Phil DeMuth, Ph.D., discusses being a tax-smart donor by strategizing your charitable giving in a way that maximizes both your philanthropic impact and your potential tax benefits. We discuss his new book, “The Tax-Smart Donor,” and highlight the benefits of creating a charitable giving plan as part of a well-structured financial plan.
Phil is a Managing Director at Conservative Wealth Management, LLC, and the author of ten personal finance books, most co-authored with his pal, economist Ben Stein. He has also written for numerous media publications and industry journals. He has appeared on various TV shows, including CNBC’s Worldwide Exchange, On the Money, Squawk Box, and Closing Bell, as well as Fox & Friends, Wall Street Week, and Consuelo Mack WealthTrack.
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This podcast is hosted by Rick Ferri, CFA, a long-time Boglehead and investment adviser. The Bogleheads are a group of like-minded individual investors who follow the general investment and business beliefs of John C. Bogle, founder and former CEO of the Vanguard Group. It is a conflict-free community where individual investors reach out and provide education, assistance, and relevant information to other investors of all experience levels at no cost. The organization supports a free forum at Bogleheads.org, and the wiki site is Bogleheads® wiki.
Since 2000, the Bogleheads’ have held national conferences in major cities nationwide. There are also many Local Chapters in the US and even a few Foreign Chapters that meet regularly. New Chapters are being added regularly. All Bogleheads activities are coordinated by volunteers who contribute their time and talent.
This podcast is supported by the John C. Bogle Center for Financial Literacy, a non-profit organization approved by the IRS as a 501(c)(3) public charity on February 6, 2012. Your tax-deductible donation to the Bogle Center is appreciated.
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Transcript
00:00:12 Rick Ferri: Welcome everyone to the 83rd edition of Bogleheads on Investing. In this episode we’re going to talk about the tax benefits of charitable giving with Phil DeMuth, who wrote a new book, “The Tax Smart Donor: Optimize your Lifetime Giving Plan.” This is a topic I thought I knew a lot about, but I did not. And what I learned is that donating haphazardly is not optimal and that a lifetime giving plan is an important part of your long term financial plan.
Hi everyone, my name is Rick Ferri and I am the host of Bogleheads on Investing. This episode, as with all episodes, is brought to you by the John C. Bogle Center for Financial Literacy, a nonprofit organization that is building a world of well informed, capable and empowered investors. Visit the Bogle Center at boglecenter.net where you will find a treasure trove of information including transcripts of these podcasts.
Before we begin, I have one special announcement. Tickets for the 2025 Bogleheads Conference are now on sale at boglecenter.net this year’s conference will begin at noontime on Friday, October 17th and run through noontime on Sunday, October 19th. It will be at the Hyatt Regency San Antonio Riverwalk Hotel, a beautiful location directly across from the Alamo. You’ll find a list of speakers at the boglecenter.net website and a full agenda will be up soon. I hope to see many of you there.
Last month on Bogleheads on Investing, we had Jonathan Clements, Jason Zweig and Christine Benz talking about the Jonathan Clements Getting Going on Savings Initiative, a nonprofit study that is being found funded through the John C. Bogle Center for Financial Literacy, a 501(c)(3) nonprofit organization. You can go back and you could listen to Episode 82 to learn more and how you can participate through your own tax deductible donation. After recording that podcast, I started thinking, what’s the other side of charitable giving? It is the tax deduction that you may get. And turns out there’s a lot more to that tax deduction than I thought.
Enter Phil DeMuth, who out of coincidence just happened to have written a new book, “The Tax Smart Donor: Optimize your Lifelong Giving Plan.” He sent me a copy of this book. I’ve read it. I was so impressed. There was so much in that book that I did not know. The strategies that Phil put forth I thought were very insightful. Phil was a previous guest on Episode 32 and he agreed to come back on this month talk a little bit about the tax benefits of a lifelong giving strategy. So with no further ado, let’s welcome back to Bogleheads on Investing. Phil DeMuth. Welcome back, Phil.
00:03:20 Phil DeMuth: Rick, thank you so much for having me. It’s a privilege to be here.
00:03:23 Rick Ferri: Well, thank you. And it’s such a timely book because last month we had a podcast talking about the Jonathan Clements Getting Going on Savings Initiative. And so your book, “The Tax Smart Donor” is actually the flip side of that, which is, yes, we want to do good, but we also maybe want to get a tax break.
Now, I have to say I thought I knew about the tax benefits of giving to charity. After reading your book, I have to say I didn’t really know very much. All of the different points that you brought out were fantastic in the book and we’re going to go through the book. But first, why did you decide to write the book?
00:04:04 Phil DeMuth: My father died about 30 years ago while he was a patriotic American, fought in World War II. He did not like paying taxes that he didn’t have to pay. And he had enough money at the time that he sort of eclipsed over into estate tax territory, so he ended up giving it to charity instead. So that was really my first introduction to charitable giving on more than a five dollar bill in the church collection plate level. Over time I came to learn more. I live in the state of California, which some of you may know is a high tax state. The taxes get very expensive here. So this made me very tax sensitive and looking for any angle I could to try to save money.
00:04:55 Rick Ferri: So the book talks about saving on taxes on many different levels. Federal income tax, federal estate tax, in some states state income tax, state estate tax, and state inheritance tax. Potentially five different taxes.
00:05:09 Phil DeMuth: Yes.
00:05:09 Rick Ferri: Before we go down that path, let’s start at the beginning with a history of the charitable contribution tax deduction.
