While the Tax Cuts and Jobs Act of 2017 (TCJA) included a provision intended to allow individuals to increase their deduction for charitable donations to 60% of Adjusted Gross Income, the way this provision was written could result in no deduction at all for some gifts of appreciated securities and there were several other aspects of the TCJA that had negative ramifications on the benefit for charitable giving by individuals.
The American Enterprise Institute estimates that charities will collect $16.3 to $17.2 billion less in donations this year as a result of tax law changes. Of course, there’s no one way to make up for such a large number, but for the charitably minded individual, there are still plenty of strategies to donate to the causes that mean a lot to them, while incorporating smart income tax planning.
Notable changes for taxpayers included the standard deduction increasing to $12,000 for single filers and $24,000 for couples filing jointly. Furthermore, state and local tax deductions are now limited to $10,000 and the deduction for mortgage interest is capped on amounts up to $750,000 for mortgages originated after December 15th, 2017. The deduction for home equity debt was also completely eliminated. This combination of changes will result in substantially fewer households itemizing deductions and therefore more households taking the standard deduction instead. The Tax Policy Center estimates that the percentage of households that itemize will drop from 30% in 2017 to 10% in 2018. That’s more than 21 million households.
Without itemizing, taxpayers receive no tax benefit for making charitable contributions. Lower marginal tax rates overall also means lower incentives to give. Compounding this problem, the estate tax exemption also doubled, even further reducing incentives to make charitable bequests by Will or other estate planning measures. Given all these factors, it’s understandable why many charities are concerned about the effects the new law will have on their receipt of donations and ultimately about their ability to fund their budgets to carry out their missions.
QUALIFIED CHARITABLE DISTRIBUTION FROM AN IRA
One strategy that existed previously and has suddenly gained a great deal of appeal is the Qualified Charitable Distribution (QCD). At age 70 ½, individuals become subject to Required Minimum Distributions from their IRA accounts. Generally, these distributions are taxed as ordinary income to the extent the IRA assets are attributable to tax-deductible contributions or returns. As an alternative, taxpayers can avoid taxation to the extent that all or a portion of the distribution is delivered directly to a qualified charity as a QCD. One limitation on this strategy is that the amount donated is capped at $100,000 per year.
As opposed to taking the money out of the IRA, being subject to tax on that amount, and then giving the money to charity, a QCD forgoes generating the taxable income. This is very similar to receiving a deduction for the donation without the requirement to itemize deductions. As a further benefit, this amount counts towards fulfilling the Required Minimum Distribution.
The QCD amount also lowers the amount of your Adjusted Gross Income (AGI) which may be used in limitations for other deductions, including other charitable contributions. That reduction in Modified AGI could potentially decrease the portion of social security benefits subject to taxation and/or Medicare Part B and D premiums.
A married couple with the $10,000 maximum state and local tax deduction, $3,000 of mortgage interest and $10,000 of charitable donations. In a normal year, this would create $23,000 of itemized deductions and the couple would instead opt to use the standard deduction of $24,000. However, if they organized with their charities to accelerate two years of gifting into one year they would have $33,000 of itemized deductions. This produces an additional $9,000 tax deduction in that year! In the second year, they would use the standard deduction just as they would have otherwise done in the third year they return to doubling up, and so forth.
Taxpayers whose personal tax situation does not provide a benefit for charitable deductions could consider doubling their donations in any one calendar year. That’s not to say double the amount of giving, (although charities would appreciate that). Instead, this strategy involves altering the timing of the gifts to make them fall within the same calendar year. This creates a scenario whereby for tax reasons next year’s contributions are given the prior December enabling the taxpayer to itemize deductions in that year and then utilize the standard deduction in the next.
DONOR ADVISED FUNDS
If the doubling of gifts or gifting of securities doesn’t work logistically, making a gift to a Donor Advised Fund (DAF) may be a beneficial strategy. This allows the deduction in the present year for amounts intended to give to charities in the future. The funds can be invested inside the DAF) for some period of time and then distributed to charity in the future. Generally, distributions to any 501(c)(3) qualified charity are allowed.
Nearly every major brokerage firm has a DAF program, which makes establishing an account, selecting investment options, and directing distributions very easy. Furthermore, this likely simplifies tax reporting as the brokerage firm will provide a Form 8283 with the pertinent details of the contribution. The investment horizon need not even be a long period, as the DAF may provide a vehicle to immediately sell the security to fund a cash gift to the charity.
GIFT APPRECIATED SECURITIES
A longstanding practice for making large charitable gifts is donating appreciated securities instead of cash. By giving securities to charity, taxpayers can receive not only the deduction amount but also get the added benefit of avoiding capital gains tax on the sale of the securities.
Any security gifted in this way needs to be a long-term holding, held for greater than one year. The designated charity will also need to have an account to receive this gift, which most major charities have. It is important to note, however, that since the appreciated security has a fluctuating market value, it is likely that the actual gift value will fluctuate slightly from the amount intended to give. For example, a $5,000 gift could actually be $4,950 or $5,050.
It is also important to note that the deduction for gifts of appreciated securities to most qualified charities is limited to 30% of the taxpayer’s Adjusted Gross Income (20% for private foundations). As discussed below, the wording of the new 60% limit effectively means that these 30% and 20% limitation amounts are reduced to the extent of cash contributions made during the year. Any excess can be carried forward for up to five years.
THE NEW 60% LIMIT ISSUE
The Tax Cuts and Jobs Act increased the limitation on deductions for cash gifts to charity from 50% of Adjusted Gross Income in 2017 to 60% in 2018. The issue with this provision is how it interacts with the other percentage limits, such as for gifts of appreciated securities. The wording of the new tax law provides that cash contributions first reduce the percentage limits of other charitable gifts. This can result in taxpayers who donate both cash and appreciated securities losing the ability to deduct some or all of their gifts of appreciated securities.
An example may be the best way to explain: If someone with Adjusted Gross Income of $200,000 contributed $50,000 cash plus $40,000 appreciated securities to charity in 2017, he/she received a deduction for the full $90,000 because the appreciated securities did not exceed the 30% of Adjusted Gross Income limit and the $90,000 total contribution was less than 50%. However, in 2018 (unless the IRS corrects the issue) this taxpayer’s current deduction would be only $60,000 because the $50,000 cash contribution reduces the 30% limitation to $10,000. While the $30,000 of appreciated securities that were contributed in excess of this $10,000 limit can be carried forward for five years, if this taxpayer continues to have the same Adjusted Gross Income and makes the same contributions each year he/she will never receive the charitable deduction for it because his/her $90,000 annual contributions will be limited to $60,000 each year.
Although charitable giving has lost some of its straightforward benefits under the current tax regime, there are still plenty of strategies to employ that can provide tax benefits. We recommend that you speak with both your financial advisor and your preferred charities about how to best achieve your philanthropic desires. You can know that by being proactive, you are doing your part to maximize your own benefit and your impact as part of the giving public.
We would love the opportunity to speak with you and/or your family about any financial planning questions that you may have. Please contact your RCL Advisor to allow us to help.
RCL Advisors, LLC
60 East 42nd Street Suite 2400
New York, NY 10165