Charitable Deductions
With the tax law changes that became effective in 2018, the average person has potentially lost the benefit of their charitable contributions. However, there are several very straightforward options that you may be able to take advantage of.
Before discussing the options, let’s take a quick look at what has caused the issue in the first place. Prior to 2017, a married couple filing jointly could itemize deductions if their total itemized deductions (medical, real estate and state income taxes, mortgage interest, etc.) exceeded $12,700. As a result of the Tax Cuts and Jobs Act (TCJA), the threshold a taxpayer must meet prior to being able to itemize almost doubled when it increased to $24,000. To make it even harder to itemize, the TCJA limited the deductible taxes to $10,000. As a result, the number of taxpayers able to itemize decreased by more than 50%. So, what are the options?
Option #1: Donor Advised Fund
With this option, a taxpayer can take advantage of a Donor Advised Fund (DAF). A DAF is essentially a tax-deferred investment account where:
- The taxpayer takes a deduction when the account is funded, thus accelerating the deductions
- The taxpayer can pay the amount out to their charities of choice over a period of years
- The money grows tax-free in the account
- The taxpayer can name a beneficiary to take over the charitable giving in the case they pass while there are still assets in the account
The reason this creates a benefit is the acceleration of multiple years of charitable contributions allows the taxpayer to exceed the threshold in year 1, and take the standard deduction in future years; thus losing fewer deductions cumulatively.
Option #2: Required Minimum Distributions to Charities
Here, a taxpayer who is over 70 ½ and, as a result, has a requirement to take Required Minimum Distributions (RMD) from their Individual Retirement Account (IRA) can direct those RMDs directly to a charity of their choosing up to $100,000 of RMDs per year. In this case:
- The taxpayer’s gross income is reduced by the amount redirected to the charity
- The taxpayer does not need to qualify to itemize their deductions to receive the benefit of the contribution
- The taxpayer can make the election annually but should do so prior to taking their RMD
This creates the largest benefit because the taxpayer gets the full benefit every year without any loss of deductions.
To illustrate the impact, the example below demonstrates the Base Case (i.e., annual contributions), Option 1 and Option 2 – as outlined above).
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To learn more about taking advantage of these planning techniques, contact Clayton & McKervey today.
| Charitable Contribution – Funding Options: (Base Case) After Tax Dollars, (2) Donor Advised Fund, or (3) IRA Required Minimum Distribution (RMD) | ||||||||
| 2019 | 2020 | 2021 | 2022 | 2023 | Cumulative Benefit | |||
| Base Case: | Make charitable contributions yearly with after tax dollars | |||||||
| Adjusted Gross Income | $200,000 | $200,000 | $200,000 | $200,000 | $200,000 | |||
| State, Local, City Taxes (maximum) | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | |||
| Mortgage Interest | 5,000 | 5,000 | 5,000 | 5,000 | 5,000 | |||
| Charitable Contributions | 15,000 | 15,000 | 15,000 | 15,000 | 15,000 | |||
| Itemized Deductions | 30,000 | 30,000 | 30,000 | 30,000 | 30,000 | |||
| Standard Deduction | 24,400 | 24,800 | 24,800 | 24,800 | 24,800 | |||
| Greater of Itemized or Standard | 30,000 | 30,000 | 30,000 | 30,000 | 30,000 | |||
| Taxable Income | 170,000 | 170,000 | 170,000 | 170,000 | 170,000 | |||
| Tax | (a) | 29,149 | 29,149 | 29,149 | 29,149 | 29,149 | 145,745 | |
| Option 1: | Fund a Donor Advised Fund (DAF) in Year 1, pay annual charitable from DAF | |||||||
| Adjusted Gross Income | $200,000 | $200,000 | $200,000 | $200,000 | $200,000 | |||
| State, Local, City Taxes (maximum) | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | |||
| Mortgage Interest | 5,000 | 5,000 | 5,000 | 5,000 | 5,000 | |||
| Contribute to Donor Advised Fund | 75,000 | – | – | – | – | |||
| Itemized Deductions | 90,000 | 15,000 | 15,000 | 15,000 | 15,000 | |||
| Standard Deduction | 24,400 | 24,800 | 24,800 | 24,800 | 24,800 | |||
| Greater of Itemized or Standard | 90,000 | 24,800 | 24,800 | 24,800 | 24,800 | |||
| Taxable Income | 110,000 | 175,200 | 175,200 | 175,200 | 175,200 | |||
| Tax | (b) | 15,917 | 30,397 | 30,397 | 30,397 | 30,397 | 137,505 | |
| Benefit of DAF (Option 1 vs Base Case) | =(a)-(b) | 13,232 | (1,248) | (1,248) | (1,248) | (1,248) | 8,240 | |
| Option 2: | Fund charitable contributions from IRA as RMD | |||||||
| Adjusted Gross Income (reduced by portion of RMD going direct to Charity) | $185,000 | $185,000 | $185,000 | $185,000 | $185,000 | |||
| State, Local, City Taxes (maximum) | 10,000 | 10,000 | 10,000 | 10,000 | 10,000 | |||
| Mortgage Interest | 5,000 | 5,000 | 5,000 | 5,000 | 5,000 | |||
| Charitable Contributions | – | – | – | – | – | |||
| Itemized Deductions | 15,000 | 15,000 | 15,000 | 15,000 | 15,000 | |||
| Standard Deduction | 24,400 | 24,800 | 24,800 | 24,800 | 24,800 | |||
| Greater of Itemized or Standard | 24,400 | 24,800 | 24,800 | 24,800 | 24,800 | |||
| Taxable Income | 160,600 | 160,200 | 160,200 | 160,200 | 160,200 | |||
| Tax | (c) | 27,049 | 26,961 | 26,961 | 26,961 | 26,961 | 134,893 | |
| Benefit of RMD vs. Funding with After tax dollars (Option 2 vs Base Case) | =(a)-(c) | 2,100 | 2,188 | 2,188 | 2,188 | 2,188 | 10,852 | |
| Benefit RMD vs. DAF (Option 2 vs 1) | =(b)-(c) | (11,132) | 3,436 | 3,436 | 3,436 | 3,436 | 2,612 | |
| Assumptions: | Married Filing Jointly | Gross Income: | $200,000 | |||||
| State Taxes: | $10,000 | |||||||
| Option 2: | Taxpayer is required to take IRA Required | Mortgage Interest: | $5,000 | |||||
| Minimum Distributions (RMD) | Charitable Contribution: | $15,000 | ||||||
