The Best Gifts Under the New Tax LawSubmitted by American Endowment Foundation on July 9th, 2018
By Andrea Kushner Ross J.D., LL.M - Director, Andrew T. Bishop, CFA - Associate Director, & Jennifer R. Ostberg, CFP ® - Senior Analyst, Bernstein Private Wealth Management Guest Columnists
Now that 2017 is behind us, it’s time to start planning for 2018. Specifically, it’s important to think about charitable gifts. Why?
The implementation of the Tax Cuts and Jobs Act (TCJA) for 2018 means that last year’s advice for charitable giving may no longer be the right advice going forward. Understanding how to structure gifts to meet one’s philanthropic goals to provide the highest benefit starts today.
Under the new TCJA, itemized deductions are mostly limited to mortgage interest, state and local taxes (capped at $10,000), and charitable gifts.1 At the same time, the standard deduction was increased to $12,000 for individuals and $24,000 for married couples. For most people, the standard deduction is projected to be greater than their itemized deductions. In fact, the Tax Policy Center estimates the number of tax returns claiming deductions for charitable contributions may drop by more than half.
Even though some donors will no longer receive a deduction for their charitable gifts, they will continue to give to charitable organizations and causes that are important to them. While the tax benefit may not be as obvious without the ability to itemize, there are ways to structure charitable gifts to provide the highest advantage to the donor. When making gifts, donors need to consider the types of assets they own, their age, tax bracket, and whether they can itemize deductions.
Bunch Together or Spread Out?
To help donors achieve their philanthropic goals and allow them to receive a tax benefit, donors should consider various gifting strategies since some may be more effective than others. Once such strategy is “bunching.” This strategy may maximize tax benefits to the donor by pushing itemized deductions above the new higher standard deduction.
Here is how the strategy works: Instead of making charitable gifts each year, a donor can aggregate two or potentially several years’ worth of gifts into a single tax year to push their total deductions above the standard deduction. Given the deduction limits,2 the donor must have sufficient taxable income to fully deduct several years of charitable contributions in a single year for this “bunching” strategy to work. In the year individuals “bunch” their charitable donations, they will itemize deductions on their tax returns; in the subsequent year or years, if they do not make charitable gifts or do not have enough other deductions, they will claim the standard deduction.
The following hypothetical example illustrates this:
We show two examples of structuring charitable gifts in the above chart. In the left example, we assumed the donor makes $10,000 gifts annually, which results in their total deductions being $2,000 higher than the standard deduction each year. This amount above the standard deduction will allow them to recognize $2,960 in total tax savings over four years. In the right example, the donor bunches two years’ worth of charitable gifts, or $20,000, in 2018 and again in 2020, which allows them to deduct a higher amount—$12,000—above the standard deduction recognizing a total tax saving of $8,880 over the four-year period, nearly $6,000 more than if they make a $10,000 gift each year.
A “bunching” strategy can create significant tax savings over time. One potential obstacle to this structure is that the donor needs to budget for higher donation amounts during the “bunching” years. Another drawback is that some donors may not want to give a larger amount of money to a charity all at once. A way around this drawback is to utilize a donor advised fund (DAF). By making a “bunched” gift to a DAF first, the donor can then make grants to a qualified charity at any time from the DAF, thus controlling the disbursement of their donations over time.
It's important to recognize that charitable gifts are not limited to cash. Other assets, such as appreciated securities or art, can also be donated. The choice of asset is essential, and can impact the level of the tax benefit for donors.
Cash Isn’t Always King
For investors who are younger than 70½, gifting is generally limited to two types of assets—cash and appreciated assets. Whether the investor can itemize or not, giving appreciated assets will likely be the optimal asset to give.
Let’s use an example to illustrate this point: A donor is choosing between gifting $10,000 in cash or highly appreciated stock with the same value (see chart below.)
Regardless of whether the donor can itemize, the effective cost will always be lower when giving highly appreciated stock. The reason is simple: When you give appreciated stock, you avoid taxes on the gain in the stock. You can see this in our example. The effective cost of a $10,000 gift when the donor receives no deduction is $10,000 for a cash gift compared to $8,810 for a gift of stock with a cost basis equal to 50% of its value. The difference comes from avoiding the embedded tax liability on the stock.
Of course, if the donor can itemize and receive the full deduction, the effective cost will be lower for both types of gifts. In this case, the gift of stock still results in a lower effective cost of $5,110 compared to $6,300 for a cash gift.
With Age Comes … the QCD
Investors over the age of 70½ with IRA assets have another option—making a Qualified Charitable Distribution (QCD). A QCD allows a donor to avoid paying taxes on the required minimum distribution (RMD), or the amount you must withdraw from your IRA each year, up to $100,000, if the distribution goes directly to a qualified public charity.3 At first glance it may seem like making a QCD is the obvious choice because of this tax avoidance benefit, but it may not always deliver the most optimal outcome. In some cases, giving highly appreciated assets might be the right choice (see chart.)
Unfortunately, many donors may not fit neatly into these boxes, necessitating another solution: combining a QCD and a gift of appreciated assets.
The New Era
The changing tax landscape highlights the importance of stepping back and assessing old rules of thumb. Because what once worked may no longer make sense in this new tax era.
1Itemized deductions can also include for those who qualify, medical expenses (deduction limited to qualified medical expenses in excess of 7.5% of adjusted gross income (AGI) in 2018, then in excess of 10% of AGI thereafter) and student loan interest (deduction limited to $2,500 if Modified AGI is less than $65,000 for a single filer, and $135,000 for a joint filer. The deduction will be gradually reduced to zero for single filers when Modified AGI is between $65,000 and $80,000 and for joint filers with Modified AGI between $135,000 and $165,000).
2 Charitable deductions are limited to 60% of adjusted gross income (AGI) for cash gifts and 30% of AGI for a gift of an appreciated asset.
3 The Protecting Americans from Tax Hikes (PATH) Act of 2015 allows IRA owners who are at least 70½ years old to donate up to $100,000 each year directly from their IRA to a qualified public charity, but not to donor-advised funds, supporting organizations or private foundations.
Co-author Andrea Kushner Ross is a member of the AEF Council of Advisors.
At American Endowment Foundation, we look forward to discussing how DAFs can play a role in better charitable giving. Contact us or call at 1-888-660-4508 to learn more.