As the season of charitable giving approaches, donors may wish to educate themselves about the significant changes in the new federal tax code and strategize accordingly.
Under the Tax Cuts and Jobs Act of 2017 (TCJA), the standard deduction for 2018 returns is nearly double that of 2017:
<$12,000 for singles (up from $6,350)
<$18,000 for heads of household (up from $9,350)
<$24,000 for married couples who file jointly (up from $12,700)
Those 65 or older, blind, or disabled can deduct an additional $1,300 if married and $1,600 if single. The personal exemption has been eliminated.
Miscellaneous expenses are no longer deductible, and the deductions for state and local taxes have been capped at $10,000.
As a result, those who might no longer itemize deductions and whose decisions are driven by tax efficiency more than by philanthropy may be less inclined to donate to charity.
Enter the concept of “bunching.” Bunching, which is not new, can help taxpayers itemize in alternating years while providing charities with a consistent income stream. TCJA increases the number of taxpayers who should consider this technique for their charitable contributions.
Most charitable organizations operate on a July-to-June fiscal year rather than a calendar year. To “bunch” contributions, one could donate to a charity both in the first half and second half of the tax year yet be acknowledged as a donor for the charity’s 2017-2018 and 2018-2019 fiscal years. The contributions could then follow the same pattern in 2020 for recognition in the 2019-2020 and 2020-2021 fiscal years. While the donor in this scenario would need to skip making donations every other tax year, the charity would likely receive the same level of contributions from the benefactor over time.
Admittedly, bunching donations to surpass the standard deduction requires a significant initial cash outlay, so only certain taxpayers will be able to utilize this strategy.
Generally, donating appreciated assets such as publicly traded securities and real estate is typically more tax efficient than donating cash, and doing so may push the taxpayer’s itemized deductions above the standard deduction. By donating an appreciated asset, one can write off the higher current value of the asset while avoiding capital gains treatment.
Another tax-reducing strategy would be to make charitable donations through a donor-advised fund (DAF), such as a community foundation, which accepts cash and appreciated securities. The donor could supercharge his or her giving during a bunching year. In subsequent years, he or she could take the standard deduction while recommending grants from the DAF to nonprofits of his or her choice, resulting in ongoing income for those charities.
Finally, it is important to note that the new federal tax law essentially doubled the lifetime estate and gift tax exemption. In 2017 the limit was $5.49 million per person, while in 2018 it is $11.2 million. For married couples filing jointly that limit is $22.4 million. Since fewer people will be subject to federal estate and gift taxes, these higher exemption levels may be a boon to charities.
One must also consider state tax laws when gifting or donating. In Pennsylvania, individually held property and retirement plan assets after age 59½ are taxable under state inheritance tax. Property jointly titled, life insurance proceeds and retirement plan assets prior to age 59½ are tax-exempt. Any property passing directly to a spouse is also not taxed. For taxable assets, the rate is 4.5 percent for property passing to children, grandchildren, parents and in-laws. The rate is 12 percent for property passing to siblings and 15 percent for property passing to all others.
With such complexity, it makes sense to continually consider the new tax code throughout the year when making financial and charitable giving decisions.
Carrie L. Fellon is a financial strategist at Agili of Bethlehem and Richmond, Virginia. She responsible for client financial strategy and counsel, comprehensive financial planning, and investment management. She can be reached at firstname.lastname@example.org.