We often give to charities on the spur of the moment during fundraising drives or at an event like a gala, rather than having a charitable giving plan. Giving by check (otherwise called checkbook philanthropy) is generally the default for these spur of the moment donations. With the doubling of the standard deduction from the recent tax reform, the tax benefit of such gifts has been reduced or eliminated as most households won’t have enough deductions to itemize.
By having a plan, we can work to reduce your tax bill, while still giving to your favorite causes.
Charitable contributions through a donor advised fund
Because fewer taxpayers will itemize deductions, charitable contributions will likely require more planning, even though there was no change in their deductibility. Charitable “bunching” with a donor advised fund (DAF) can allow multiple years of contributions (and their deduction) in a single year.
Case study: A couple nearing retirement gives a few thousand dollars to their favorite charities year after year. Outside of charitable deductions, they have $14,000 of other itemized deductions between mortgage interest paid, and sales tax and real estate taxes. Since the former standard deduction for a couple under age 65 was $12,700, any dollar this couple gave to charity directly reduced their tax bill as it was added on top of the $14,000.
Now that the standard deduction has increased to $24,000, this changes the effectiveness of their giving. If they give $10,000 or less to charity, they lose all tax benefits associated with this gift because the $24,000 standard deduction is higher. In many cases, it can make sense for couples to contribute several years’ worth of donations into a DAF that can be distributed to charities in any amount or frequency for the rest of their lives. So instead of donating $5,000 a year, which is below the standard deduction, this couple could contribute $50,000 of appreciated securities to the DAF and receive the tax deduction now and be able to distribute to charities later. This especially makes sense for individuals nearing retirement who are in a much higher tax bracket now than they will be once retired.
Charitable contributions through a qualified charitable distribution
Similar to the above, many retirees won’t receive the full tax benefit related to their charitable giving due to the doubling of the standard deduction. One way for individuals age 70½ and above to receive the full benefit from charitable giving is through completing a qualified charitable distribution (QCD) from their annual required minimum distribution (RMD). Rather than having to itemize these donations, 100% of the gift is tax-free, so it doesn’t show up in your taxable income. With a QCD, you’re eligible to give up to $100,000 of your RMD to any number of charities throughout the year.
Case study: Phil and Sue are retired and in their 70s. Giving to charity is a priority for this family. In fact, they like to give 10% of their pension and Social Security benefit and 15% of the previous year’s investment returns from their portfolio to several charities important to them. For this year, this amounts to a $10,000 gift based on income and a $25,000 gift based on last year’s investment returns. Phil’s RMD for this year is $45,000.
Previously, this couple wrote checks to their designated charities and deducted the gifts as part of their itemized deductions. Outside of charitable giving in the range of $20,000 to $40,000 a year, this couple had $14,000 of other deductions made up primarily of state and local income tax and real estate taxes and a small amount of mortgage interest paid.
Now that the standard deduction has increased from $15,200 in 2017 ($12,700 standard deduction + $2,500 additional standard deduction for being above 65) to , part of their charitable giving won’t produce any tax benefits. In this example, there are no tax benefits for $12,600 of their gift-related deductions ($26,600 total standard deduction – $14,000 other itemized deductions) because their other non-charitable itemized deductions were well below the $26,600 standard deduction.
Instead of itemizing, this couple could complete $35,000 of QCDs to cover a large part of Phil’s RMD. Instead of receiving this $35,000 of taxable income first from Phil’s retirement account, the QCDs allow these pre-tax dollars to never be taxed. This means the couple receives 100% of the tax benefit from their giving versus losing $12,600 worth of tax benefits if they itemize.
Please contact Merriman to speak with an advisor about how best to give to charity given your circumstances, or for any of your other financial planning needs.