00:05:18 Phil DeMuth: Yes. It’s one of the oldest sacred cows in the tax code going back to, I think, 1916, just a few years after the income tax itself began. It started basically because President Wilson wanted to raise taxes to allow the U.S. to participate in World War I. Turned out to be a fairly calamitous decision. He rose taxes from 15% to 67%. And at that point it became an open question for the wealthy people in America. Why should we give all our money to these various civic institutions, you know, concert halls and libraries and education institutions and so forth? If the government’s taking two thirds of our money, why don’t we let them pick up the tab and we’ll just spend the money on stuff that we want to spend money on.
And so Congress quickly realized this was not going to work. They wanted to spend on their own schemes. So they thought, we better have the rich people paying this, so we’re going to give them a tax break. They can deduct the money from their income tax. That way they’ll take care of all the stuff that we don’t want to bother with. So it’s stayed in place ever since.
00:06:40 Rick Ferri: So that begs the question, what is a charity?
00:06:44 Phil DeMuth: It’s a concept that’s nowhere defined. You know, it’s broadly designed to further, you know, important social goals, educational, medical, any, you know, civic, artistic. Nobody has a definition of it, but there is a practical definition, which is that if you’re thinking about giving to charity and have any interest in getting a tax deduction, it better be, for the most part, a 501(c)(3) public charity. And so is it one or not? You can go to the IRS website, look for tax exempt charitable organizations, and they’ve got a very clunky tool that you can look it up and find out if your charity is a 501(c)(3) charity or perhaps if it’s a private foundation. That would be another category you might be able to give to.
00:07:39 Rick Ferri: Now, part of the book talks about giving to charities outside the United States, where that can also be a tax deduction. I just want to touch on that because we have a lot of people that I talk with who do want to give to charities outside the U.S. so how does that happen?
00:07:54 Phil DeMuth: With difficulty. It used to be the case, I believe, that you really could not do that very effectively, but now you can usually do pretty well with some kind of a workaround. If you know there’s a foreign charity that you like, you can ask them directly whether they have a US Charity that is a feeder organization that passes money to them. And I know people that have done that. I think I have a client who started one so he could just direct money to a foreign charity that he was interested in supporting.
That’s one way to go. Oftentimes the larger donor advised funds will have expertise in this area because there are certain compliance hoops you’ve got to jump through to make sure that it’s actually a legitimate charity and not some, you know, money laundering organization or mafioso organization. So they’ve got to do some amount of due diligence before you can just say this is a charity. So that’s another way to go. There are also some charities themselves that specialize in transferring money to charitable organizations in foreign countries. So it’s not quite as straightforward if you want to give to the charity down the street.
00:09:12 Rick Ferri: So we can give directly to a 501(c)(3) organization. We can also give to a donor advised fund, which itself is a 501(c)(3).
00:09:19 Phil DeMuth: Correct.
00:09:20 Rick Ferri: Let’s talk about what a donor advised fund.
00:09:23 Phil DeMuth: Sure. Well, a donor advised fund is itself a charitable organization and you can give money to them and they will keep it in a segregated account in your name. And then you have the right to direct some of the investment of that money and you have the right to advise them as to how you’d like the money distributed to a charitable organization downstream from them. So it’s kind of a holding tank for charitable dollars where you can let them grow in index funds if you want. I’m kind of a shill of the financial services industry because I see a lot of valuable use for these outfits. Now some of them are affiliated with major brokerages. There might be some people that have accounts at Vanguard listening to this. And Vanguard is a very fine 501(c)(3). Same is true with the one at Fidelity and the one at Schwab. I like all of those very much.
But there are also community based 501(c)(3) donor advised funds that have expertise in your local area if you want to give locally. So they’re very useful and they’re especially useful in purposes of this book because they allow you to give more tax efficiently than you might otherwise.
00:10:48 Rick Ferri: I want to make a shout out to one organization that was founded or co-founded by Adam Nash. It’s called Daffy, which is the donor advised fund for you. Daffy.org this is an intersection between Silicon Valley and donor advised funds.
00:10:58 Phil DeMuth: Yes.
00:10:59 Rick Ferri: And I’ve been talking to Adam about this and his organization for a few years. So I wanted to just give a shout out. It really is interesting. Very low cost. Actually even lower cost than Vanguard. It’s just got fixed fees. It is a 501(c)(3) nonprofit organization. But there’s a lot of, you know, again, Silicon Valley meets donor advised funds. You’re going to have a lot of automation to how these things work and you could actually transfer in assets from other donor advised funds to Daffy. So I found it to be interesting and I wanted to give a shout out. So you’ve heard of this organization?
00:11:39 Phil DeMuth: Well, not only that, it was in my book and an editor read it and said I think maybe we should leave that out and just put in the big boys. But I had it in the book originally.
00:11:48 Rick Ferri: Oh, is that right? And it was taken out. Interesting how we kind of come full circle on that. I don’t want to call it like a Robinhood of donor advised funds.
00:11:57 Phil DeMuth: Yes.
00:11:57 Rick Ferri: Very efficient, very low cost. All index funds. Pick your own family giving and a whole lot of different things.
00:12:02 Phil DeMuth: The next generation DAF.
00:12:04 Rick Ferri: The next generation. I mean, well thought out as you would expect from that group of people.
00:12:09 Phil DeMuth: Yes.
00:12:10 Rick Ferri: So let’s go ahead and move on to beyond donor advised funds. There are more complex organizations than that. Private foundations.
00:12:21 Phil DeMuth: Yeah, private foundations have certain trade-offs. They are certainly more expensive to set up than just giving to a pre-existing charity. You’ve got to file paperwork with the IRS and you have annual reporting requirements. So you’re going to have a tax form you have to fill out every year. But they are a way of having more control and a little more flexibility than you might if you just gave to a 501(c)(3) charity. I think for most people it would not be at the top of my list. When my father died, we started a very small private foundation and it was a fair amount of work to keep the whole thing going. I tend to believe that for most people, most of the time a donor advised fund is going to be a better answer than a family foundation. The donor advised fund is the private foundation of America’s middle class and in some cases upper middle class.
