How to reduce your tax liability using qualified charitable donations and state tax credits
by Stephanie Sterling, EA, AIF®, ChFC®
Every year it seems the tax code becomes more and more complicated; as some opportunities disappear, others are created that can lower taxes due when tax returns are filed. Below are two common techniques tax professionals use to lower their clients’ tax burden.
If you have a Traditional IRA (not 401(k), TSP, 403(b) or 457(b) plan), you are over 70 ½ and you are charitably inclined, you can donate directly from your IRA to a qualified charity. This is called a Qualified Charitable Distribution (QCD). Once you reach age 72, the amount you donate can also be counted toward your Required Minimum Distribution (RMD) for the current tax year.
RMDs are normally included in income and subject to both federal and state income taxes. QCDs are excluded from income and not subject to federal or state taxes. The distribution must be paid directly from the IRA to the charity, not paid by personal check. Using this technique, you can exclude up to $100,000 ($200,000 on a married filing joint return) from income, lowering both federal (and state) taxes by the amount donated.
You can also use state tax credits as a tax planning tool. These credits do not technically “lower” your tax liability, but they allow you to direct where your tax dollars are being spent. State tax credits are non-refundable and can be used to help reduce your state tax liability to $0. You can make contributions up to April 15 of the year after the tax year you apply them to.
If you make cash donations to a charity certified by the Arizona Department of Revenue, your donation qualifies for the credit. The charity must provide you with a receipt containing a special code used on your tax return. Your contribution reduces your tax liability by the amount donated (with limitations). The great news is you don’t need to itemize to receive state tax credits!
For example, let’s say your 2020 state tax liability is $300. You donate $200 to a listed charity. Your state tax liability is reduced to $100, and the named charity receives the $200 you donated. If your state tax liability is $100 and you donate $200, your tax liability is reduced to $0, and the $100 balance is carried forward against future taxes for up to five years.
The Arizona Department of Revenue (ADOR) has a resource page listing every organization that qualifies for tax credits and the donation limits: https://azdor.gov/tax-credits.
Reach Stephanie Sterling, EA, AIF®, ChFC® at 928.460.5526 or 100 E. Sheldon Street, Suite 105 in Prescott.
The information provided in this article is not ideal for every tax situation. It is not intended to be a substitute for individualized tax advice. For your specific tax circumstances, you should seek advice from your own tax professional.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Stratos Wealth Partners, LTD., a registered investment advisor and separate entity from LPL Financial.