You Could Have $0 Taxable Income in 2021

You Could Have $0 Taxable Income in 2021.

(And zero or reduced IRA required distributions hereafter.)

Sound too good to be true? Maybe. Or maybe, just for this year, you can have your cake and eat it too!

If you can answer “yes” to both of the following two questions, you should keep reading:

• Do you have significant charitable intentions that you would like to fulfill sooner rather than later, but have always encountered limits on how much you can deduct against income?
• Can you live without some or all of your IRA required minimum distributions, both now and in future years? Would it be nice to eliminate or reduce unwanted income from your IRA going forward?

The 2020 CARES Act introduced the ability for individuals to take a charitable tax deduction of up to 100% of adjusted gross income (“AGI”) for the 2020 tax year. In legislation passed earlier this year, this enhanced charitable deduction amount is now applicable to gifts made in 2021 as well.

You may be thinking, “I don’t have that much cash to give without incurring large capital gains in my taxable portfolio.” But if you have a large IRA balance, you might just have the “cash” on hand. A distribution to you from your IRA is treated as ordinary income regardless of the assets that are sold to raise the cash for the distribution. You might consider taking a large distribution from your IRA this year and using the funds to make a gift to a charity that will qualify for the 100% AGI deduction limit.

Again, you should only consider this if you have funds in your IRA that you’ll never need, and you should already have charitable intentions in your estate planning.

Here is a basic example:

What’s the catch? Well, there’s not a catch exactly, but of course there are rules. In the example above, the only rules to follow are those introduced by the CARES Act: 1) the charitable gift must be made with all cash, 2) the gift must be made directly to charity and, 3) you must elect the “CARES enhanced deduction” on your tax return for this gift to qualify.

The scenarios get more complicated beyond this first one, which involves only cash gifts made directly to public charities. If you want to give dollars to a donor advised fund or if you want to also give appreciated stocks or other assets alongside your cash gifts, there are ordering rules to follow for the application of the deductions. Here’s an overview of those rules and how the Cares Act 100% allowance is integrated.

1. In general, charitable gifts may be made using cash and/or non-cash assets—i.e. appreciated securities, real estate assets, etc. However, you are limited on the amount of income you may offset with gifts of non-cash assets and, for 2021, cash gifts not made directly to a public charity (for example, to a donor advised fund instead). Gifts of appreciated assets may reduce your taxable income by only 30%.
2. If you are aiming to deduct 100% of your AGI in 2021, the remaining 70% of your taxable income will need to be donated under the CARES Act enhanced deduction election. For the CARES Act portion of the charitable donation, the gift must be made to a public charity. Gifts to a donor advised fund, supporting organization or private foundation do not qualify for the CARES Act enhanced deduction. However, the non-CARES Act portion of your donations may still be made to a Donor Advised Fund. See number 1 above.
3. You must make an affirmative election on your tax return to identify the contributions that you want to qualify for the 100% AGI CARES Act enhanced deduction amount.

Below are a few scenarios to demonstrate the ability to incorporate the IRS charitable donation ordering rules with the CARES Act rules.

Scenario #1: I’d rather make large gifts to my donor advised fund to give me time to decide to which charities I wish to contribute.

Solution: Make both a gift to your donor advised fund and a gift direct to charity.

Once you’ve taken a distribution from your IRA, you now need to make a gift of cash direct to charity to receive a deduction of 100% of your AGI. However, you can first deduct up to 60% of your AGI for cash gifts to any charity, including your donor advised fund or private foundation. On your tax return, this gift would not be treated as a “Qualified Cash Contribution for 2020.” You would then make an additional cash gift direct to charity electing the contribution as a Qualified Cash Contribution.

Here is the simplified math:

In this example, you distribute $1,000,000 from your IRA to yourself, but you make $1,500,000 in gifts. This means you have an additional $500,000 in cash from a source other than your IRA to make the additional gift direct to charity. You would not want to fund this additional $500,000 by liquidating assets, thereby creating additional taxable income.

Scenario #2: I have charitable deduction carry forward still available.

Solution #2: Using the ordering rules for charitable deductions, you can use your remaining charitable deduction carry forward first, make a gift to your donor advised fund without making the CARES election, and still make a gift direct to charity up to your remaining AGI using the CARES election.

Here is the simplified math:

Scenario #3: I don’t have excess cash outside my IRA to maximize the charitable deduction in 2021 and fully bring my AGI to $0.

Solution #3: You can still give appreciated securities to your donor advised fund, direct to charity, or to a private foundation as you may have done in the past. This kind of gift is generally limited to 30% of your AGI. You would not reduce your income all the way to $0 but this could still be a very good option for many folks looking to reduce their income below their average.

Here is the simplified math:

If you’ve gotten this far and we haven’t lost you, we’ll remind you of the first two questions we asked: Do you have strong charitable intent that you would like to fulfill? And can you live without your IRA required minimum distributions, both now and in future years?

If the answers to both of these questions are “yes” or even “maybe,” you should consider a conversation with us as well as your CPA before time runs out. Remember, this opportunity is set to expire at year-end.

This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.