00:13:24 Rick Ferri: So a little bit more restrictions on a private foundation. First of all, there is a tax. The IRS does collect a tax from you.
00:13:33 Phil DeMuth: A 1.37% excise tax on your investments every year. So you’ve got that going. And the amount of money you can give is more circumscribed. The tax code clearly is prejudiced against private foundations and in favor of public charities. Although the amount of money going to charity every year is far greater to private foundations than it is to donor advised funds.
00:14:02 Rick Ferri: According to your book, there’s like 10 times the number of donor advised funds than there are private foundations. But the amount of assets in private foundations is about five or six times what it has in donor advised funds. So some big, big families.
00:14:16 Phil DeMuth: Yeah, there are a lot of wealthy families that have these set up.
00:14:20 Rick Ferri: Like the Gates Foundation.
00:14:21 Phil DeMuth: That would be one of the larger ones. Yes.
00:14:23 Rick Ferri: You also talk about using an LLC as a charitable giving tool. Could you explain that? You talk about Mark Zuckerberg doing this?
00:14:33 Phil DeMuth: Yes, it became a very fashionable idea when the Zuckerbergs decided to channel their charitable giving through an LLC. But as far as I can tell, it doesn’t really have much of the way of an advantage over just using your checking account to give to charity. There’s no special charitable prerogatives that obtain to the LLC structure. So it sort of, it became a quick flash in the pan. I think for most people it’s not going to be a way of setting up a charity.
00:15:08 Rick Ferri: You also talk about non-profit organizations that don’t offer a tax deduction. And these are 501(c)(4).
00:15:18 Phil DeMuth: Yes.
00:15:19 Rick Ferri: Now, it was the first time I really knew what the IRS code was for this. Would you describe what a 501(c)(4) is?
00:15:26 Phil DeMuth: It’s a organization that serves a socially beneficial purpose in their own eyes. And you can give money to it, but you can’t get a tax deduction for giving that money. I give two examples to show sort of why you might think it was a good idea or a bad idea. One would be Planned Parenthood and one would be the National Rifle Association. People probably have strong feelings about these organizations on one side or the other. And you can give money to them, you won’t get a charitable donation for it.
00:16:03 Rick Ferri: There are some workarounds though, are there not?
00:16:05 Phil DeMuth: Yes, especially a large, well organized 501(c)(4) organization like these are. They will also typically have a charitable wing that they operate that might donate to charitable causes that are considered to be good enough to rate the 501(c)(3) designation. They might be contributing to reproductive education or they might be donating to gun safety or things like this that almost anybody would be in favor of. It would be more widely socially acceptable.
00:16:42 Rick Ferri: So within the 501(c)(4) there are 501(c)(3)s.
00:16:46 Phil DeMuth: They might also establish something like that for people that want to give money.
00:16:50 Rick Ferri: But that money can only be used for specific uses.
00:16:54 Phil DeMuth: Yes, exactly.
00:16:55 Rick Ferri: All right, so let’s talk about tax benefits. And before we talk about tax benefits, we have to talk about the tax code and we have to talk about deductions that are what are called above the line and deductions that are below the line. So describe above the line and below the line deductions.
00:17:11 Phil DeMuth: Okay, form 1040 on line 11 you finally get to something called your adjusted gross income. So anything that’s above line 11 is considered now an above the line deduction. And there aren’t very many of them, but there are things like if you give money to a health savings account every year, that would be considered an above the line deduction. Or you contribute to a 401(k) or an IRA, that would be considered an above the line deduction. And above the line deductions are very valuable because they come right off the top of your income. And so the tax code is never applied against them.
00:17:55 Rick Ferri: Even things like Medicare, IRMAA, yes.
00:17:58 Phil DeMuth: All these horrible ancillary taxes that are downstream, they will not add to those. Whereas if you have below the line deductions, that’s nice, that’s wonderful. But those insidious organizations that you refer to, you know, Medicare IRMAA taxes, they don’t care about your below the lines deduction. They want to know what that adjusted gross income is. And we’ll start there.
So it’s great, especially if you can find or take advantage of the above the lines deductible. The below the line deductions appear further down Form 1040 on a separate schedule called Schedule A. There you can itemize deductions and they will subtract from your adjusted gross income and you will get the tax benefit from those.
00:18:49 Rick Ferri: I just bring that up because there are some deductions that will lower your adjusted gross income, which would also lower things like Medicare IRMAA or give you a higher tax credit if you’re on Obamacare. But the deductions for charitable contributions are below the line. So they don’t do anything to lower your adjusted gross income or your modified adjusted gross income, but they do lower your taxable income.
Most people, 90% I understand, use a standard deduction on their tax returns, which for a married couple is this year, $30,000, and for single it’s $15,000, a little higher for head of household. With a charitable deduction, before you get any tax benefit from it, you have to get above the standard deduction.
00:19:43 Phil DeMuth: This has become very relevant under President Trump’s Tax Cuts and Jobs Act of 2017. Before then, the standard deduction was fairly low, which forced anybody that wanted to get these other deductions to go to Schedule A and itemize how much they spent on investment expenses, health care, how much they spent on state and local taxes and their mortgage payment. It was another whole complicated ordeal.
So the thought was, well, we’re going to simplify the tax code, which is a great, great thing to do. So we’re going to give very high standard deduction. So almost nobody is going to have to go beyond that. They’ll just take the what’s now a $30,000 for married filing jointly taxpayers deduction, and nobody’s going to have to worry about it anymore.
