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Among the sweeping changes included in the federal tax reform legislation passed last year by Congress are various reforms that may affect the federal tax benefit of charitable giving.
Among the sweeping changes included in the federal tax reform
legislation passed last year by Congress are various reforms that
may affect the federal tax benefit of charitable giving. While the
reforms discussed below will expire at the end of 2025 (unless
extended by future legislation), they have sparked vigorous debate
about their potential impact on charitable giving. Donors may want
to consider the below strategies to maximize the value of their
charitable contributions under the new law, as well as the impact
of their gifts.
Increased Standard Deduction and Reduced Itemized
Deductions
The new law increases the standard deduction to $12,000 for
unmarried individuals, $18,000 for heads of household, and $24,000
for married individuals filing jointly. In addition, it eliminates
or limits various itemized deductions. In particular, the law
generally caps the deduction for state and local property, income
and sales taxes at $10,000 annually. Likewise, it reduces the
availability of the home mortgage interest deduction and eliminates
miscellaneous itemized deductions in their entirety. As a result,
the number of individuals who itemize their deductions is expected
to decrease significantly. Individuals who do not itemize cannot
claim a federal income tax deduction for their charitable
gifts.
Real World
Examples
Higher-Income Donor
Cathy, an unmarried professional who lives in a high-tax
state, has annual gross income in excess of $300,000, state and
local income and property taxes of $27,500 (limited to a $10,000
deduction), and deductible home mortgage interest of $15,000. Cathy
has regularly made charitable gifts of $20,000 annually to
organizations that have been meaningful to her life and serves on
the board of trustees of her alma mater. She would now like to
increase the amount she gives to 10% of her annual income and would
like to use this additional giving to support organizations in her
immediate community.
Middle-Income Donor
Tom, an unmarried professional who lives in a high-tax
state, has annual gross income of approximately $140,000 and state
and local income taxes of $12,000 (limited to a $10,000 deduction).
Tom rents his home and has no debt. He has historically made modest
charitable gifts each year, motivated in part by the tax savings.
He is now concerned, though, that he will not be eligible to take a
charitable contribution deduction.
Cathy previously itemized her deductions and will itemize under
the new law. Her gifts were previously deductible in full in the
year in which she made them, and her future gifts – including
the increased contributions she is contemplating – will be
deductible without any carryforward as well. Consequently, these
changes should not adversely affect her giving.
Strategy #1. The board of trustees of Cathy's alma
mater is concerned that gifts to the school from middle-income
donors may decline because fewer of such donors will itemize under
the new law (see right). Cathy might take advantage of her ability
to give on a tax-favored basis by offering to match a certain
dollar amount of gifts made by donors to the school. A matching
gift program would encourage contributions by those who might
otherwise be less inclined to give because of the increased
standard deduction and enhance the impact of Cathy's
donations.
Strategy #2. If Cathy would also like to assist
smaller organizations in her community, she could support them
directly (and the gifts would be deductible). Alternatively, if
Cathy is concerned about the organizations' ability to manage
the gifts, she could consider making her contributions through an
intermediary, such as a community foundation, that supports her
local organizations. Community foundations and other intermediary
organizations exist in many fields to direct funds and technical
support to community-based entities. Cathy might also find a
community foundation helpful if she is unsure of which
organizations to support. Community foundations are often able to
identify the organizations that best dovetail with a donor's
interests given their familiarity with local groups.
While Tom previously itemized his deductions, he will not
itemize now because his deductions do not exceed the standard
deduction. If Tom does not itemize, he may not claim a federal
deduction for his charitable gifts. However, Tom's itemized
deductions are only $2,000 short of the standard deduction.
Strategy #1. If Tom is able to afford it, he could
"bunch" the donations he would otherwise give over the
course of multiple years into one or more gifts this year that are
large enough to exceed the standard deduction. Tom could then make
"bunched" gifts every three years, for instance, rather
than annually. This strategy would enable Tom to continue to
support the organizations he cares about, while receiving a tax
benefit for his giving.
Strategy #2. If Tom is able to bunch his gifts, but is
concerned that the recipients would prefer to receive (and will
request) annual gifts, he could alternatively make his gifts
through a donor-advised fund (a "DAF"). The entire amount
of Tom's initial contribution to the DAF would be deductible in
the year he makes the gift. Tom would then have the flexibility to
recommend distributions from the DAF to the charitable recipients
of his choice at the times of his choosing (but would not receive
any further deductions for such distributions). As an added
benefit, the assets in the DAF would be invested and would
therefore likely grow over time. A contribution to a DAF could
therefore enable Tom to have an even greater charitable impact than
if he made his gifts directly.
