Explaining the New Landscape for Charitable Tax Breaks

Lower Tax Rates

One key aspect of the TCJA is the reduction of income tax rates, welcomed by many taxpayers. Lower rates, however, devalue all deductions, including charitable contributions. Suppose, for example, Alice contributes $1,000 to her favorite charity. Under prior law, Alice was in the 28% tax bracket. Her $1,000 deduction saved Alice $280 in tax, so her true cost was $720. With similar income, Alice might be in the 24% tax bracket now, so that same $1,000 saves Alice only $240 in tax, and her after-tax cost rises from $720 to $760. For roughly the same after-tax cost, Alice might donate only $950 to this charity rather than $1,000. These numbers might seem minimal, but people making larger donations may have to scale back substantially to hold down the after-tax cost of their charitable giving.

Fewer Itemizers

Unlike Alice, many taxpayers will see the after-tax cost of a $1,000 donation rise from, for example, $650 or $720 or $750 to $1,000—that is, their donations will receive no tax benefit at all. This could happen to taxpayers who choose to take the standard deduction rather than itemizing. The TCJA raised the standard deduction and restricted itemized deductions, especially the one for state and local taxes (SALT). For years, approximately 30% of taxpayers (mainly those with higher incomes) itemized their deductions; starting with 2018 tax returns, it is estimated that only 10% will itemize. Taxpayers might not realize that taking the standard deduction means they will not itemize and therefore will not receive any tax benefit from their charitable contributions.

Qualified Charitable Distributions

Overcoming the lack of itemized deductions for charitable contributions might be easiest for taxpayers age 70½ and older, as they are eligible for qualified charitable distributions (QCD), up to $100,000 per person per year, from their IRAs to charity. These QCDs will not be tax deductible, but they will count toward required minimum distributions (RMD).

For example, suppose Jan, age 74, has $850,000 in her traditional IRA. Her RMD this year is about $36,000. If Jan makes a QCD of $25,000 to her favorite charity, her remaining RMD would be only $11,000. She has reduced her income by $25,000, effectively getting a tax deduction for the QCD. Indeed, reducing her adjusted gross income (AGI) by $25,000 may create greater tax savings than a $25,000 itemized deduction, due to various tax code provisions.

Bunching Donations

Taxpayers younger than 70½ who do not itemize deductions will have to find other ways to receive charitable tax benefits. One possibility is to bunch donations together every few years in order to benefit from itemizing in the donation years. Suppose, for example, that Brad, age 50, expects to pay no mortgage interest and have no deductible medical expenses each year. His only itemized deductions would be state and local taxes (SALT) paid (capped at $10,000 a year) and $10,000 of charitable donations, for a total of $20,000. Brad and his wife Dee will take the $24,400 standard deduction on their joint tax return in 2019, so they will not itemize.

Instead, they might donate $30,000 to a donor-advised fund in 2019. Together with a $10,000 SALT deduction, they would receive $40,000 of itemized deductions in 2019. During the next two years, they refrain from making charitable contributions. Assuming the standard deduction remains at $24,400, their deductions for 2019 through 2021 would be $40,000 (for 2019) + $24,400 (for 2020) + $24,400 (for 2021) = $88,800. Taking the standard deduction all three years would save them only $24,400 × 3, or $73,200, so they would receive some tax benefit from this arrangement. Meanwhile, after their $30,000 contribution in 2019, they could spread out donations from their donor-advised fund over those three calendar years so that the charities are not adversely affected by this bunching approach.

Corporate Donations

Regular C corporations can deduct charitable contributions of up to 10% of their taxable income each year, regardless of whether shareholders itemize deductions. Thus, owners of C corporations can receive some tax benefit from contributing to charity, even though the reduced 21% corporate tax rate limits the value of such a contribution.

Business owners operating as sole proprietors or via pass-through entities will report business charitable donations on their personal returns. Again, they can receive a tax benefit only by itemizing. If the payment to charity has a valid business purpose (e.g., advertising in a charity’s publication), freelancers and owners of pass-through entities might legitimately claim a deduction for a business expense.

Estate Planning

Current law provides that charitable bequests are deductible from the decedent’s estate, which might reduce estate tax. With a current exemption of $11.4 million, however, few people will owe the federal estate tax, and thus few estates would receive a deduction from a charitable bequest.

Instead, people who intend to make charitable bequests might accelerate their giving and make lifetime donations. After age 70½, the donations can be QCDs, with the tax benefits explained previously. Younger people could front-load donations, making them large enough that itemizing makes sense.

Another tactic to consider is to make charitable bequests from an IRA at death; this could permit larger bequests of other assets to heirs. Even if heirs will not have to be concerned with federal estate tax, they still could enjoy income tax advantages if they inherit fewer IRA dollars and more appreciated assets with a step-up in basis.

Donations of Securities

Since the stock market chaos of 2008–2009, equity values have broadly increased. Investors may be holding appreciated stocks and stock funds in taxable accounts; in this case, donating some appreciated shares to charity, rather than giving cash, may be a tax-effective tactic.

For example, suppose Jim donates $20,000 to his alma mater every year. In the past, he has written checks for the contributions. In 2019, Jim donates $20,000 worth of stocks that he bought years ago for $5,000. Assuming Jim would owe 15% tax on a $15,000 long-term capital gain, the tax bill on a sale would be $2,250; thus, those shares are actually worth $17,750 to Jim, in terms of cash. By donating the shares to his alma mater, Jim is receiving the tax benefit of a $20,000 charitable contribution, even though he is relinquishing assets worth $17,750 after tax. The college, as a qualifying charitable organization, can sell the donated shares and keep the full $20,000. Meanwhile, no one ever pays tax on this $15,000 long-term capital gain.

Note that this strategy makes sense only if the donor will itemize deductions; the larger the donation, the greater the itemized deduction, and the more tax benefit from the charitable contribution. Therefore, it may make sense to contribute a large amount of appreciated securities in one year to a donor-advised fund, take a large upfront tax deduction, and then spread the contributions to a charity or charities over multiple years.

To donate shares to charity, an investor should contact the financial firm or mutual fund company holding the shares to get the required transfer form. It is also a good idea to notify the charity that shares are on the way, providing the security’s name, the amount being transferred, and the donor’s address for an acknowledgment.

Donating securities that have lost value is not a good idea. It is usually better to sell the shares at a loss and donate the cash from the sale. The capital loss can be valuable, either as a current tax deduction or as an offset to realized capital gains in the year of the sale or in the future.

Charitable Remainder Trusts

A charitable remainder trust (CRT) can be funded with many types of assets, but appreciated securities are frequently suggested. Once the assets are in the trust, income beneficiaries (often the donor or the donor and spouse) receive a stream of cash flow, perhaps for life. After the payout period from the trust to the income beneficiaries has expired, the remainder goes to a named charity or multiple charities.

As is the case with any donation of appreciated securities, a transfer to a CRT generates current tax benefits. There is no upfront capital gains tax on the asset appreciation. In addition, the donor will receive a tax deduction; the larger the income stream and the more time until the expected donation to charity, the smaller the deduction (as a percentage of the donation).