The issue that comes up relative to this book is that unfortunately, or fortunately, charitable deductions all got listed on Schedule A as well. So what it means is that for the most part, people are not getting any tax credit at all for their standard average charitable deductions, because they never quite cross the borderline of that $30,000 a year threshold for a married couple or $15,000 for a person filing single.
Even when you add up the other relevant deductions they might get, those might come to $20,000 in a good case. But that still means the next $10,000 you give to charity, you’re going to get no tax credit for it. So this is sort of the downside of the tax simplification, and it’s not anything that’s encouraged a lot of charitable giving.
00:21:41 Rick Ferri: But this all may change this year. We don’t know yet. As Congress sorts out what the new tax bill will be and probably will be signed this summer, maybe where things like SALT, which is state and local taxes, the House bill that is sitting on the table right now, $40,000. That’s a big jump from $10,000. So that immediately for people in California per se, who are paying a high property tax and paying high state income tax, almost immediately now, their charitable deduction now becomes a federal income tax deduction.
00:22:21 Phil DeMuth: Well, we’re all licking our chops in California about that. But I have some bad news, and this gives a certain insight. It’s interesting because it sort of shows a little bit more about how the sausage is made in Washington, D.C. the real origin of the SALT deduction is that the three liberal blue coastal states with high state taxes (New York, New Jersey, California) love this idea of the SALT tax, because in California, you know, a person makes a million dollars and they owe $100,000 in California tax. And they could write that off. They don’t care that much about the $100,000 tax because they write it off on their federal taxes, in effect forcing the other 49 states to chip in and pay their California tax.
00:23:15 Rick Ferri: I moved to Texas to avoid this.
00:23:18 Phil DeMuth: So the whole state and local tax deduction was kind of a boondoggle in that respect. The House bill wanted to raise it to $40,000, but what happened is that now the bill’s gone to the Senate. Let’s name all of the Democratic senators from New York, New Jersey and California that are going to be pushing this through. And the answer is there aren’t any.
And President Trump has also told the Senate that, by the way, I don’t really care about this. So there’s no constituency to push this forward. So the best case they could hope for is that the House version would be passed as is. But even there, there’s a cap on it. And so if you earn over $500,000 and you’re married, it starts to get cut away 1% for every thousand dollars over that you earn.
00:24:14 Rick Ferri: 1% for every $1,000?
00:24:18 Phil DeMuth: Yes. Because when you get to the next hundred thousand dollars, by the time you get to $600,000, the deduction has fallen from $40,000 back to $10,000.
00:24:29 Rick Ferri: Oh, okay.
00:24:30 Phil DeMuth: So basically one hand gives, the other hand takes away. But it still would represent a $350 billion hit as they account for the how much it’s going to cost to do it. So I think that the Republicans will be eager to find a way to make it less expensive to pass this tax bill. This benefit to New York, New Jersey and California is going to be one of the first things they look askance at and maybe think of paring back a bit.
00:25:01 Rick Ferri: In addition to SALT, the other major deductions on your Schedule A are your mortgage interest and charitable contributions. So to the extent that mortgage interest since 2019 on new homes purchased has been capped at $750,000, it was a million dollars prior to that, a lot of people can’t deduct their mortgage interest.
00:25:26 Phil DeMuth: Of the people that claim it, I think that the average they can cough up is like $11,000. It’ll help you get to $30,000. But there’s still going to be a gap somewhere unless you have huge medical expenses.
00:25:41 Rick Ferri: Right. And the medical expenses are above 7.5% of what is it your adjusted gross income?
00:25:47 Phil DeMuth: Yeah, something like that.
00:25:49 Rick Ferri: Yeah. So it has to be fairly high threshold. So we’re still looking at a fairly high threshold here before charitable giving actually becomes a tax deduction.
00:25:59 Phil DeMuth: But wait, there’s one in the House bill. There is one charitable deduction that’s above the line. They’re letting you, if you’re a single person and you don’t itemize, if the House bill passes, you can give $150 to charity and write that off. And if you’re married, you can give $300.
00:26:17 Rick Ferri: That used to be in the tax code a few years ago and I think it sunset like two years ago, if I’m not mistaken.
00:26:25 Phil DeMuth: Right? Yes. Under Covid, they thought they would give Americans a chance to do so.
00:26:30 Rick Ferri: So we’re going to get into some things like bunching a little bit later on and where you could still finagle your giving to a donor advised fund to be able to take a tax deduction. But we’ll talk about that in a little bit. I want to get into another tax. And this is where charitable giving helps reduce that tax. And this tax is the estate tax. Not only federal estate tax, but state estate taxes. So first, how does this work into charitable giving?
00:27:01 Phil DeMuth: Well, the estate tax is a big deal. It’s 40% when you cross that threshold, which I think is roughly $14 million per person, $28 million for a married couple this year. So for people that have estates that are larger than that, 40% of that money is just going to the big landfill in Washington, D.C. people that are in that situation are meeting with their estate attorneys and trying to figure out ways around it. And one of the big ways around that is to give money to charity in your estate.
00:27:40 Rick Ferri: So let’s say your estate was $60 million and you had a $28 million federal estate tax exemption for a couple. The other $32 million would be taxed at 40%. So the estate would pay almost $13 million in estate taxes. Of that 32 million, if you gave a portion to charity, then it comes out of the estate.
00:28:09 Phil DeMuth: Yes.
00:28:09 Rick Ferri: And the estate does not have to pay the tax on that. Is that how it works?