Reduced Marginal Income Tax Rates
Very generally, the new law lowers the marginal income tax
rates, notably reducing the top marginal rate from 39.6% to 37%.
Lower tax rates reduce the tax savings generated by a charitable
contribution deduction. The tax brackets for capital gains remain
at 0%, 15%, and 20%.
Real World
Examples
Higher-Income Donor
Henry and Chris have annual gross income in excess of
$700,000, largely consisting of capital gains and dividends from
well-performing investments. In particular, they hold publicly
traded securities and complex investments in real estate and
private equity. Their itemized deductions, primarily consisting of
home mortgage interest, typically exceed $30,000 annually. Having
had significant financial success, Henry and Chris want to give
back by contributing to charity.
Middle-Income Donor
Pam and John have annual gross income of approximately
$175,000, consisting primarily of compensation. They live in a
state without an income tax, but pay property taxes and have a
mortgage. Nonetheless, their itemized deductions typically do not
exceed $15,000. While Pam and John have children and a good deal of
expenses, they manage their finances well and live comfortably.
They would therefore like to add charitable giving to their
budget.
While the federal tax liability on Henry and Chris's
ordinary income will likely decrease under the new law, the
liability on their capital gains will be comparable to prior
years.
Strategy #1. Henry and Chris could obtain two tax
benefits for their charitable gifts, and therefore maximize the
value of their philanthropy, by donating appreciated investments
that they have held for more than one year, rather than cash. Gifts
of appreciated capital gain property produce two tax advantages:
The donor avoids recognition of capital gains tax on the property
and is generally eligible for a deduction equal to the fair market
value of the assets. A gift of investment assets, instead of cash,
would also have the benefit of leaving Henry and Chris with
increased liquidity for expenditures.
Strategy #2. If Henry and Chris's chosen
charitable recipients do not have the capability to accept a
property gift, Henry and Chris could instead contribute their
assets to a DAF and support the organizations by recommending
distributions from the DAF to them. DAF sponsors typically have the
resources and expertise required to accept and manage non-cash
assets – whether marketable securities or more complex
investments.
Because of the reduction in tax rates, Pam and John's
federal income tax liability will likely decrease under the new
law, resulting in increased cash in their pockets following the
payment of taxes.
Strategy #1. While Pam and John may not itemize under
the new law, they might take advantage of their tax savings from
the reduced tax rates to make a charitable contribution they
otherwise could not afford.
Strategy #2. As discussed above, Pam and John might
also strategically structure their gifts to take advantage of the
charitable deduction – by "bunching" their
donations and using a DAF. In particular, if Pam and John need to
retain cash for expenses but have some appreciated assets that they
have held for more than one year, they could maximize their tax
savings by contributing a portion of the assets to a DAF. Pam and
John would receive a charitable deduction in the year of
contribution. Moreover, as discussed left, donating appreciated
capital gain property would be an especially tax-efficient giving
strategy because it would provide two tax benefits –
avoidance of capital gains tax as well as a fair market value
deduction. This approach would also enable Pam and John to provide
regular support to the causes they care about through periodic
distributions from the DAF.
Increased Charitable Contribution Limit
The new law increases the amount an individual who itemizes may
deduct with respect to cash gifts to public charities and certain
private foundations to 60% of the donor's contribution base (up
from 50%). The law also temporarily repeals the so-called
"Pease" limitation on certain higher-income taxpayers.
When applicable, this provision limited certain of a taxpayer's
otherwise allowable deductions, including the charitable
contribution deduction.
Real World
Examples
Higher-Income Donor
Susan is a wealthy, 72-year-old retiree. She has substantial
IRAs and investment assets, producing gross income in excess of
$400,000 annually. She has paid off the mortgage on her home, but
has state and local income and property taxes of $25,000 (limited
to a $10,000 deduction). She is extremely generous and would like
to give away as much of her income as possible in the form of
charitable gifts while she is able.
Middle-Income Donor
Mark, a 75-year-old retiree, lives in a state without an
income tax and rents his home. He consequently does not have any
itemized deductions. Mark has annual gross income of approximately
$75,000, primarily consisting of distributions from an IRA. He also
recently received a moderate inheritance from a family member and
would like to make a $10,000 charitable gift in the family
member's memory. At the same time, Mark anticipates his
expenses increasing with age and so has some reservations about
making the gift.
