2018 is the first tax year we will see the direct effects of the 2017 Tax Cuts and Jobs Act as these effects relate to donors’ inability to deduct their charitable contributions on Schedule A of their Form 1040 income tax returns. The Internal Revenue Code allows tax filers to claim either their itemized deductions or the standard deduction (whichever is greater) on their annual tax return. As the standard deduction for married filing joint filers has increased from $12,700 in 2017 to $24,000 in 2018, it is projected that close to 90% of Form 1040 filers will not be itemizing their deductions, eliminating the tax benefit of claiming certain deductions such as charitable contributions.
For example, if you’re a family of four with an adjusted gross income (AGI) of $125,000, total giving of $10,000, and total Schedule A deductions of $19,000, you were able to reduce your 2017 taxable income by $6,300, due to your giving during 2017. That reduction to your taxable income resulted in total federal and state “tax subsidies” of approximately $1,890, assuming a federal marginal tax rate of 25% and state rate of 5%. Fast forward to 2018, assuming similar circumstances, your total tax subsidies will be $0, also assuming there are no special income subtractions in your state for certain charitable giving.
Many taxpayers wonder if there is a way to “lump” this giving every few years in order to still take advantage of these available tax subsidies. While it can be difficult to significantly adjust the timing of other itemized deductions such as income taxes, property taxes, and mortgage interest (don’t forget, home equity interest is no longer deductible starting in 2018), charitable giving is a bit easier to consolidate in order to still receive a tax benefit.
Donor-Advised Funds
Donor-advised funds are established by a donor and are held by a nonprofit organization (the sponsoring organization) in order to provide a flexible and efficient way for the donor to recommend grants to other nonprofit organizations. When the donor funds the initial contribution into the donor-advised fund, the donor receives a tax deduction at that time. From a timing perspective, a donor may wish to lump his or her charitable giving by contributing a large sum of money into the fund, thereby receiving the tax deduction in that year, notwithstanding how many years it may take to distribute grants out of the fund to recipient organizations. In recent years, this has become a very popular way of making charitable contributions, so much so that in 2015, the Fidelity Charitable Gift Fund became the largest recipient of charitable funds in the United States.
Charitable Gift Annuity
A charitable gift annuity is a written agreement between an existing charitable organization and the donor. The donor receives a tax deduction when making the initial contribution (usually either cash or appreciated securities). This calculation is based on the value of the assets donated, less the expected amounts to be received from the trust. The charitable organization invests the funds and makes monthly or quarterly annuity payments back to the donor (the “annuitant”). These payments are generally fixed and do not fluctuate or adjust due to inflation or market performance. A portion of these annuity payments may be tax-free to the annuitant based on the annuitant’s life expectancy.
Charitable Remainder Trusts
Charitable remainder trusts are a nice option for larger donations, especially donations of appreciated property which can then be sold by the trust. Donors create and fund this irrevocable trust, which must be a charitable entity in the eyes of the IRS. Donors receive a tax deduction when funding the trust that is calculated similarly to that of a charitable gift annuity. Each year, the trust earns investment income and pays annuity payments, typically to the donor (although the donor can also name other living annuitants). Payments can be made based on a percentage of trust assets or based on a fixed number of years, subject to certain rules. When all annuitants pass away, the trust distributes the remaining funds to the beneficiaries named by the donor. Very often (as our nonprofit clients will attest) a beneficiary may be unaware of the existence of the trust until they receive the funds. These trusts will have some annual fees that charitable gift annuities don’t have, which is why they are a better option for larger donations. But, again, having the ability to obtain a large tax deduction when funding the trust allows the donor to not be concerned with the timing of when funds will eventually be paid to the beneficiaries.
Donors should know that regardless of the method chosen, gifting appreciated securities is generally better than gifting cash. If a donor sets up a charitable remainder annuity or a donor-advised fund by gifting appreciated securities, the value of the gift is the fair market value of the securities on the date of the gift, not the donor’s basis. Not only does the donor receive a higher charitable deduction, he or she will avoid the capital gains tax that would have been triggered if the securities were sold. Donors can use the tax savings and the newly created tax subsidy from the deductible donation to repurchase more of the same securities and, in doing so, they will have a higher cost basis. So, donors should never sell appreciated securities with the intent of gifting the cash. Donors should always gift the appreciated securities without selling them.
When considering giving large donations to a public charity, taxpayers should be mindful of the following limits:
Standard limit on donations to public charities and private operating foundations is 50% of AGI
Limit on donations to certain other private foundations is 30% of AGI
Limit on donations of appreciated securities is generally 30% of AGI
Any amounts that exceed the aforementioned limits can be carried over to each of the next five tax years until used.