00:28:14 Phil DeMuth: Yes, indeed. Typically, as great as that is. And it’s great for the charities, to be sure. For the most part, if you find yourself doing that, you have to ask yourself the question, would I have been better off giving more of this money away sooner, giving it away while I was alive? Because while it’s great to give it to your estate and avoid the estate tax, you’re not getting any income tax benefit from that. Whereas if you’d given that money away while you were living, you might have been able to deduct that against your income tax and, you know, keep. Carry that forward for a number of years, and then that money is still out of your estate. And furthermore, it’s not compounding within your estate to just get bigger and bigger, to just have a bigger and bigger tax attached to it. So there’s a lot to be said for giving money away earlier. Give while you live is what they say.
00:29:08 Rick Ferri: Give more than you’re allowed to charity in a given year, like you give 100% of your income to charity in a given year, you can’t take the full tax deduction on it, but it carries forward, correct?
00:29:25 Phil DeMuth: Right. You have five years to carry it forward. But every year that it carries forward, it still has to cross the same threshold. Rick, this is great news. You can give away all your money to charity anytime you want. It’s a free country. You won’t get a tax benefit from it, though. You’ll only get a tax benefit if you give away an amount that falls under a certain amount of your a certain percentage of your adjusted gross income.
And so if you’re giving to a public charity and you’re giving away cash, that might be 60%. If you’re giving to a private foundation, you’re giving away cash, it might be 30%. If you’re giving away stocks, it’s less. It might be 30% for public charities and 20% to a private foundation. There are all these limitations you have to meet. So the tax benefit is circumscribed.
00:30:20 Rick Ferri: It’s interesting, I was reading in your book, and I did not know this either, that if you give cash, it’s 60% of your adjusted gross income, but if you give a combination of cash and securities, it drops to 50%. There’s all kinds of little quirks in the book that I found interesting.
00:30:36 Phil DeMuth: They don’t make it easy. It’s incredibly complicated.
00:30:41 Rick Ferri: Well, to make it even more complicated, if you happen to be in 12 states, plus the District of Columbia that imposes an estate tax at the state level, or six of the states that imposes an inheritance tax which is different than the estate tax, then it’s even higher. So first of all, what’s the difference between estate tax and a state inheritance tax?
00:31:17 Phil DeMuth: Right. So you have to watch two things, and especially if you’re thinking of retiring, find a state that doesn’t charge an estate tax on your net worth when you pass on. Because sometimes the thresholds on these are different. They don’t necessarily follow the federal model. You know, the state’s tax could be considerably lower. But also you have to watch where your beneficiaries live, because if they live in a state that has an inheritance tax, a local state could come after them. So, and you could get both. If you live in a state that has a state tax on your inheritance, you’d pay that. And if your beneficiaries live in another state that has estate inheritance tax, they could also have to pay. So you got to watch out these.
00:32:05 Rick Ferri: Six states that have an inheritance tax, one of them, Maryland, has both an estate tax and an inheritance tax. So for a wealthy individual that lives in Maryland, it could be five taxes on the same money. So there could be a federal estate tax on money that is inherited in an IRA, and then there’s the state estate tax for money that’s inherited in an IRA, and then there’s the inheritance tax at the beneficiary yet that they have to pay. And then when they withdraw the money from the IRA, they have to pay federal income tax and state income tax on that money. Five taxes on the same money.
00:32:56 Phil DeMuth: Yes.
00:33:00 Rick Ferri: There’s supposed to be some offsets, but you were saying in the book it’s very complicated and you need to have the same CPA doing the estate tax returns as you do your own tax returns in order to catch all this. I mean, this can be very taxing, giving pre-tax IRA money or 401(k) 403(b) money to your children.
00:33:20 Phil DeMuth: Right? To say the least. To say the least. One of the quotes I come back to, I put it on the back of the book, is from Warren Buffett. He says there are tax deductions to be had from charitable giving, but they don’t happen automatically. You really have to seek them out or otherwise they’re going to come bite you probably.
00:33:40 Rick Ferri: So we were talking in your book quite a bit and you make a lot about this, about bequesting money from your IRA accounts to charity before you die and also bequesting money from your IRAs to charity when you die. That’s a very tax efficient way of doing things, right?
00:34:00 Phil DeMuth: I think, especially for Bogleheads. Bogleheads tend to be big savers. They tend to be conscientious about contributing to their tax deferred accounts and so they find themselves in retirement, sometimes with surplus capital. And for Bogleheads in that position, or anybody in that position, donating from your IRA is unbelievably great. You can make a qualified charitable distribution. The cap on that this year is $108,000. And this comes out effectively as an above the line distribution.
This is money that otherwise was going to come to you and you’re going to pay taxes on at your marginal rate. But instead it’s money going to charity. And it also never hits your adjusted gross income. So the most despised taxes in the entire tax code, if my class or any guy, are the IRMAA taxes, the adjustments to Medicare based on your income. And these involve a series of tax cliffs. So if you exceed the income level by even a dollar, you have to pay the entire next tax all at once. So it’s very good for if you want to perhaps pay less in IRMAA taxes. It’s a very tax efficient way to give. It basically underwrites your tax giving to the tune of whatever your marginal tax rate is. So if it’s 24%, you have an immediate 24% tax savings by giving by way of a qualified charitable distribution.
00:35:42 Rick Ferri: Now, you can only do that when you’re 70 and a half. And the that’s when you could start doing a qualified charitable distribution. And it has to come from an IRA. It can’t come from a 401(k). So you have to move the money from your 401(k) or 403(b) to an IRA and then make it from the IRA. But you said something.