Susan previously itemized her deductions, although the Pease
limitation restricted them. She will itemize under the new law as
well, but will no longer be subject to the Pease limitation. She
will consequently be eligible to take advantage of the increased
charitable contribution limit.
Strategy #1. Under the new law, Susan will be able to
contribute a materially larger amount of cash to public charities
and certain private foundations on a tax-favored basis. By way of
example, if Susan's adjusted gross income ("AGI") was
$400,000 in 2017, she was eligible to deduct cash gifts to charity
of up to 50% of her AGI or $200,000. Susan's itemized
deductions were also subject to the Pease limitation, however,
reducing her charitable deduction by approximately $4,000. As a
result, Susan could ultimately take a charitable deduction of only
$196,000 for a $200,000 gift, leaving her with $204,000 of taxable
income (prior to the application of the state and local tax
deduction). If Susan has the same $400,000 of AGI in 2018, she may
make deductible cash gifts to charity of up to 60% of her AGI or
$240,000. In addition, the Pease limitation is no longer
applicable. The entire amount of Susan's gifts would therefore
be deductible, leaving her with just $160,000 of taxable income
(prior to the application of the state and local tax
deduction).
Strategy #2. If Susan would like to give away even
more, preferably on a tax-favored basis, she could obtain
significant additional tax benefits by using the IRA charitable
rollover (discussed right) as well. For example, assume that Susan
anticipates having $400,000 of income in 2018, $150,000 of which
will constitute IRA distributions. If Susan makes qualified
charitable distributions of $100,000 from her IRAs, the $100,000
would be excluded from her taxable income and Susan would have
$300,000 of AGI remaining. Of this, she could make deductible cash
gifts to charity of up to 60% of her AGI or $180,000. By combining
tax incentives, she would therefore be able to make $280,000 of
charitable gifts on a tax-favored basis and would have only
$120,000 of taxable income remaining (prior to the application of
the state and local tax deduction).
Strategy #3. Susan might also consider making a
charitable bequest. A bequest would not be deductible and is
currently unlikely to produce federal estate tax savings since
Susan is unlikely to be subject to the tax (see our
prior alert). However, if Susan would like to increase her
philanthropic impact through a charitable bequest, the bequest
could be structured to produce tax efficiencies (see right).
Mark did not previously itemize his deductions. He was therefore
not subject to the Pease limitation, but was also unable to deduct
his charitable gifts. Going forward, his income and expenses might
prevent him from strategically "bunching" his donations
(see above). As a result, Mark may continue to be prevented from
deducting his charitable gifts.
Strategy #1. Mark could obtain a meaningful tax
benefit for a gift in his family member's memory –
regardless of whether he itemizes – by using the
charitable IRA rollover. The charitable IRA rollover permits all
taxpayers age 70 ½ or older to transfer up to $100,000
annually from their IRAs directly to most types of public charities
(but not, for example, to DAFs) without recognizing the amount as
income. Donors who make qualified charitable distributions from an
IRA therefore avoid federal taxation on their gifts. They can also
use the charitable rollover amount to satisfy their required
minimum distribution for the year.
Strategy #2. If Mark remains concerned about future
expenses, he could alternatively consider using a portion of his
inheritance to fund a charitable gift annuity ("CGA") or
other planned gift. Mark would not receive a charitable deduction
if he does not itemize. However, a CGA would enable him to
accomplish his charitable objectives while providing him with a
meaningful lifetime income stream that would mimic the investment
income that he would otherwise have earned on the inherited
assets.
Strategy #3. Alternatively, if Mark ultimately
concludes that he is uncomfortable parting with capital-producing
assets during his lifetime, he could consider making a charitable
bequest. A bequest would not provide Mark with any federal income
or estate tax savings, but it would enable Mark to honor his family
member while retaining assets for lifetime expenses. In particular,
if Mark takes this approach, the most tax-efficient strategy would
be to make the bequest out of any retirement funds remaining in his
estate. If Mark names individuals as beneficiaries of his
retirement plans, withdrawals from the plans after Mark's death
would be taxable to the individuals as ordinary income. If Mark
names a tax-exempt charitable organization as the beneficiary, in
contrast, the organization would not be subject to tax on
withdrawals and Mark could bequeath other assets in his estate that
have more favorable tax profiles to his family or other chosen
individual beneficiaries.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.