The Tax Cuts and Jobs Act of 2017 (TCJA) overhauled federal taxation for individuals and businesses. There were numerous changes made to the tax law, including to tax rates, the standard deduction, itemized deductions, deductions for moving expenses, benefits for dependents, alimony payments, and retirement plans.
When filing a return, individuals must decide between taking the standard deduction or itemizing deductions. Under the TCJA, a single taxpayer can deduct $12,000, married taxpayers filing jointly can deduct $24,000, married taxpayers filing separately can deduct $12,000 each, and heads of household can deduct $18,000. Individuals older than age 65 may deduct an additional $1,300 if married and $1,600 if single. The TCJA raised the standard deduction in all cases, making it more advantageous for many to take the standard deduction instead of itemizing. According to the Tax Foundation, nearly 90% of taxpayers are projected to take the TCJA’s expanded standard deduction (Erica York, “Nearly 90 Percent of Taxpayers Projected to Take the TCJA’s Expanded Standard Deduction,” Sept. 26, 2018, http://bit.ly/2kX3OXf). Thus, the tax write-off utility of deductions will be lost to many. The Exhibit illustrates this prediction with data from 2018.
Exhibit
The Tax Cuts and Jobs Act Reduced the Value of Complicated Itemized Deductions
In previous years, the tax deduction for charitable giving has helped taxpayers who choose to itemize reduce their taxes. With the new higher standard deduction, charitable donations will have a null consequence for many. As one solution, those who are age 70½ and older facing a required minimum distribution (RMD) from an individual retirement account (IRA) can elect to transfer some or all of these funds directly to a qualified charity, circumventing the distribution’s taxability on their individual tax returns. This article explains the tax benefits of making such qualified charitable distributions (QCD).
Standard vs. Itemized Deductions
In 2015, Congress passed the Protecting Americans from Tax Hikes (PATH) Act, which allows individuals to exclude up to $100,000 per year of income from an IRA distribution for charitable giving. The RMD is calculated by dividing the account balance at the end of the preceding calendar year by the distribution period from the IRS uniform life table. After calculating this amount, individuals can then determine how much they would like to earmark for their charity of choice.
For example, Mary and John are a married couple living in New York City; both are 71 and retired. Each receives $25,000 from Social Security and has an IRA distribution of $30,000. The couple contributes $20,000 per year combined to charities. The couple files their taxes jointly every year.
Mary and John’s itemized deductions would include the medical deduction, the state and local tax (SALT) deduction, and the deduction for charitable contributions. The SALT deduction was capped at $10,000 by the TCJA. If taking the itemized deduction, Mary and John would thus deduct $0 for medical, $10,000 for state and local tax, and $20,000 for charitable contributions, totaling $30,000. As shown below, however, this does not mean that the itemized deduction is the best choice for the couple.
The QCD Factor
Mary and John’s income is $60,000 from the IRA distributions and $50,000 from their Social Security benefits. Up to 85% of the couple’s Social Security benefits can be taxed because the total of one-half of their benefits and all of their income is more than $44,000. When calculated using the taxable benefits worksheet, the couple’s taxable Social Security income is $40,850; total taxable income for the year thus totals $100,850. If Mary and John take the itemized deduction of $30,000 ($0 for medical, $10,000 for SALT, and $20,000 for charitable contributions), their taxable income would be $70,850.
If, however, $20,000 of Mary and John’s combined IRA distributions is earmarked for a charity of their choice, the amount of the distribution counted as income would be $40,000. They would still receive $50,000 from the Social Security benefits, of which $23,850 would be taxable. The couple’s taxable income for the year would thus total $63,850. If Mary and John take the standard deduction of $26,600 ($24,000 + $1,300 + $1,300) for married filing jointly status, their taxable income would be $37,250. This represents a decrease in taxable income of $36,600 compared the first scenario.
The marginal tax rate for John and Mary is 25%; therefore, the taxes due in the first scenario would be $8,387, and the taxes due in the second would be $4,225. By donating to charity directly using a QCD, the couple could save $4,162 in taxes.
While each person’s (and each couple’s) tax situation is different, the above demonstrates how tactical use of QCDs can reduce taxable income, and thus income taxes paid, for taxpayers older than age 70½. CPAs with clients in this age group who made use of the pre-TCJA charitable contribution deduction should examine their individual circumstances to determine whether this strategy might prove useful.
