One of the most significant changes under the Tax Cuts and Jobs Act of 2017 is its impact on individual taxpayers and their decision whether to itemize income tax deductions or claim the dramatically increased standard deduction.
By Michael King, NCF
To itemize or not to itemize
The new tax law almost doubles the standard deduction to $24,000 for a married couple filing jointly, $18,000 for head of household, and $12,000 for individuals. This means that, in order to receive a tax benefit from your charitable contributions, your total itemized deductions – state income taxes, real estate taxes, mortgage interest, charitable contributions, etc. – must exceed these standard deduction thresholds.
Exceeding these thresholds has become more challenging for many taxpayers due to other restrictions placed on state and local taxes and mortgage interest imposed under the new law. For example, state and local taxes are now capped at a maximum allowable deduction of $10,000. In other words, if your state income taxes and real estate taxes combined are $18,000, you’ll lose any tax savings on the $8,000 that exceeds the $10,000 cap.
Some estimates predict that as many as 90 percent of all taxpayers will now opt for the standard deduction.
Furthermore, the amount of mortgage interest that can be deducted has been limited to a loan amount of $750,000 (down from $1 million under the previous law), and interest on home equity loans is no longer deductible unless the money is specifically used to acquire, construct, or improve your home. A single taxpayer or a married couple filing separately can each deduct a maximum of $375,000 (down from $500,000). However, there is a grandfather provision that allows a deduction at the higher thresholds under prior law for mortgages and home equity loans already in place prior to the new tax law changes.
The higher standard deductions, combined with these restrictions and limitations on state and local taxes and mortgage interest are expected to result in a dramatic decline in the number of taxpayers who will itemize their deductions. Some estimates predict that as many as 90 percent of all taxpayers will now opt for the standard deduction. In light of this new reality, generous taxpayers who may not itemize their deductions on an annual basis should consider three primary strategies that may allow them to capture at least some tax benefits from their charitable contributions.
“Bunching” charitable contributions
This helps by capturing charitable deduction benefits every few years
Some taxpayers may benefit from bunching two or three years of charitable contributions into a single year in an effort to exceed the standard deduction threshold for that year, and then taking the standard deduction in subsequent years. For example, consider the following couple who files a joint tax return.
Joe and Mary incurred state income taxes of $14,000, real estate taxes of $8,000, mortgage interest of $4,000, and made charitable contributions totaling $8,000. Their combined state income and real estate taxes are capped at $10,000 under the new law. Therefore, Joe and Mary can claim total itemized deductions as follows:
$10,000 State and Local Taxes
$ 4,000 Mortgage Interest
$ 8,000 Charitable Contributions
$22,000 Total Itemized Deductions
Because Joe and Mary’s standard deduction of $24,000 exceeds their allowable itemized deductions of $22,000, they will pay less tax by simply claiming the standard deduction. Assuming their marginal income tax rate is 32 percent, the additional $2,000 of deduction provided by the standard deduction saves them $640 of taxes.
However, let’s assume Joe and Mary have the capacity to accelerate two years of giving into the current year, providing a charitable contribution deduction of $16,000 instead of $8,000. The total itemized deductions they can now claim are as follows:
$10,000 State and Local Taxes
$ 4,000 Mortgage Interest
$16,000 Charitable Contributions
$30,000 Total Itemized Deductions
Joe and Mary’s itemized deductions now exceed their $24,000 standard deduction by $6,000 producing tax savings of $1,920 at their 32 percent marginal rate. In the subsequent tax year, they would claim the standard deduction, and then bunch their deductions the following year and again claim their itemized deductions. If Joe and Mary were able to bunch three years of giving into a single year, they could increase their total itemized deductions further to $38,000, and capture additional tax savings of $4,480 over the standard deduction benefit.
If Joe and Mary have the capacity to bunch three years of giving into the current year, they receive charitable deductions of $24,000, producing tax savings of $4,480 for the current year and can grant to their favorite charities for the next three!
The bunching strategy is not limited exclusively to taxpayers who don’t itemize their deductions on an annual basis. Even taxpayers who would otherwise itemize their deductions each and every year might also benefit from this strategy. For example, consider another couple who also files a joint tax return.
Bob and Sheila have the same itemized deductions as Joe and Mary in the example above, except Bob and Sheila have $8,000 of mortgage interest instead of $4,000. The total itemized deductions they can therefore claim are as follows:
$10,000 State and Local Taxes
$ 8,000 Mortgage Interest
$ 8,000 Charitable Contributions
$26,000 Total Itemized Deductions
Because Bob and Sheila’s allowable itemized deductions exceed the $24,000 standard deduction, claiming their itemized deductions would capture $2,000 more in total deductions, saving them an additional $640 in taxes at their 32 percent marginal tax rate.
However, if Bob and Sheila were to bunch two years of charitable contributions into a single year, they would increase their current year charitable contribution deductions from $8,000 to $16,000, and their total itemized deductions would be as follows:
$10,000 State and Local Taxes
$ 8,000 Mortgage Interest
$16,000 Charitable Contributions
$34,000 Total Itemized Deductions
Bob and Sheila’s itemized deductions now exceed the $24,000 standard deduction by $10,000, saving a total of $3,200 in taxes, $2,560 more than the $640 tax savings they would otherwise recognize by giving each year. If they were able to bunch three years of charitable contributions into a single year, Bob and Sheila would save $4,480 more than if they gave each year.
