By: Greg Pearson, tax advisor
As the end of the year quickly approaches, it is a great time to reevaluate your charitable giving strategies. One important factor to consider when determining the amounts and methods of your charitable donations is the impact on your income taxes. The Tax Cuts and Jobs Act was approved by Congress in late 2017, providing for a major overhaul to the US tax system. The new law nearly doubled the standard deduction for 2018 – to $12,000 for single filers and $24,000 for joint filers under age 65. While increasing the standard deduction alone will mean far fewer taxpayers will be claiming itemized deductions, that is further exacerbated by the change to the state and local income tax deduction, which is now capped at just $10,000.
So, what does this mean for the charitable deduction? It means fewer taxpayers will see a direct tax benefit from their charitable contributions without careful planning.
What planning can be done to minimize the after tax cost of charitable contributions? Combining several years of planned charitable contributions into one year, known as “bunching”, may provide a better after tax result. The bunching strategy provides the largest benefit to taxpayers who have nearly the amount of itemized deductions as the new standard deduction, but don’t quite cross that threshold in a normal year. Bunching the charitable deductions in to one year allows the itemized deductions to exceed the standard deduction, providing a tax benefit for the charitable deductions made. In the following years, you skip the charitable donation and the higher standard deduction is utilized.
What if you intend to provide a revenue stream for the charity and don’t wish to give it all to them now? There is a tool, known as the Donor-Advised Fund (DAF), which allows the donor to contribute funds to the DAF, creating a current tax deduction, while also determining when the DAF later transfers the funds to the designated charity. For the right person, the use of a DAF can be very beneficial from a tax perspective, but still allow you to provide the funds to the charity of your choosing on the intended timeline. Donor-advised Funds are available through financial services firms (Fidelity, Schwab, etc.), some independent groups (National Philanthropic Trust), and community foundations.
What other benefits may a Donor-advised Fund provide? For someone wishing to contribute appreciated marketable securities, the DAF may allow them to time the recognition of the charitable deduction with market highs, while not having to actually contribute the funds to the ultimate donee organization until desired. This locks in the charitable deduction amount at the market high value. Another benefit is that DAF’s can be utilized to help match up extraordinary income years (sale of business, taxable IRA rollover, etc.) with larger charitable contributions while continuing to maintain a steady annual stream of donations to the intended charity.
In order to illustrate the benefits of the charitable bunching concept, imagine a married couple that normally has about $20,000 of itemized deductions: $10,000 of taxes + $5,000 of mortgage interest + $5,000 of annual charitable donations. Under the new tax law, the $20,000 of itemized deductions is less than the $24,000 standard deduction and, therefore, the donor will receive no tax benefit for their charitable contributions. The total standard deduction of $24,000 per year taken over a 3 year period is equal to $72,000 of deductions.
Using that same example, imagine that the couple utilized a Donor-advised Fund in year 1 to combine 3 years of contributions. The DAF would allow them to provide the charity with the same $5,000 per year as intended. Now their itemized deduction for the current year totals $30,000: $10,000 of taxes + $5,000 of mortgage interest + $15,000 of bunched charitable donations. The $30,000 total itemized deductions exceed the $24,000 standard deduction and some tax benefit is received for the charitable donations made. The total deductions taken over a 3 year period utilizing a DAF is $78,000: $30,000 itemized in year 1 + $24,000 standard in year 2 + $24,000 standard in year 3. In comparison to the results in the prior example, the bunching strategy allowed for $6,000 of additional deductions over the same three year period using the same total amount of contributions.
As every individual’s tax situation is unique, it is recommended that you have a discussion with your tax advisor to determine the most advantageous method of meeting your charitable goals under the new tax laws, including whether the charitable bunching strategy and/or usage of a Donor-advised Fund are right for you.
Greg Pearson is a tax advisor at UHY, LLP. He provides tax consultation and compliance services for businesses and high net worth individuals, while UHY, LLP as a firm offers a full range of accounting services. He can be reached at: firstname.lastname@example.org or (314) 615-1249.