Mark Witaschek, CFP®, Rob Cordeau, CFP®, RICP®, Catrina Buxton, CFP®
Some have stated that the new tax law is going to kill charitable donations. While the tax law does hinder some from reaping the tax benefits of charitable donations, there are still a number of ways to capture the deductions to which we’ve grown so accustomed.
The biggest factor impacting charitable deductions is the increase to the standard deduction. Under the old law, about 26% of taxpayers chose to itemize deductions – that is, their total itemized deductions exceeded their standard deduction. However, under the new law – with its higher standard deductions – it’s estimated that only 5% to 10% will be able to itemize.
As you can see from the chart below, these are some sizeable increases. It’s not that charitable deductions have been taken away – it’s just that fewer people will have access to them!
|Standard Deduction for Taxpayers Filing as…||Old Law (2017)||New Law (2018)|
|Single (under age 65)||$6,350||$12,000|
|Single (age 65 or over)||$7,900||$13,600|
|Head of Household||$9,350||$18,000|
|Married Filing Jointly (both under age 65)||$12,700||$24,000|
|Married Filing Jointly (one age 65 or older)||$13,950||$25,300|
|Married Filing Jointly (both age 65 or older)||$15,200||$26,600|
|Additional Amount for Blind Taxpayers||$1,250||$1,300|
Let’s take a hypothetical married couple who are both 72 years old. Under the old law, they simply needed to exceed the standard deduction of $15,200 in order to itemize. Let’s imagine they had $12,000 of medical deductions, $8,000 of state and local taxes, and $6,000 of charitable donations. That gave them a total of $26,000 of deductions. Since this was far more than the $15,200 standard deduction, they would have chosen to itemize under the old law.
However, under the new tax law, their $26,000 of deductions in 2018 would actually be less than the new standard deduction of $26,600. They’ll receive the same $26,600 standard deduction whether they contribute zero or $6,600 to charity (or any amount in between). The tax incentive to donate has been effectively wiped out for the first $6,600 of donations.
So, what’s a tax-savvy, charitably inclined person to do? We’ll look at two powerful strategies:
1. Qualified Charitable Distributions
Qualified Charitable Distributions, or QCDs, have been around for a number of years now. However, with the passage of the tax law, and its higher standard deduction, QCDs have had new life breathed into them.
A QCD allows an individual over age 70½ to make a donation of up to $100,000 directly from an IRA account to a charity. Two major benefits to this approach are:
- The distribution does not count as a taxable IRA distribution
- The distribution does count toward satisfaction of your required minimum distribution (RMD)
For those whose deductions fall below the standard deduction amount, this opens up a way to give to charity, and still receive a powerful tax benefit. In fact, even those who can itemize under the new tax law can capture benefits by using QCDs:
Benefits & Features of QCDs:
- Removes funds from your IRA without increasing your adjusted gross income (AGI). Having a lower AGI can result in:
- Lower taxes
- Higher medical deductions
- Reduced Modified Adjusted Gross Income (MAGI), which could reduce the taxation of Social Security benefits due to the “Social Security inclusion ratio”
- For those taxpayers who have Medicare premiums that are increased by the level of their income, lower premiums are possible if MAGI is reduced by a QCD
- Amounts distributed via a QCD apply toward satisfying your required minimum distribution (RMD).
- Check must be payable directly to the charity. Taxpayer may NOT take possession of the funds and write a subsequent check to the charity.
- If you donate directly to a charity via a QCD, you cannot also claim a charitable deduction on your Schedule A (itemized deductions) for that same donation. This would constitute ‘double-dipping’, as you would already be receiving a tax benefit since the QCD is not adding to your AGI.
A QCD is not for everyone over age 70½, however. In addition, a QCD, in and of itself, cannot increase your net worth. You might compare a QCD to a coupon at a restaurant to buy one entrée and get one free. If your sole objective was to increase your net worth, you wouldn’t travel to the restaurant for the explicit purpose of using that coupon – you’d stay home and boil some water for ramen noodles instead! However, if you were going to that restaurant anyway, then the coupon would absolutely improve your net worth, by saving you the cost of one entrée.
The same principle applies to a QCD. You can’t increase your net worth simply by using this approach. You are – after all – giving away money. But if you were planning to give to a charity anyway, and if that donation could come from an IRA, then by all means use your QCD coupon! It’s the most tax-effective way of getting IRA dollars into the hands of the charitable organization of your choice.
2. ‘Bunching’ Deductions
While QCDs work great, they just aren’t available for those under age 70 ½. However, ‘bunching’ or ‘bundling’ together certain itemized deductions is a strategy that can work at any age. The concept is useful for those whose normal deductions are equal to, or less than, the standard deduction amount. These taxpayers can bundle together certain deductions every other year and achieve a total itemized deduction amount that exceeds the standard deduction every second year. Here’s an example:
Our hypothetical couple is under age 65, and has a standard deduction of $24,000. Let’s assume they don’t have enough medical expenses to take that deduction. However, they do have $10,000 of state and local taxes, plus $8,000 of mortgage interest, and $5,000 of budgeted charitable donations. Total deductions = $23,000. That’s $1,000 less than the $24,000 standard deduction.
This couple can’t do much to alter the amount of state and local taxes or mortgage interest that they pay each year. But they are in complete control of the amount and timing of their charitable donations. Rather than making donations of $5,000 per year, the chart below shows a side-by-side comparison of normally spread deductions vs. bunching deductions – with $10,000 in even years, and zero in odd years (still averaging $5,000/year):
|No Bunching of Deductions||Bunching Deductions|
|Year||Deductible Expenses||Standard Deduction||Deduction as Filed on Return||Year||Deductible Expenses||Standard Deduction||Deduction as Filed on Return|
Even though this couple contributed the same amount to charities over this 7-year period, they enjoy $16,000 more in tax deductions – simply by controlling the timing of their donations.
This could be accomplished by contributing $5,000 in early January, and another $5,000 in late December (slightly less than a 12-month interval) in even years like 2018, and then they would wait until early January 2020 (slightly more than a 12-month interval) until the next charitable contribution. Another method to allow for even distributions every month or year to charitable organizations while obtaining a larger deduction in the year of donation is the use of a Donor Advised Fund.
As you can see, charitable donations are not dead. Far from it. Giving really is its own reward. And those who are charitably inclined will donate to non-profit organizations even if there were zero tax benefit. But the reality is – there’s still a tax benefit. It just requires a bit more planning to capture it.
As you plan your family’s giving this year, don’t forget to talk to your tax or financial advisor about the potential use of these two strategies. You’ll sleep well knowing you’re making the world a better place. And you’ll save some tax dollars while you’re at it!
McLean Asset Management Corporation (MAMC) is a SEC registered investment adviser. The content of this publication reflects the views of McLean Asset Management Corporation (MAMC) and sources deemed by MAMC to be reliable. There are many different interpretations of investment statistics and many different ideas about how to best use them. Past performance is not indicative of future performance. The information provided is for educational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy or sell securities. There are no warranties, expressed or implied, as to accuracy, completeness, or results obtained from any information on this presentation. Indexes are not available for direct investment. All investments involve risk.
The information throughout this presentation, whether stock quotes, charts, articles, or any other statements regarding market or other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither our information providers nor we shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission there of to the user. MAMC only transacts business in states where it is properly registered, or excluded or exempted from registration requirements. It does not provide tax, legal, or accounting advice. The information contained in this presentation does not take into account your particular investment objectives, financial situation, or needs, and you should, in considering this material, discuss your individual circumstances with professionals in those areas before making any decisions.