12 Jan 2018 Charitable Giving Can Still Reduce Your Tax Bill
Gone with the new tax law are most of the deductions we traditionally used to lower our tax bills. With only three primary survivors; charitable giving, primary residence mortgage interest, and state and local taxes, it is estimated that almost 90% of taxpayers will fall within the standard deductions, seemingly eliminating the need for tax planning for most. But if you gain even the slightest bit of enjoyment from finding creative and legal ways to rescue more of your hard-earned income from Washington’s grip, take heart and read on.
Two of the three remaining deductions, mortgage interest and state/local taxes offer limited options. State and local taxes are capped at $10,000 and your home’s mortgage interest is fixed by your loan agreement. Unless you refinance to consolidate additional non-deductible debt (a topic we will examine in a later Brief) there’s not much tax-reducing flexibility with these two.
Charitable giving represents the most flexible area for most taxpayers to reduce their tax bills beyond the standard deduction. So if you give to charities and are interested in saving hundreds, maybe thousands in tax dollars while doing so, please read the following before you do anything more this year.
It should be noted, that none of the following suggestions should be uniformly applied, as everyone’s tax situation is unique. Any two families with very similar outward attributes can have significantly different tax exposure as well as opportunities to reduce those taxes. We are happy to work with you and your tax professional to find the best ways for retaining as much of your income as possible.
Qualified Charitable Distribution
If you (or someone you know) are over 70 1/2 and have not yet satisfied your IRA’s required minimum distribution RMD, consider using some or all of it to fund your charitable giving instead of writing checks yourself. The procedure is referred to as a Qualified Charitable Distribution (QCD). Its significant benefit is that it directly and immediately reduces your top-line income rather than being added to your itemized deductions, which, under the new tax law, may in total fall below the higher standard deduction (thereby reducing the tax savings of the gift).
But timing is very important. The IRS deems that first funds withdrawn from any of your IRAs go to satisfy your RMD requirement and they may not later be reclassified for QCD purposes. Stated another way, early withdrawals from your IRA are taxed as ordinary income, unless you have your IRA custodian write the checks for you to qualified public charities through a QCD. Once your required minimum distribution is met, you can continue your charitable giving through QCD all the way up to $100,000..
Another key benefit of the QCD is that it reduces your Adjusted Gross Income (AGI). A lower AGI can have a positive impact on means-tested items like the amount of your Social Security that is taxed, the amount of medical expenses you can deduct, the amount of your Medicare Part B and D insurance premiums will be, and how much ACA tax credit you can get, if you qualify.
To qualify as a QCD, your IRA custodian must write the check directly from your IRA (401ks do not qualify) to a qualified public charity. Funds may not go to donor advised funds (discussed later). Please call us to see how and whether this option is helpful for you.
Giving Appreciated Stocks
For households with deductions exceeding the standard, the new tax law does not change or limit most often the best way of giving money to charities; that is by donating appreciated stock or other assets directly to the charity, which in turn sells the stock or asset in their account. The donor receives an immediate charitable deduction of 100% of the asset’s market value at sale and eliminates the obligation of capital gains tax realized sometime in the future.
Giving appreciated stock is generally superior to the QCD even though it saves up to 32% in taxes, compared to capital gains savings of only 20% (plus 3.8% for high earners). Giving appreciated stock saves you both the 20% (possibly 23.8%) capital gains tax that will likely be paid sometime in the future, in addition to the 32% ordinary income tax (highest brackets) that is saved by the charitable deduction. In some rare cases though, when adjusted gross income can be lowered sufficiently by a QCD, savings from Social Security taxes, Medicare premiums and medical deductions may exceed the combined savings of capital gains and deduction made possible with giving appreciated stocks.
Consider Doubling Contributions to Pass Standard Deduction to Earn Write-Offs
If you have the means to do so, consider putting two or more years of your regular annual giving into a donor advised fund (DAF). A DAF allows you to add cash, appreciated properties like stocks, real estate, even shares of businesses into a qualified fund and take an immediate tax deduction. The DAF will distribute checks to your charities as you direct them in the amounts and frequencies you desire. Some will professionally research the merits of charities of interest with which you are unfamiliar.
If your estimated itemized deductions from last year approach the new minimums of $12,000 for singles and $24,000 for couples, you might consider a strategy of donating a larger lump-sum (whether cash or appreciated assets) that you normally given in a single year in order to to realize additional tax savings on the contributions that exceed your standard deduction. Your charities won’t impacted as your DAF can maintain the same frequencies and amounts of giving you have done in the past.
Example: Bill and Sally are married, normally give $10,000 a year and find that their itemized deductions will be $24,000 this year ($10,000 state and local, $10,000 charitable giving, and $4,000 mortgage interest). Their income of $120,000 puts them in the 22% tax bracket. They decide to open a donor advised fund and transfer stock that Sally received from her parents years ago worth $20,000. The stock has a very low cost basis of just $200.00. They receive an immediate deduction of $20,000 bringing their total itemized deductions for 2018 to $34,000. The extra $10,000 deduction beyond the standard deduction produces a tax savings of $2,200 this year that Bill and Sally would not have realized had they simply continued their practice of giving $10,000 each year, whether by cash or by appreciated stock.
Donor advised funds are offered by local charitable organizations like The Triangle Community Foundation, faith-based charitable organizations like The National Christian Foundation and brokerage firms like Schwab Charitable, Vanguard Charitable, or Fidelity Charitable to name but a few. You get an immediate deduction for the full amount you add to the DAF. Funds are distributed go to your charities as checks to your charities in the amounts and frequency you direct. Many will professionally vet the credentials of charities you like the sound of, but don’t know that well.
Please give us a call or schedule an appointment if you would like further examine any of these ways to continue giving generously, while saving taxes in the process.