Most of us know that the tax laws have changed. Personal exemptions are gone, and the standard deduction is way bigger. Should we still make the year-end rush to get the tax deduction?
The new rules. The new tax rules double the standard deduction to $12,000 for individuals, $18,000 for heads of households, and $24,000 for married filing joint. You can itemize if your itemized deductions exceed those amounts. In addition, itemized deductions have been curtailed to basically the following:
- Medical expenses, if they exceed 7 ½% of your Adjusted Gross Income; plus
- State and local income taxes, plus property taxes, plus personal property taxes (license tabs on cars) up to $10,000 if married and $5,000 if not filing jointly; plus
- Mortgage interest on your residence (including a second residence) on mortgages up to a dollar limit ($1 million for pre-2018, $750K for post-2017 mortgages), plus certain home equity loan interest; plus
- Charitable contributions.
- Most other itemized deductions (unreimbursed employee expenses, and so forth
If Sue and Jake (married) have $6,000 of total state income taxes and property taxes and car tabs, plus $10,000 of mortgage interest, plus $5,000 of charitable contributions; their itemized deductions are $21,000. They would take the standard deduction. There is no tax benefit to taking additional deductions this year, unless it exceeded $3,000, and then only the amount over $3,000 would be deductible.
Enter the bunching idea. For many people on the cusp (you have near the standard deduction), there is a strategy called ‘bunching.’ Bunching is where you put a whole bunch of contributions in one year, and then take them in future years using something called a Donor Advised Fund, or a Community Foundation. A Donor Advised Fund lets you make a contribution (and get a deduction) now, but give the money to the charity later, plus make interest on the fund. If Sue and Jake made regular contributions to a charity of $5,000 a year, they could contribute $15,000 to a Donor Advised fund and get a $15,000 deduction for 2018. They’d then have itemized deductions of $31,000 for 2018. For 2019 and 2020, they’d make their $5,000 contribution from their Donor Advised Fund and take their standard deduction for those years. That strategy made them the tax savings on the excess amount over the standard deductions (in their case, $10,000). This puts tax dollars in their pocket.
Three scenarios. There are three scenarios for people who make charitable contributions:
- Those well under the standard deduction limit. If you are well under the standard deduction limit, recognize that short of a large donation, you will not reap additional tax benefits from charitable donations, so make them because you want to. There is a glaring exception for people over 70 ½ with IRAs.
- Those near the cusp of standard deductions. If you are near the standard deduction limit, you will clearly want to look at the bunching strategy.
- Those well over the standard deduction. For taxpayers over the standard deduction, every dollar of contribution will provide a tax deduction, all the way up to rather large limits (60% of Adjusted Gross Income).
Big bonus for those over 70 ½ with IRAs. There is a great opportunity for taxpayers over the age of 70 ½ who have IRAs where they have to take Required Minimum Distributions (RMDs). This is called a Qualified Charitable Distribution (QCD). Here you can take part of your IRA RMD (up to $100,000) and directly give it to the charity and the contribution doesn’t show up in your income. Since a lot of things like the taxation of social security benefits or Medicare B and D premiums are based on income, this can give you a big benefit. Say Millie is 72, and single, and like to give $5,000 to her church. She has a pension of about $24,000, Social Security of $21,000 and an IRA with $250,000 in it, which has a Required Minimum Distribution of about $10,000. Millie has her house paid off, and has $3,000 of taxes, her only itemized deductions other than her charity. If she donates to her charity from her checkbook, she would have about $3,869 of federal taxes. Using the QCD saves her $400 of federal tax and $212 of Michigan taxes. The QCD is a superior way to make a charitable deduction for almost everyone over age 70 ½ with an IRA.
So, should you quit giving? I’d hope not. I think now more than ever charitable donations are valuable and necessary. All the normal rules can still apply: clean out your closet or garage and give that stuff away. Use appreciated stock or funds to get a bonus on donations (since you avoid the capital gains tax even if you don’t itemize). And recognize that you shouldn’t let the tax tail wag the chartable dog.
Leon LaBrecque, JD, CPA, CFP®, CFA
Managing Partner and CEO, LJPR Financial Advisors
5480 Corporate Dr., Suite 100 | Troy, MI 48098 Main: 248.641.7400 | Fax: 248.641.7405 Email: firstname.lastname@example.org