I just want to clarify that the limit of $108,000 this year, which adjusts for inflation every year. Yes, that’s the limit that you could use to do to take off of your required minimum distribution. But if you had no required minimum distribution, meaning you’re 70 and a half this year, then it’s a $108,000 is the limit on the amount that you could give out of the IRA every year. It’s just that if you’re 75 and your RMD is $50,000 and you give $100,000 out of your IRA, it doesn’t carry forward that second $50,000. It only takes care of the $50,000 of your RMD. And the other $50,000 is just another contribution. But you don’t have to pay tax on that either. But it doesn’t go to the future RMDs.
00:36:53 Phil DeMuth: This is a little bit tricky. You can give a qualified charitable distribution when you’re 70 and a half, but you can’t credit that against your RMDs. So you don’t get an immediate tax benefit from it. It’ll lower the balance in your IRA and that will, over the course of the next 50 years, have some benefit. But I would encourage people to wait till they’re 73. I know they’re impatient to give, but wait two more years and that way you can write it off against your income that year and you’ll be happier.
00:37:28 Rick Ferri: Okay. I just wanted to clarify that you’re not limited to the RMD amount. Once you start hitting RMDs, you’re not limited to that amount. You’re limited to $108,000.
00:37:38 Phil DeMuth: You can only get the tax deduction up to the amount of the RMD. You will not get any further tax benefit from it.
00:37:44 Rick Ferri: And to clarify, by tax deduction, the RMD does not hit your adjusted gross income because you have given it to charity. I want to get off the topic of qualified charitable distributions for people who are 70 and a half and get back to anyone who’s making a charitable contribution.
And I want to explore the strategy of bunching contributions. We earlier talked about having to get over the standard deduction before your charitable contributions are a tax deduction. But every year we give to charity. So talk about bunching.
00:38:16 Phil DeMuth: So bunching is an attempt to solve this very problem. How do we get over the standard deduction threshold so we can get a charitable deduction? And the idea is that there are certain kinds of, certain maneuvers you can make. Instead of giving every year, you could try to compress a lot of the things you do into a one year, every other year slot. So you could pay your January mortgage payment of the following year in December. You might be able to pay your property tax bill early and also bring that into this current year. And then also you can supplement this by doing the bulk of your charitable giving and trying to put that into one year as well.
The idea is to compress as much giving as possible into one year. So that pushes you over the hurdle of the standard deduction threshold. And then if you use a donor advised fund as the recipient charity, you can then make your distributions from that fund or advise on those distributions and spread them out over two years rather than one year. So it allows your giving to be consistent without having to shove it all onto one end charity or many charities, if you want, if you use a donor advised fund. So it’s just a way of trying to get a tax deduction. It’s not as good as a qualified charitable distribution from an IRA, but it’s probably going to be the best you can do before you retire, especially if you’re a prudent saver. In a taxable account, you probably will have securities that you might be able to give to charity.
00:40:09 Rick Ferri: And we’re going to get into that right now. There’s another aspect of the tax savings and that is giving appreciated securities to a charity directly or through say a donor advised fund. And what’s the benefit of giving appreciated securities? Not selling the securities first, but just giving the appreciated securities?
00:40:28 Phil DeMuth: Sure. The last thing you’d want to do is sell the securities first. Because you sell the securities, then you’ve got to pay capital gains taxes on the gains and then you give what’s left over to charity. It’s a bad idea. But what you can do is you can donate appreciated securities directly from your brokerage account to a 501(c)(3) charity. Let them sell it. They’re charities, they don’t pay taxes on this.
So they get 100 cents on the dollar benefit from it. Not the 65 cent or whatever it would be the cost to you as the private citizen selling so it turned out to be a double win. You get a tax deduction for the fair market value of the securities and you avoid ever having to pay the capital gains tax that you would have had to pay had you sold those securities later on and used them for living expenses.
00:41:18 Rick Ferri: In your book, you spend some time talking about giving appreciated stock directly to charity, while giving it to charity through a donor advised fund. And you fall very heavily on donor advised funds rather than trying to give it directly to charity.
00:41:36 Phil DeMuth: Yeah, there are a number of steps you’ve got to go through if you want to give your 100 shares of NVDA to, you know, the local library association, you’ve got to call up the charity or go online and hunt through their instructions on how they like to do it, who their brokerage firm is, what’s the account number, what’s the exact name on the account, what’s their depository trust fund number.
Then you’ve got to call up your brokerage or go online to your brokerage and find out what are their policies for how you donate securities. You’ve got to download their forms, you’ve got to copy information from the charity onto the forms here. You got to go to your brokerage account, figure out what stocks or mutual funds you might want to donate, and you got to list that on the form. Then you got to send it all into the brokerage. Then you’ve got to wait for a week or two while this whole gets thing processed and then cross your fingers and hope that it happens by the end of the year so you get the tax deduction. It’s a real mess.
In contrast, I have an account at the Fidelity donor advised fund and I’m sure it’s the same way at Vanguard or Schwab. Your brokerage account pops up on screen with all the shares and all of the embedded capital gains in each one and you click one to that one and that one, press a button, you’re done, you’ve made the transfer. It’s about as difficult as ordering a book from Amazon.com and they take care of all the paperwork. Once you’ve tried it, you won’t turn back.
00:43:12 Rick Ferri: And then all you need to do is find the charity you want to give to and then there’s another couple of steps to actually give the money to them, that you transfer the money to them. You’ve already made the gift, you’ve already gotten the tax deduction. So yes, the actual distribution of the money to the various charities are very simple as well.
00:43:29 Phil DeMuth: They make it very easy. They just bring up a list of every 501(c)(3) charity and you just type in the name until yours pops up. They ask you a few questions, you know, do you want to give this anonymously? How do you want credit for it? Like that. And then you recommend the gift. And the next day it’s gone, you’re all done.
