‘Tis the season – with December 31 rapidly approaching - for charitable giving. Charitable contributions can be tax-deductible, but only for taxpayers who are able to itemize on Schedule A of your 1040 income tax return. But it’s not as straightforward as it once was; before passage of the 2017 Tax Cuts and Jobs Act (TCJA).
The new law, which went into effect on January 1, 2018, introduced three significant changes affecting charitable giving: eliminating personal exemptions, limiting many previously allowed itemized deductions and raising the standard deduction.
It is anticipated that households claiming itemized deductions will be reduced from 37 million to 16 million in 2018. And many of these taxpayers will be taken by surprise when they learn – in April of 2019 – that they won’t be able to itemize on their 2018 returns.
While a multitude of factors motivates charitable giving, the tax code has provided an economic incentive for philanthropy by including a deduction for charitable contributions for over 100 years. But the deduction is only available to taxpayers who decline the standard deduction and itemize their deductions on Schedule A.
Tax Law Details
Under prior law, all taxpayers were entitled to a personal exemption of $4,050 for themselves, their spouse and each dependent. The TCJA eliminated the personal exemption – even for taxpayers who itemize – and rolled that benefit into the standard deduction, which has been raised from $12,700 to $24,000 for married taxpayers filing jointly and from $6,350 to $12,000 for single taxpayers.
Whether or not you can itemize on Schedule A requires comparing your potential itemized deductions to the new standard deduction. Potential itemized deductions (e.g., state and local taxes, mortgage interest, medical expenses in excess of 10% of Adjusted Gross Income (AGI), and charitable contributions) are all added together; and if they exceed the standard deduction, you can itemize and lower your tax bill.
For example, in 2017, a couple might have had AGI between $100,000 and $200,000, $8,100 in personal exemptions and the following deductions: $10,000 in mortgage interest, $10,000 in state income and property taxes and $4,000 in charitable contributions; bringing their total exemptions/deductions to $32,100. (The new law caps state and local income and property tax deductions (SALT) at a combined $10,000 – not nearly as big a problem in a moderate tax state like Colorado as it will be in New York and California.) But in 2018, because of the standard deduction having been increased to $24,000, the same couple would have no incentive to itemize and would lose any tax benefit from the $4,000 in charitable contributions.
So it may be time to get creative with a couple of solutions that restore the tax benefit for charitable contributions.
Bunching and the Donor Advised Fund
One such strategy for getting over the standard deduction threshold is lumping or “bunching” - in which you group more than one year’s worth of itemized deductions, including charitable contributions, into one year. Prepay up to $10,0000 of your state income and property taxes (in a state where that is permissible); make your January mortgage payment in December and make several years of charitable contributions all at once. And then aggregate them all on Schedule A to a combined amount above the standard deduction. You can revert to the standard deduction in subsequent years.
If you are not sure which charities you ultimately want that larger donation to benefit, you can make the contribution to a Donor Advised Fund (DAF), sponsored by a public charity. Like many community foundations, The Summit Foundation sponsors a DAF within its endowment. As do most of the larger brokerage firms. The DAF then acts as a staging area, allowing you to make distributions at your own pace to their ultimate non-profit destinations.
The IRA Charitable Rollover
Another arrow in the quiver is the IRA Charitable Rollover, more technically know as the Qualified Charitable Distribution (QCD).
Once you reach age 70 ½ you are required to withdraw, by December 31, a minimum amount every year (RMD) from your traditional IRA and include the amount withdrawn as ordinary income on your tax return. For those with large balances in their IRA’s these required taxable withdrawals can be for substantial amounts; even if you don’t need the money to live on.
But a QCD allows an IRA owner who has reached age 70 ½ to make a tax-free transfer of up to $100,000 per year directly from an IRA to a public charity without reporting the distribution as taxable income. Such a distribution can satisfy your RMD up to $100,000 or can be in excess of the RMD up to that amount.
Since the QCD is not included in your income, this strategy is not hemmed in by the deduction limitations of the new tax law and effectively functions as a charitable deduction without the fuss.
Get Some Advice and Counsel
These are the highlights of just a couple of techniques to help you get more out of your philanthropy. There may be others that work for you, as well. If you are interested in learning more about charitable giving -- and planning to manage the tax consequences, please don’t hesitate to give us call. As with any matters involving the tax code there are technical rules you need to follow to properly take advantage of these strategies. So please first consult with your own advisors to determine how the new law applies to your own personal circumstances.
And have the Happiest and Most Joyful Holiday Season!
Board Member, The Summit Foundation
CFP, RightPath Investments and Financial Planning
For more information, contact Megan Nuttelman, Director of Donor Relations, firstname.lastname@example.org