Most of you are aware that the Tax Cuts and Jobs Act signed into law by President Trump in late December 2017 will bring sweeping changes to our federal tax landscape in 2018 and beyond. The tax deduction for charitable contributions and the resulting impact on charitable organizations is one area that deserves a more in-depth look.
While the new law is generally taxpayer friendly, we need to examine a few provisions that could hinder our ability to deduct charitable contributions and in-turn have a negative impact on the underlying organizations and their ability to carry out their charitable mission.
To Itemize or Not to Itemize
The primary concern is that far fewer taxpayers will itemize deductions in 2018 and future years. Each year taxpayers total their allowable itemized deductions and compare this amount to a statutory standard deduction and claim the greater of the two amounts. In the past, itemized deductions have included not only charitable contributions; but also state and local income taxes paid, real estate taxes on non-business property and residential mortgage interest. Some taxpayers could also deduct out of pocket medical expenses and a variety of other miscellaneous expenses if they met specific limits.
For many, the sum of these itemized deductions was far greater than the standard deduction. In 2017, the standard deduction for a couple filing jointly is $12,700 (higher for taxpayers 65 or older).
Here is where the BIG changes come in 2018:
- First, the standard deduction for a couple filing jointly has been raised to $24,000 (also higher for those over 65).
- Second, the maximum amount of state and local taxes plus real estate taxes that may be deducted is now limited to $10,000.
- Last, an entire category of itemized deductions known as “Miscellaneous Itemized Deductions” no longer exists. These are items such as out of pocket job expenses and investment and tax preparation fees.
With the tax deduction now limited to $10,000, a couple would need more than $14,000 worth of mortgage interest (subject to certain limitations), charitable contributions and medical expenses over the annual limit. Should the sum come up short of that figure, the couple would merely deduct the $24,000 standard deduction.
This provision will simplify recordkeeping for many taxpayers, but the burning question is, how will it influence charitable giving habits? Will knowing that they are not getting a tax deduction for their charitable donations cause people to curtail their giving? We think not, but many charities are concerned that they will see a dip in their support and in-turn will have to cut some of their valuable services.
All is not lost though! There are some tax planning strategies that taxpayers can follow to not only maximize deductions but also continue to support those charities that they value.
Deductions to the Max
One easy method to follow if the concept of “bunching.” Bunching is the strategy of potentially combining two years worth of contributions into one year. Here’s an example.
- Married couple filing jointly
- Mortgage is paid off, no significant out of pocket medical expenses.
- Give $12,000 annually to the same charities each year.
- In the 32% tax bracket.
Under the new rules limiting their state, local and real estate tax deduction to $10,000, their total itemized deductions would equal $22,000, and they would be better served to claim the $24,000 standard deduction. Will this impact their $12,000 annual giving?
Instead of giving $12,000 per year, they could delay their 2018 contributions until January 2019 and then make their regular $12,000 contributions in 2019.
The couple would claim the standard deduction of $24,000 in 2018 and save $7,680 of taxes ($24,000 x 32%). In 2019, they would claim itemized deductions of $34,000 ($10,000 taxes + $12,000 + $12,000) and save $10,880 of taxes rather than $7,680. This strategy saves them $3,200 of taxes over the two year period, keeps the funds flowing to their favorite charities, and may be repeated every two years!
Additional Maximizing Options
Donor Advised Fund
A very user-friendly technique is to establish a “Donor Advised Fund” (DAF) at your local community foundation or at most brokerages. A taxpayer can fund several years of contributions with one substantial gift into their DAF without any obligation to commit to future recipients or amounts of charitable grants. Furthermore, the funding could be with appreciated assets (such as marketable securities) which provides for a deduction at the fair market value of the asset and no tax on the unrealized gain.
As another advantage, the distributions from the taxpayer’s DAF account can be as little as $100 thereby enabling the taxpayer to use appreciated assets for smaller contributions effectively. Another benefit is that DAF decision making (to grant future gifts) may be shared with and/or transferred to the next generation(s) with no tax consequences and thereby provide financial and estate planning opportunities for the taxpayers.
Using our Married Couple Filing Jointly example, if a DAF was funded with $48,000 (four years of contributions) of appreciated property, the couple would be entitled to a $48,000 contribution deduction, pay no tax on the appreciated property gain and could more than triple the annual tax savings to almost $11,000!
Required Minimum Distributions
Taxpayers 70 ½ years of age or older receiving Required Minimum Distributions (RMDs) from Individual Retirement Accounts (IRAs) may make charitable contributions directly from their IRA RMD’s. This provision is not new, but since many older taxpayers will not itemize with the new law’s higher standard deduction, this opportunity becomes more important since it will effectively allow for a tax deduction for charitable giving by excluding what would be otherwise taxable IRA RMD income. Plus, there is an additional benefit of lowering Adjusted Gross Income which impacts other tax return amounts such as taxable social security.
Upping Your Contribution
In addition to the changes above, there is an enhancement to the charitable contributions rules in the new tax law. Previously, individuals who itemize deductions could deduct contributions up to 50% of their Adjusted Gross Income. For example, a married couple with $100,000 of taxable income could make deductible contributions up to $50,000.
Under the new law, that threshold has been raised to 60% meaning this couple could potentially contribute and deduct another $10,000 per year. While this new provision is certainly generous, the majority of taxpayers do not approach the 50% threshold, so the number of taxpayers benefiting from this provision will likely be limited.
The Tax Cuts and Jobs Act certainly has not brought simplification to federal income taxes, but it does create many new and enhanced tax planning strategies. While the general feeling is that the law is taxpayer friendly, each taxpayer will be impacted differently.
If you would like to see an analysis of how the law will affect you and what actions you can take to maximize your benefits, please contact me to schedule a Tax Reform Impact Review.