The Tax Cuts and Jobs Act (TCJA), passed in December 2017, included an increased standard deduction for taxpayers. The increased standard deduction will limit the number of taxpayers itemizing deductions and the usage of charitable contributions as part of itemized deductions. For 2018, the standard deduction is $24,000 for married filing jointly (MFJ) taxpayers and $12,000 for single taxpayers. This has become more complicated because the state and local income tax deduction under the TCJA was capped at $10,000 for all taxpayers.
The TCJA also provides for an increase in charitable deductions of up to 60 percent of adjusted gross income. This was previously 50 percent of adjusted gross income, but many taxpayers won’t benefit from this increased allowance of deductions. Taxpayers have several strategies they can consider as they look to find ways to get the tax benefit of their charitable contributions.
The first strategy to consider is to bunch charitable contributions to get an increased itemized deduction and tax benefit. Assume MFJ taxpayers who typically give $10,000 a year to charity have a $10,000 state income tax deduction and home mortgage interest deduction of $4,000. The new standard deduction is $24,000, so if they itemize, their deduction will be the same as the standard deduction. This gives them no tax benefit from their charitable contributions.
If, however, the taxpayers give $20,000 every other year to charity, they would still get the $24,000 standard deduction in the year with no charitable contributions and $34,000 of itemized deductions in the year with charitable contributions.
A tool that can be used to assist with bunching charitable deductions is a donor-advised fund (DAF). A DAF allows a taxpayer to give a current-year charitable contribution and receive a deduction, but distribute the funds to qualified charities over time. There are several organizations that help taxpayers set up a DAF, some with a minimum donation of $5,000. This is an alternative to setting up your own private foundation that requires less administrative maintenance. There are multiple organizations that can help set up these funds, including investment brokers, colleges and universities, or your local community foundation. Once you’re ready to make those charitable gifts, your DAF advisor can help you direct the donation to a qualified charitable organization.
Here’s an example of how a DAF can assist with bunching charitable contributions to increase itemized deductions. Using the example above, assume instead that the taxpayer wants to give $20,000 a year to charity. If they give this amount evenly over five years, they would get an itemized deduction of $34,000 each year. If they give $100,000 in one year—the same amount they planned to give over five years—they would have an itemized deduction of $114,000 the year of the $100,000 gift, and could use the standard deduction of $24,000 the other four years. Over a five-year period, that equates to $40,000 more in tax deductions.
Another consideration is the use of qualified charitable donations, which are available to individuals with traditional individual retirement accounts (IRA) who have reached age 70.5 and are required to take a distribution from their IRA account each year. The required minimum distribution—up to $100,000 annually—can be paid directly to a public charity. The charitable distribution can’t be directed to a private foundation or DAF in this scenario. Other items to keep in mind are that the distribution can be used to satisfy a taxpayer’s pledge to a qualified charity and the taxpayer must not receive any benefit from the charity.
This strategy avoids the income tax on the amount distributed from the IRA. The $100,000 doesn’t show as income to the taxpayer on the tax return, but also doesn’t show as an itemized deduction and isn’t subject to limits on itemized deductions. MFJ taxpayers should keep in mind the $100,000 limit is per taxpayer, so MFJ taxpayers are eligible to pay up to $200,000 directly to a public charity. This must be taken out of each spouse’s IRA account.
The strategies for maximizing itemized deductions—and using charitable contributions to do this—have changed with the passage of the TCJA. Taxpayers concerned with increasing the economic benefit of their charitable contributions should consider working with their tax advisor to determine the best way to accomplish this. It’s also important to keep in mind the higher standard deductions are effective from January 1, 2018, until December 31, 2025, so there may be a need to revise your charitable giving strategy in a few years.
BKD hosted a webinar in September 2018 that went into more detail on these strategies—watch the archived presentation. For more information, contact Nicole or your trusted BKD advisor.