And at the end of the year, you don’t have to go chasing around. My gosh. Do I have this letter of acknowledgement from the charities? Did I get that? Yeah, I gave that $200 to that outfit. Did I ever get a receipt for that? So you don’t have any of these hassles. You have one donation that you made, one donor advised fund. You can just go online and download the letter from them and you’re all set.
00:44:16 Rick Ferri: Now, I have to say I did pick this up and I didn’t know this because again, when I read your book, there was lots of little things I picked up that I didn’t know. And this I have to say I didn’t know. Maybe I should have known it, but I didn’t. If you give appreciated securities to charity, it has to be a long term capital gain to get the tax deduction. If it’s a short term capital gain, no tax deduction. I didn’t know that.
00:44:44 Phil DeMuth: Right. I’ve made that mistake myself. So live and learn.
00:44:50 Rick Ferri: Now let’s get into giving away, say, founders stock, stock that’s not publicly traded yet. So how do you do that?
00:45:00 Phil DeMuth: You do that by talking to your attorney. This is an area where you want to be extremely careful. It’s very easy for even smart rich people to make mistakes and find that the whole thing sort of blows up in their face like an exploding cigar. So you want to proceed carefully. There are a lot of legal traps along the way.
Recently, somebody wanted to give their founder’s share to a donor advised fund. They found a donor advised fund that was willing to accept it and they knew the price it was going to sell for when it went public. And so because they had all the whole deal worked out, so everything was done, ready to go, the transfer happened successfully, and then the IRS said, no, you can’t do that. You violated the assignment of income doctrine. This is an important doctrine we should all study which says that you cannot divide your gifts among entities to gain a tax benefit if that’s the sole reason for doing it. The IRS said you weren’t risking anything. You knew what the company was going to sell for. So this is simply assignment of income. You can’t have it. So the guy said, okay, okay, I’ll go back and I’ll get the estimate of the company’s value, and I’ll just write it off as a tax donation on my Schedule A.
And then the IRS said, no, you can’t do that either, because you don’t have a qualified appraisal of the business. You have an appraisal that you’ve done to find out its value, but that doesn’t count as a qualified appraisal for our purposes. So, sorry. Million dollar plus deduction disallowed. Better luck next time.
00:46:49 Rick Ferri: This reminds me of another section of the book where you’re talking about giving artwork where depending on the value of the asset that you give, you have to have all these different appraisals.
00:47:01 Phil DeMuth: Yeah, again, there are sort of a lot of hopes and dreams wrapped up in this, but the reality is not as much fun as you might think. If you are giving art and say, want to claim a deduction of higher than $250 for it, is the value you claim escalates the stringency of the requirements you face in valuing the artwork also escalate.
By the time you’re giving artwork that costs six figures, you have to have an incredibly thorough appraisal done of that. And then if that’s not enough, you also have to pay the IRS to do its own valuation on it.
00:47:44 Rick Ferri: Which I found really interesting. I didn’t know you actually had to pay the IRS to do their own valuation of your artwork that you’re trying to donate to charity.
00:47:54 Phil DeMuth: And I can imagine that the IRS experts take a whole different view of the art market than your expert does. And so then it’s going to be your expert versus their experts. And good luck with that.
Some people, I’ve heard, try to cheap out on getting all this paperwork done to submit to the IRS, and that’s a big mistake. If you’re not paying a lot to, well, credentialed people to do your appraisals, you’re just asking for trouble. So be prepared to pay a lot for the privilege of giving your art to charity.
00:48:32 Rick Ferri: And other properties as well. I mean, you were talking in here about if you just make an honest mistake in valuing your property when you. And then take a tax deduction on it. If the IRS disagrees with you, the penalties are enormous.
00:48:48 Phil DeMuth: Right. I’ve forgotten the exact figures, but it’s shocking. So you want to make sure that everything is done right. Your accountant has looked at it. Your experts have looked at it, and probably you yourself should look at it. You yourself should read through all of this stuff because somebody from the IRS is going to look at it. And if you don’t think it makes sense, why would the IRS think it’s going to make sense? And it’s just going to make your life a lot more difficult. So be very careful with donating property.
The truth of the matter is the IRS really doesn’t want you donating property. They want to make it as difficult as possible. They want you to give a check. If you have real estate that’s like a building, real building, that’s got an appraisal and there’s rent coming in, that’ll be fine. But as soon as you start wandering away into sort of the gray areas, you’ve got to be very careful.
00:49:41 Rick Ferri: I want to get into pivot here a little bit into a couple of more different types of ways of giving. And that is with a charitable lead trust and charitable remainder trust. So we’ve got a few minutes. Can you talk about these two entities, these two ways of which you give to charity?
00:49:59 Phil DeMuth: I can. They’re incredibly complicated, but they are relevant for some people. Especially they’re relevant for very wealthy people that they want to give to charity and also give to their families. But basically they come down to two different kinds of trusts. One kind, you might say, is a charitable lead trust where you put a pot of money in the trust and the charity is able to take annual distributions from that trust for a period of time. And then at the end of that pre specified time period, you get the appreciated principal back and there’ll be tax advantages because the amount you gave to charity counts against the gift taxes on the money you put in. So that would be a lead trust.
The other example is just the reverse of that, where you put it in a charitable remainder trust and you or your descendants or your relatives get an annual distribution from that remainder trust, say for their lifetime. And then at the very end, then the charity gets the pot of money and the appreciation and walks off with it. So these are two complicated ways of giving. If you’re interested in this, this book will give you just a little bit of information about them, but it’s going to basically be referring you back to your estate attorneys, typically somebody that has expertise, and these kinds of trusts.
And it’s going to be a little bit of an un-Bogleheadish transaction. Bogleheads like things that are simple, clear, transparent. These are complicated. You’re going to deal with accountants, attorneys, financial planners, and you have to do careful projections of what these things are going to cost. The costs are going to be high, as opposed to a Boglehead philosophy where the costs are low. They still might be a great thing to do.
