The Tax Cuts and Jobs Act of 2017 (TCJA) eliminated or impacted many aspects of individual income tax deductions. Among these was the much-cherished charitable contribution deduction. Fortunately for the philanthropic and their chosen charities, Congress did not eliminate the charitable contribution deduction and even expanded the limitation to 60% of adjusted gross income under the TCJA.
However, the TCJA significantly increased the standard deduction and eliminated or capped many existing itemized deductions. As a result, more taxpayers are projected to claim the standard deduction, in which would cause tax returns claiming itemized deductions to plunge from 47 million to 19 million. In turn, the number of taxpayers who receive a tax benefit from charitable contributions is estimated to fall from 36 million to 16 million.
While some experts predict many taxpayers will continue to make charitable contributions, despite the potential loss of a tax benefit, several strategies are available to the savvy taxpayer and his/her advisors to leverage as much tax benefit from a charitable contribution as possible. This article is the first of a two-part series examining strategic options for claiming a charitable contribution post-tax reform.
Every year, IRA owners over 70-and-1/2-years-old are required to take a required minimum distribution (RMD) from their IRA. RMDs and other IRA distributions are generally reported as taxable income on an individual’s tax return. For qualified taxpayers, using an IRA to make charitable contributions is one of the best options to maximize tax benefits from a charitable contribution.
Qualified IRAs have been given the opportunity to gift part, all, or more than their RMD each year to charity and not be taxed on the distribution. This is unique because normally when a taxpayer takes a distribution from a retirement account, they receive the distribution, pay tax on the distribution, then make a charitable contribution. In an increasing number of cases, the taxpayer may not realize any tax benefit from the charitable gift for reasons explained above. However, a qualified IRA owner may gift his/her distribution to a charity and it will escape taxation. Distribution to a charity also satisfies the taxpayer’s RMD, and it can be used to satisfy legally binding charitable pledges.
This favorable outcome does not produce a charitable contribution deduction because the income was never attributed to the taxpayer. Only in best case scenarios can a taxpayer fully maximize a charitable deduction, but if the income is never included on the taxpayer’s return, the taxpayer is effectively receiving a 100% charitable deduction for that income.
- IRA owner must be over 70-and-1/2years-old
- Maximum is $100,000 per year, per person ($200,000 MFJ)
- Only IRAs qualify—not 403(b), 401(k), or other retirement accounts
- IRA distributions cannot go to a donor advised fund
- The taxpayer cannot receive anything in exchange, such as food, event tickets, etc.
Donation of appreciated stock
Many older taxpayers own publicly-traded stock purchased years ago that is now worth substantially more than the original purchase price, which would result in capital gains tax if the stock is sold. Instead of selling the stock and donating the proceeds, net of tax, to charity, taxpayers are allowed to donate the stock itself to a charity and claim a charitable contribution deduction equal to the fair market value of the stock, as of the date of donation. This powerful option saves the taxpayer from paying capital gains tax while netting him/her a fair market value tax deduction.
A charitable swap is a donation of appreciated stock with a twist. In some instances, a taxpayer may have appreciated publicly-traded stock prime for donation, but he/she wants to keep the stock for some reason (strong performance, idiosyncratic preference, etc.). Instead of donating cash to the charity, the donor can instead donate the appreciated stock, receiving a full charitable contribution deduction as mentioned above. Afterwards, the taxpayer uses the cash he/she would have donated to charity to repurchase the same stock on the stock market. The end result is the taxpayer receives a fair market value charitable contribution deduction, escapes paying capital gain tax, and effectively receives a step-up in basis in the prized stock. This is especially powerful if the stock is later sold by the taxpayer, waiting at least one year for capital gains rates.
Many high net worth individuals may not have enough itemized deductions each year and will default to claiming the standard deduction, potentially leaving charitable contribution deductions unutilized. If cash flow is sufficient, taxpayers in this situation can “bunch” their charitable contributions for several years into one year by making a large donation one year and claiming a higher itemized deduction that year, then resorting to claiming the standard deductions in other years.
“Bunching” one’s charitable contributions is one of the simplest strategies, but it can leave charities searching for additional donations in the non-bunching years. Donor advised funds (DAF) are an increasingly popular charitable vehicle that solves the economic puzzle of bunching for charities, while still giving the taxpayer control over the timing and amount of their donations. A DAF is like a charitable bank account; it receives your donated funds and then waits for you to determine how much of the donation, when, and to whom your donation should be given. This method allows the taxpayer to bunch his/her deductions in one year, but spread the payments to a charity equally over several years.
Although tax reform threw a wrench in the charitable giving machine, opportunities still exist in many situations to harvest a tax benefit from taxpayers’ charitable contributions. Part Two of this series will explain how additional opportunities involving trusts can be created to claim a charitable deduction.
For more information regarding charitable giving, please contact John Ure or one of our tax advisors at 301.231.6200.