The tax changes passed by Congress at the end of 2017 involve major changes to the way most people itemize deductions. The combination of the increase of the standard deduction to $24,000 or more, the limitation to $10,000 on the amount of state and local taxes that can be deducted and a few other changes, means that only an estimated 10% of taxpayers will itemize in 2018, compared to the 30% of taxpayers who itemized before the tax law went into effect.1
These changes may have a significant impact on charitable giving because a donor who does not itemize deductions receives no tax benefit for his or her charitable contributions. Major donors, those who give around $15,000 or more per year, will largely be unaffected by these changes since these donors likely will continue to itemize. However, many smaller givers will lose significant tax breaks for their charitable giving.
Most donors give without consideration to the tax benefit, but if you are going to give, you should look for ways to find some tax benefits even if you no longer itemize. Here are some ideas to consider, from simple solutions to more complex strategies.
Use Your IRA
If you are older than 70 ½ and have a traditional IRA, you should consider using the IRA to make direct contributions to your charity. We have written about this strategy in the past. If the IRA custodian pays the charity directly, the distribution does not appear on your federal tax return as income, putting you in the same (or better) position than if you took the distribution, paid tax on it, made the contribution, and then deducted the contribution. There also can be state income tax (especially in Ohio) and other federal tax benefits to this approach, and it is still a great idea even if you do itemize deductions.
Bunch Your Contributions
You should consider bunching multiple years’ worth of contributions into a single year. For example, if you normally give $5,000 to a charity, you could donate $15,000, $25,000 or even $50,000 in a single year, maximizing the deduction in that year, and then use the standard deduction in the other years. Of course, you should let the charity know what you are doing and to not expect contributions in later years. If you can, consider this this approach in a year when you have other deductible expenses, such as large medical expenses.
Use Appreciated Securities
The tried and true approach of using appreciated long-term securities to fund your gifts remains valid even if you do not itemize. By using appreciated stock, you avoid the capital gain tax on the sale, even if you do not get a deduction. This idea can also save state income taxes in states that use the federal taxable income as the starting point for state income tax (like Ohio).
Use a Donor Advised Fund
The rationale behind this idea is the same as the one for bunching contributions, but now you “pre-fund” your donations through a Donor Advised Fund (DAF). When you fund a DAF, you give money to a public charity, which agrees to hold the money to fund future donations to other charities as directed (technically, as “advised”) by you. The charitable donation deduction is triggered in the year you fund the DAF, not when the funds are distributed to the ultimate charitable beneficiary. As a result, you can get a large itemized deduction in the year that you fund the DAF, and then use the standard deduction after that. You can use appreciated securities to fund the DAF (with some restrictions), thereby increasing the tax value. Many charities sponsor DAF programs, including the charitable arms of Fidelity and Schwab, two of the custodians we use here at Ancora. There are some administrative fees associated with DAFs, and you should consider these when determining whether to fund a DAF and how much you should give.
Use a Trust
This last idea is the most complex and carries the concept behind bunching contributions and funding a DAF one step further. You could use what is called a “non-grantor” or “complex” trust to fund your future charitable giving. A non-grantor trust is a trust that pays the income tax on its income at trust tax rates. Normally, these trusts are avoided in planning since they pay the maximum tax rate at relatively low levels of income. However, if the trust distributes all its income to a beneficiary, then the trust gets a deduction for the distribution, and the income tax is paid by the beneficiary. If the beneficiary is a charity that pays no tax, no income tax is due on the trust’s income.
Here’s an example. Let’s say you normally give $4,000 to $10,000 a year to charities. You set up a non-grantor trust and fund it with $200,000. (This is a taxable gift requiring the filing of a gift tax return and the use of some of your lifetime gift and estate tax exemption.) The trust gives you the power to distribute income to charities and names your children as the ultimate and discretionary beneficiaries. The trust assets are invested in high dividend producing stocks, as an example, and in the first year produces $6,000 in taxable income. All the taxable income is distributed to various charities. You pay no income tax because the trust income is not included on your return, the trust pays no income tax because it distributes all its income, and the charity receives the money just like it would normally. The tax impact to you is identical (if not better) than making a tax-deductible charitable gift. You do have to give up the use of the money you give to the trust during your lifetime, just like funding a DAF, but, unlike a DAF, the trust assets ultimately stay in the family. There are some state tax issues that must be considered, so this is a strategy that must be carefully vetted by your trust attorney and tax advisor.
As is always the case with taxes, each situation is different, and you should consult with your attorney and/or tax advisor before adopting any strategy discussed in this article.
1Source: Tax Policy Center Report T18-0009, Impact on the Tax Benefit of Charitable Deduction of H.R.1, The Tax Cuts and Jobs Act, By Expanded Cash Income Level, January 18, 2018.