Year End Tax Strategies & the New Tax Code: Charitable Giving

Many wealthier taxpayers no longer itemize their deductions and instead are taking the standard deduction for income tax purposes.  For 2019 the standard deduction is $12,200 for individuals and $24,400 for married couples filing jointly. This is a significant increase from just two years ago in 2017 when it was only $6,350 for single filers and $12,700 for married couples filing jointly. In addition to the significant increase in the standard deduction, taxes such as state income taxes and property taxes is now capped for itemization purposes at only $10,000. However, with a little planning, there are still strategies taxpayers can employ in order to get the benefit of the deductions they may have otherwise been lost.

Enter the IRA & the Required Minimum Distribution (RMD)

Higher net worth taxpayers often have other sources for income other than their IRAs and/or have substantial IRA accounts from a lifetime of retirement saving. Often these taxpayers are looking for tax efficient gifting opportunities or the ability to perpetuate these tax deferred retirement accounts. Unfortunately, deferral is made more difficult because the IRS requires a minimum amount, the Required Minimum Distribution (RMD), be withdrawn each year once a taxpayer reaches age 70 ½ and is a meaningful percentage (about 3% to 5%+) of the IRA’s account value. As these distributions come out of the taxpayer’s IRA they are taxed at ordinary income rates, currently a high of 37%.

Many of these taxpayers are also charitably inclined, and yet they no longer benefit from their charitable contributions since they are not itemizing their deductions. In order to continue getting the income tax benefit of these donations, the taxpayers should consider making a direct donation of all or a portion of their RMD. Using this strategy, the taxpayer would notify their financial advisor or custodian of their IRA to pay their RMD directly to the charity. The 1099 the taxpayer receives will report the full distribution amount, but not the taxable amount. The tax amount will be the total distribution reduced by the amount that went directly to a charity. The result is the taxpayer reports neither the income nor the donation as an itemized deduction. Managing the distribution and donation like this has the benefit of reducing income tax because income is reduced. This technique also has the added benefit of ensuring 100% of the donation is deducted in the year it is paid. This is because cash donations reported as an itemized deduction are limited to 60% of a taxpayer’s adjusted gross income and any excess gets carried forward to be deducted in future years. It is important to note that donations to personal foundations using IRA funds do not receive this treatment. Instead, the income from these distributions are reported as taxable IRA distributions and the donation is deducted as an itemized deduction.

Power Packing Donations with a Donor Advised Fund

Another strategy to ensure your itemize deductions is to “power-pack” donations in a given year. For example, if your intent is to give a particular charity $5,000 each year for the next five years, you could give them $25,000 all in one year and inform the charity the gift is your five-year commitment. For some taxpayers, this isn’t desirable because they do not want the charity to have all their donation upfront. If that is the case in your circumstance, then you could consider establishing a foundation. However, unless you are putting a substantial amount of money into the foundation, the administrative costs of the foundation will likely outweigh any benefit received. This is when a donor advised fund can be a powerful tool. A donor advised fund is a pooling of many taxpayers’ charitable contributions into one fund. The taxpayer receives an immediate deduction for their donation and then directs the fund which organizations will receive grants from the fund in a particular year. This way the donor can control how much money a charitable organization receives each year, while receiving the tax benefit of their donation in the year paid.

Direct IRA charitable contributions and donor advised funds are two increasingly popular options that will help taxpayers get the benefits of deducting their charitable contributions while controlling how much an organization receives each year. Please contact us if you would like to discuss these concepts in more detail and be on the lookout for additional tax planning ideas in future articles.

Written by Bart Haag, CPA, Principal.