As many have heard by now, the Tax Cuts and Jobs Act (TCJA) made numerous changes to the prior law, upsetting the tax strategies used by many Americans. While some changes were designed to “simplify” the tax code, many unintended consequences followed.
Perhaps the most impactful change was the near doubling of the standard deduction. This change led to a significant reduction in the number of taxpayers who continued to itemize. The Tax Foundation estimates that only 13.7% of taxpayers will itemize in 2019, compared to 31.1% in the previous year.
The unintended consequence of this dramatic reduction in itemization was the loss of the tax benefit of charitable deductions for those no longer itemizing. If your itemized deductions, which typically include mortgage interest, state and local taxes, and charitable contributions for most taxpayers, don’t exceed the new higher standard deduction, there were no tax savings for having made the contributions.
To be sure, charitable contributions should always be made based on one’s desire to support an important organization, not for a tax deduction. After all, giving $1 to save 30¢ in taxes never made financial sense, but it was nice to reduce your tax bill based on giving you were already doing. So, do these former itemizers have any opportunities to enjoy tax savings from their philanthropic contributions? Actually, yes, they do!
3 Tax-Savvy Charitable Giving Strategies
Here are three tax-smart ways to donate, whether you still itemize or not. Of course, each taxpayer’s situation is different and some may not apply to your specific tax situation. Always consult a tax professional before implementing any of these strategies.
1. Donate Appreciated Securities
Suppose a taxpayer has investments in a taxable brokerage account that they’ve held for over one year and which have gone up in value since they were purchased. This is rather common with the long bull run in the stock market.
Instead of using cash to make a contribution, donate the appreciated securities to the charity. Then, if you still like the investment, use the cash you would have donated to repurchase a like number of shares.
You will not receive a tax deduction, as we’re assuming you’re in the group of people who will no longer itemize (if you did itemize, you would be able to deduct the higher market value of the security, not the lower cost you paid). However, you will create a “stepped-up basis” in your shares, reducing your tax bill when you eventually sell the shares. Perhaps an example would make this clearer.
👉 For Example
Assume you purchased a stock for $1,000 five years ago and it’s now worth $3,000. Also, assume that you plan to contribute $3,000 to your church or other charity with cash that you have on hand.
Instead of donating the cash, donate the stock and then use the cash to repurchase new shares of the stock. The charity still receives a $3,000 gift. You still own the same number of shares and the cash is gone. But your cost basis in the new shares you purchased is $3,000.
Suppose two years later, you sell the stock for $5,000. Instead of having a $4,000 gain based on your original $1,000 purchase price, you have only a $2,000 gain based on your stepped-up $3,000 cost basis!
This results in a $2,000 reduction in your income in the year the stock is sold, along with a corresponding smaller tax bill.
2. Donor-Advised Fund
A donor-advised fund (DAF) is a charitable organization that receives tax-deductible contributions and then makes grants to other charities that the original donor requests.
As a charitably-inclined taxpayer, I can contribute several years of donations in one tax year by using a DAF to hold the funds until I’m ready for them to be distributed. I would receive a tax deduction for the full amount added to the DAF, allowing me to itemize for that particular tax year.
Then, in subsequent years when the DAF is distributing funds to my local church or other charities, I would take the standard deduction.
This strategy results in higher deductions over the course of several years. My wife and I use this strategy ourselves. We will contribute to our DAF and itemize in Year 1, followed by utilizing the standard deduction in Year 2. During Year 2, the funds in the DAF are used to contribute our tithe to our church and for other annual giving.
💡 The DAF can be combined with the earlier strategy to donate appreciated securities, thus providing multiple tax-saving benefits.
3. Qualified Charitable Distributions
This option is only available to taxpayers over 70 ½ years old with pre-tax IRA or 401k-type accounts.
Once a retiree has reached the age of 70 ½ years old (now extended to 72 years old by the recently passed SECURE Act), they are required to take Required Minimum Distributions (RMD) from a pre-tax retirement account and, of course, pay tax on the withdrawal. This is required even if they don’t need the money to meet their financial obligations.
Congress instituted the RMD as a way to ensure they would begin to receive tax dollars on pre-tax accounts. The addition of RMD income to a taxpayer’s return would not only increase their income tax liability but may also impact how much of their Social Security is taxed and potentially increase their future Medicare premiums! Failure to take the RMD results in a whopping 50% penalty for the IRS, so ignoring this mandate is not a good idea
For charitably-inclined taxpayers, the QCD may be a great option. With a QCD, the IRA or 401k custodian sends the withdrawal directly to a qualified charity that satisfies the RMD requirement but the taxpayer does not claim the distribution as income. By keeping the withdrawal off their tax return, the income tax owed is less, and Social Security taxation and Medicare premiums are not negatively impacted.
A Word of Caution
As with every area of tax law, there are exceptions and limitations to these strategies, so be sure to consult a tax professional familiar with your situation. Still, for many taxpayers, one or more of these tax-smart ways to donate may offer significant benefits, even for the multitude who now take the standard deduction.