What I notice about them is that people go into these thinking I’m going to come out ahead in the sense that I’m going to get more money back for having given a sort of charitable donation this way than I would have otherwise. I’m going to be paid to give money to charities. This can happen, but for the most part it doesn’t happen. Many of these are going to end up with your spending more money on the charity and more money on the establishing the structure and setting it up and filing tax returns on it for 50 years. And then when you add all those up, the amount that you’re going to get back is not going to be as much as you dreamed of originally. So that’s why I encourage people to do a very careful upfront analysis of the whole transaction to make sure it’s something you want to do.
That said, there are cases where I think even in the average case, you can give a lot of money to charity through these vehicles fairly cheaply. So if you count the money given to charity, it’s is having some value to you as well, it can be worth doing, but you have to have what attorneys might say is a charitable intent behind it. If you have a purely selfish intent, it might work in some cases. But look at it very closely.
00:53:23 Rick Ferri: Circle back to something you said you can’t get something from the charity. It’s like, I can’t donate money to your charity and you’re going to take me on a cruise around the world.
00:53:32 Phil DeMuth: No, no, no. People hope that the charitable giving is going to somehow offset the other money that they are going to be making. So they come away net with more than they went in with. And that’s what tends not to happen as much as we might wish for it to happen.
00:53:50 Rick Ferri: Last one is a charitable gift annuities. I’ve been hearing quite a bit about charitable gift annuities lately, and so could you talk about what they are and how they work?
00:54:01 Phil DeMuth: Most charitable gift annuities are vehicles that are set up by the charities themselves. They will say, you’ll give us $100,000. We will give you and your spouse a check every quarter, every month, every week, whatever you want for the rest of your life. So you’ll get that income and we will get the remainder that’s left over when you die.
And charities are happy to set these kinds of structures up. Many, many charities will have these. If this is something you’re looking for, it might be a good deal. As I looked at them, I did not come away thinking this is something I’ve got to just rush into and do. Certainly they’re designed to favor the charity.
I think I have a Boglehead-ish skepticism of any kind of a dual purpose investment. If I want an annuity, I’ll just buy an annuity from a commercial annuity provider insurance company. And if I want to give to charity, I will just give it to charity. I would treat those as two separate transactions.
00:55:04 Rick Ferri: And you don’t get a full tax deduction for the charitable annuity. It’s a lesser amount.
00:55:09 Phil DeMuth: Correct. And in theory, the charity would have an advantage because the charity can take your, say, appreciated stock that you give, sell it and not pay any taxes. Whereas if I go to the commercial annuity provider, I’ve got to somehow come up with money that’s going to be after tax money, either from my checking account or whatever, to pay them for the policy.
00:55:36 Rick Ferri: I see. So you can gift appreciated securities, not pay the capital gain tax, but get the whole entire amount turned into a single premium immediate annuity that pays you back money as opposed to selling the stock, paying capital gain tax on the sale of the stock, and then what’s left? Putting it into an annuity. Is there any information on how much these annuities pay or what the cost is or if there are fees to this?
00:56:05 Phil DeMuth: There’s an organization, some national association of gift annuities or something that specifies what they think is a recommended payout amount and they think that the charity really should have a 1% annual fee for managing this. Many people think 1% annual fee, that’s nothing. But if you peruse the Boglehead forums, you come to dislike the idea of a 1% annual fee on anything. So that’s just, it’s my stark prejudice here.
00:56:37 Rick Ferri: I want to mention your website phildemuth.com because you have put a lot of information up there, including some tools to help figure out how you should be gifting to charity. You created this simple to understand formula called Gifting Power. Talk about the Gifting Power idea and how do people use it on your website.
00:57:03 Phil DeMuth: So in the course of writing this book, what I was primarily interested in doing was getting people out of the idea of doing charitable giving planning on a year by year basis. I wanted to promote the idea of charitable giving as a lifecycle investment. So Just as people do retirement planning or tax planning or college planning, I want people to do charitable planning based on a lifetime approach.
I wrote the book to try to hound the people that write the financial planning software into including this kind of a module in their presentations. What this requires though is you’ve got to have some way of comparing options. If I give this year, if I give this way versus this way, which way is better, which way is more tax advantageous.
And secondly, the other idea is what about giving now versus then? What about giving now versus later? If I give later, what does the scenario look like versus giving today? And the reason all of this becomes important is because the tax code is really the elephant in the room in terms of controlling the value of charitable giving. So the giving power metric is simply a way of trying to equilibrate all of these at the transvaluation of all values.
And it looks at how much was the charity savings, the tax savings you got for giving the money over the total amount you gave. So if you gave $100 but you saved $20 on taxes, that would be a 20% giving power. But if you spent $20 on taxes, there would be a negative 20% giving power. So it was just a very quick and easy way of figuring out am I better off doing it this way or not.
00:58:57 Rick Ferri: Phil, we’ve run out of time. But again, as I read through your book, there were so many things that jumped out at me that I just didn’t know. I learned a lot. And it’s called “The Tax Smart Donor: Optimize your Lifetime Giving Plan.” Thank you so much for coming back on Bogleheads on Investing and explaining these sometimes very complicated concepts.
00:59:17 Phil DeMuth: Rick, thank you so much. It’s a great honor to be here. Thank you.
00:59:21 Rick Ferri: This concludes this podcast on charitable giving. And remember, the John C. Bogle Center for Financial Literacy is a 501(c)(3) nonprofit organization that you can give to using direct contributions or your donor advised fund.
Go to boglecenter.net to contribute. Thanks for listening.
