a machine. According to the story, the engineer took a long look, grabbed a hammer, and gave the machine a solid whack, after which it started humming again. When asked to explain the resulting $500 invoice for what appeared to be a single hammer strike, the engineer replied that hitting the machine cost $10, but knowing exactly where to hit it cost $490.

We recently had the opportunity to know exactly where to hit the machine when a client recently approached us with a goal of making a significant charitable contribution in 2020, with the hope and expectation of making the same contribution for as long as they are able in subsequent years. After determining that they could do this without jeopardizing their other spending goals, we set about figuring out the best way to make their gift this year.

Most folks know about the potential to receive a tax deduction for gifts to charity, even with the new higher standard deduction limits that started in 2018. But hidden in the tax code is the fact that taxpayers may not receive a full deduction for their gift, depending on the taxpayer’s income, the nature of the gift and the type of recipient charity. Our knowledge of these complexities – as well as our staying current with temporary changes in 2020 – enabled the client to receive a significantly higher deduction than they’d anticipated.

Long-time readers and clients have likely heard our suggestions about donating appreciated securities, because such gifts are usually more tax efficient than simply writing a check. The trick for donating appreciated securities, however, is that the IRS limits the deductibility of such gifts to 30% of your income.

This is rarely an issue for many people, based on their income and annual gift amounts. But for this client, the limitation would have resulted in only being allowed to deduct 40% of their desired gift in 2020. Anything they couldn’t deduct this year could be carried forward as a possible deduction into 2021. But the fact that the client wanted to make similar gifts in future years would mean that they would perpetually have charitable carry-forwards that they couldn’t fully use.

Another potential option was to make a charitable contribution directly out of the client’s Individual Retirement Account (termed a Qualified Charitable Distributions, or QCD). QCDs don’t qualify as tax deductions, but they also don’t show up as income on your tax return. They also count towards any Required Minimum Distribution you need to take out of your IRA, which can be helpful in most years.

But not 2020. With the passage of the CARES Act, Congress suspended Required Minimum Distributions this year. Absent the need to satisfy this distribution, a QCD for this particular client didn’t make much sense.

The CARES Act, however, did something else for this year that proved incredibly useful in this situation. Specifically, the CARES Act increased the limit of deductible charitable gifts made in cash from 60% of income up to 100%!

We ordinarily don’t worry about that limit, because most of the time it makes more sense to donate appreciated securities. Additionally, most folks don’t make large enough gifts for that limit to be of concern, or they don’t have large amounts of cash available for such gifts.

But in this case, the stars aligned. Not only did the client want to make a large gift, we were also able to raise enough cash in our clients’ brokerage account without realizing any capital gains because of some trades we’d made earlier in the year.

By making this gift in cash (and not creating any taxable gains in the process), we were able to lower our clients’ projected tax liability in 2020 by almost the amount of our annual fee, while at the same time avoiding creating a carryforward that our client would never be able to fully use. Next year things will be different, so we’ll figure out the optimal way to satisfy their gift requests all over again.

We couldn’t have told this client when they hired us eight years ago that we’d have a solution for them in 2020 that would have so much value. But we could tell them – as we tell every prospective client – that we’d have the right solution for them when the time called for it. We knew exactly where to whack the machine with the hammer. And that’s the real value of working with a true financial planner.