By Jane M. Searing, CPA, MS Taxation
The Tax Cuts and Jobs Act’s change to the standard deduction provides opportunities for multi-year tax planning. The new law may affect charitable giving, depending on the taxpayer’s taxable income before their charitable deduction.
Let’s take the case of a married couple and their three basic deductions: state and local taxes, home mortgage interest, and charitable contributions. Of these three most common deductions, only the charitable deduction allows for flexibility or tax planning; the remaining are relatively fixed deductions.
Our first couple earns $200,000, has $24,000 of mortgage interest and $10,000 in state in local taxes. For this couple, a $1,500 charitable contribution would reduce their taxable income and reduces their marginal tax rate from 24 to 22%. Because $165,000 taxable income is the break point between the 22 and 24 % marginal tax rate for married filing jointly taxpayers, this couple’s $1,500 deduction brings taxable income below $165,000.
Another couple, similar to the one above, but who do not have large mortgage interest, would require a larger charitable deduction to reduce taxable income to the 22 % bracket. In their case, it may be more advantageous for this couple to group their charitable contributions into one year and take the standard deduction in subsequent tax years. In order to know for certain, a tax planner would need to do the calculation based upon the fixed amounts of interest and taxes and adjusting the variable amount of charitable contribution the taxpayer is considering making.
The change enacted by the Tax Cuts and Jobs Act of 2017 suspended or sharply curtailed most itemized deductions for tax years 2018 through 2025. State and local tax deductions are limited to $10,000 for the year, and home mortgage interest is limited to purchase and improvement debt up to a maximum threshold of $750,000 ($375,000 for married filing separately). These all affect taxable income before the charitable deduction, which is key to planning for the optimal benefit from charitable deductions. Each taxpayer must look at their own tax situation to determine whether total itemized deductions will provide more tax savings than the standard deduction. If the sum of the two fixed itemized deductions, mortgage interest and taxes are close to the standard deduction amount, grouping charitable contributions may be an effective tax savings strategy. The Pease amendment, which limited itemized deductions for adjusted gross income above certain thresholds, was also repealed so taxpayers must compare the full amount of itemized deductions to the increased standard deduction.
Continuing with our examples above, suppose the married couple are baby boomers who are likely in their higher income years to have a dwindling mortgage, but still have high state and local taxes. With no charitable contribution, and solely considering the deductions for state and local taxes and mortgage interest, they are better off with the standard deduction. However, with a $10,000 charitable contribution deduction, itemizing is more beneficial because it is more than the standard deduction. By grouping or bundling charitable contributions into a single tax year, they can obtain even more benefit from their contributions. Instead of contributing $10,000 per year for 2018 and 2019, the couple contributes $20,000 in 2018 and nothing in 2019. This will also allow the taxpayers to qualify for the lower 24% marginal tax rate. $315,000 is the break point between the 32 and 24 percent income tax rate for individuals in 2018.
Donor Advised Funds
If a taxpayer has no preferred charity to which they normally contribute, or wants to defer deciding which charity to support, a donor advised fund (DAF) can be an ideal way to manage the grouped or bundled contributions. A DAF allows contributors to make a completed gift in one year and advise to whom distributions are made from the DAF in future periods. There are restrictions on how a DAF may be used. DAFs may not make distributions to any natural persons, may not satisfy a personal pledge (except as outlined in IRS Notice 2017-73), and may not be used to purchase memberships or tickets to fundraising events the donor/donor advisor uses to attend. However, so long as none of these restrictions are a barrier, a DAF can be an excellent tool to accommodate bundling of contributions to take advantage of the larger standard deduction created by the Tax Cuts and Jobs Act of 2017.
If you have questions on how the changes in the tax law affect your personal circumstances, please call or email to make an appointment with your Clark Nuber tax advisor. We are always happy to meet with you to discuss your individual goals and help you minimize your tax liability.
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