There is a new tax law that has changed everything for a while. One of the biggest changes is the new expanded standard deduction and the elimination of many itemized deductions. Before we discuss these changes, a good understanding of the standard and itemized deductions is necessary.
The standard deduction is a reduction of taxable income that every American collects. In essence, the standard deduction is the initial amount of tax-free income every American, from the poorest to the richest, receives. Under this new tax law, that amount is $12,000 if you file as a single person and $24,000 for a married couple. If a single person is blind or over 65 years of age, then the standard deduction increases by $1,600 to $13,600. For each married person, blind or over 65 years of age, they receive $1,300 per person for a potential maximum of $26,600.
The standard deduction is the automatic tax-free portion, but if the itemized deductions exceed the standard deduction, then you receive the itemized amount (instead of the standard deduction) as your tax-free reduction of taxable income. Under the new tax law, itemized deductions are the accumulation of your medical, state, local, and property taxes; interest paid; and charitable donations, with each category subject to limitations. If you are married, and the total of each category of itemized deductions after the limitations is $23,000, then the standard deduction of $24,000 is more; thus, you typically will take the standard deduction. Whenever you take the standard deduction, then this means that in essence, you garner no tax benefit from your charitable donations. Even if you had a total of $25,000 of itemized deductions, and you do itemize, it is important to realize that you received $1,000 of extra deduction. Hopefully this brief explanation of standard versus itemized deductions helps clarify the magnitude of the problem for tax-deductible charitable contributions.
As in any tax law, there is a workaround, but no workaround will apply to everyone. Three things to consider in terms of tax-deductible charitable contributions are as follows:
- For anyone over age 70.5 years (that is not a typo: you must be 70 ½ years of age or older) with monies in an individual retirement account (IRA), you can and should make a qualified charitable distribution (QCD) for any gift to a charitable organization of more than $100. Therefore, you should try to overcome the desire to give your church or charity of choice a weekly or monthly check and instead contribute with a single lump sum QCD from an IRA. Note that a QCD can only be made from an IRA and not from a 401K or 403B retirement account. It is also worth noting that at tax time, it is only you and your records that can alert a tax preparer to the fact that you donated part of your IRA distribution tax-free to charity, that is, your IRA custodian will not designate the charitable distribution on any tax forms at the end of the year. You also must be provided with a charitable receipt acknowledging the gift. Making a QCD assures the tax-free benefit of charitable giving. The other tremendous benefit of using an IRA for your charitable giving goals is that it reduces your adjusted gross income, which impacts so many parts of your overall tax return.
- If you are not over 70.5 years of age and are concerned about the loss of charitable giving deductibility, then consider bunching. Bunching is when you give two years of charitable contributions in one year and then skip the next year of giving. For example, assume my itemized deductions get me to $23,000 in 2018, which therefore means that I will likely use the standard deduction of $24,000. Assume also that of the $23,000 in itemized deductions, charitable contributions were $10,000 of the total. As a wise tax planner, you would give all $10,000 of 2019 charitable donations in December 2018 so that in 2018, your itemized deductions blossom to $33,000, making $9,000 of charity donations tax-free. If you waited until 2019 to give the same $10,000, then you would receive no deduction for all $20,000 of contributions in 2018 and 2019.
- The next technique is the penultimate of bunching and it is giving to a donor advised fund using highly appreciated stock. This is still a viable technique if you use cash, but it is most effective if you use appreciated stock. The donor advised fund is a vehicle (offered by both Schwab and Fidelity) that allows for a contribution in the year of the gift, but then can be given in any amount (over $50) to any charity of your choice over multiple years into the future. Assume that you have $100,000 of highly appreciated stock, and you typically give $15,000 per year to charity. You give the $100,000 of the appreciated stock in 2018 to a donor advised fund, take the majority of the charitable gift as an itemized deduction in 2018, and then use the donor advised fund to make tax-free gifts to your choice of charities over the next 5+ years. In addition, the funds are invested in the donor advised fund such that there may be continual tax-free growth of the assets until gifted to charity. One important note, gifts of highly appreciated stock are limited to 30% of your adjusted gross income, and if giving $100,000, then you need $333,333 of total income to be able to deduct the full amount. Any excess can be carried over to the next year, but that defeats the purpose of the donor advised fund getting the itemized deduction benefit. If you make a large tax donation to a donor advised fund, then it requires careful tax planning and consideration of a Roth conversion to create the income to absorb the deduction.
Most individuals do not make charitable contributions because they believe there is some special tax benefit; however, these tax strategies help to restore the tax benefits that charitable citizens were previously receiving under the law for the last 50+ years.
Be sure to contact your Financial Consulate personal financial manager if you are over 70 ½ years of age or if you give more than $3,000 per year in cash, check, stock, or charitable donations.