Your NCF Giving Fund plays an integral role in the bunching strategy, as you can give multiple years of charitable contributions in a single year, and then grant the contributions to charities over the years you claim the standard deduction. In the meantime, the assets in your Giving Fund can be invested, and any growth or income will accrue tax-free, allowing you to give even more to your favorite charities. These tax benefits can be obtained simply by planning the timing of your charitable contributions wisely.
Gifts of appreciated publicly traded stock
This helps by eliminating capital gains tax
Gifts of appreciated publicly traded stock and mutual funds that have been owned for more than a year have always been a tax-leveraged asset to give, allowing you to capture a “double” tax benefit. Not only do you qualify for a charitable income tax deduction, but you and the charity avoid capital gain tax when the stock is subsequently sold. For taxpayers who no longer itemize their deductions, gifts of appreciated publicly traded stock can, nonetheless, provide tax savings from the avoided capital gain tax. For example, let’s revisit Joe and Mary’s situation above.
Gifts of appreciated publicly traded stock and mutual funds owned for more than a year are a tax-leveraged gift, allowing you to capture a “double” tax benefit.
Recall that the $24,000 standard deduction exceeds Joe and Mary’s itemized deductions of $22,000, and therefore, they would generally claim the higher standard deduction. Ignoring the bunching strategy for a moment, if Joe and Mary simply gave appreciated publicly traded stock instead of cash, they could increase their overall tax savings.
Assume Joe and Mary gave $8,000 of stock in Netflix that they purchased for $1,000. Upon sale, both Joe and Mary, and the charity, will avoid tax on the $7,000 capital gain, saving $1,400 (based on a 20 percent capital gain tax rate) that Joe and Mary would have otherwise paid when they sold the stock themselves. Even if Joe and Mary didn’t want to remove the Netflix stock from their investment portfolio, they could give the stock to charity, and simply repurchase the stock with a new basis of $8,000, effectively eliminating the built-in capital gain.
Therefore, despite Joe and Mary claiming the standard deduction, and therefore not capturing a tax deduction benefit from their charitable giving, they could nonetheless capture some tax benefits by giving appreciated, publicly traded stock instead of cash. Of course, Joe and Mary might consider implementing both the bunching strategy and giving appreciated publicly traded stocks, thereby further maximizing the overall tax benefits of their charitable giving.
And your NCF Giving Fund can simplify your giving of appreciated publicly traded stock. For example, if you desire to support four different charities with your stock gift, instead of making four separate gifts of stock to each of the charities, you can make a single gift of stock to your Giving Fund. Once NCF sells the stock, the proceeds can then be granted to each of the four charities.
In addition to publicly traded stock, other appreciated assets might also be good candidates for giving, instead of cash. For example, NCF often helps families give interests in their private family business or real estate holdings. These assets often have a very low tax basis and, correspondingly, high built-in gain. Giving these assets can similarly provide significant capital gain tax savings upon an ultimate sale.
Qualified charitable distributions
This helps by avoiding income tax on distributions from an Individual Retirement Account (IRA)
Qualified Charitable Distributions (QCDs) from an IRA, also known as a Charitable IRA Rollover, remain an attractive giving strategy for many taxpayers, especially taxpayers that don’t itemize their deductions. If distributions are made from an IRA directly to a qualified charity, you avoid income tax on QCDs, and the distribution counts toward your required minimum distribution.
For example, let’s revisit Joe and Mary’s situation. If they were to satisfy their annual $8,000 giving by making a QCD, and again, ignoring the other strategies of bunching and giving appreciated publicly traded stock, they could avoid $2,560 of taxes (at their 32 percent marginal tax rate) that they otherwise would have incurred if they took distributions from their IRA directly.
It is likely that the use of the QCD strategy will increase dramatically under the new tax law, as IRA assets represent such a significant source of wealth for so many taxpayers.
It’s important to be aware of certain restrictions on this strategy, including the requirement that the IRA owner must be 70 ½ or older. QCDs are limited to a maximum of $100,000 each year, and distributions must be made directly to a qualified charity. Although, private foundations, donor advised funds, and charitable remainder trusts do not constitute “qualified” charities, NCF can help facilitate such gifts through designated funds that name a single charity as the beneficiary of a fund. NCF can also establish multiple designated funds so that someone who wants to make a QCD and benefit two or three charities can simply create a separate designated fund for each charity.
It is likely that the use of the QCD strategy will increase dramatically under the new tax law as IRA assets (and 401(k) and other qualified retirement plans that are converted to IRAs) represent such a significant source of wealth for so many taxpayers. In addition, legislation has been proposed over the years that would increase the benefits and reduce the restrictions on this strategy—lowering the age requirement, increasing (or eliminating) the $100,000 maximum distribution, and expanding the definition of qualified charity to include donor advised funds and other charitable vehicles. There will likely be an even stronger push for greater flexibility with QCDs in future legislation, in light of the fact that so few taxpayers will now itemize their deductions.
Tax-wise planning so you can give more
While the primary motivations for charitable giving have not changed, the tax implications for giving may have shifted meaningfully for many taxpayers. However, with wise planning, you can continue to maximize your charitable giving through strategic tax-minimization strategies. If you are not planning to itemize your deductions on an annual basis under the new tax law, our team would love to help you explore how you might benefit from these strategies.
