Tax Strategies for Charitable Contributions
Unless you've been living under a rock for the last several months, you probably know that we've got a tax bill! And you might be wondering how that new tax bill will impact you and your family. I'll save the full impact for another (longer) post, but some of the biggest changes are:
- Marginal tax rates (mostly) went down
- Standard deductions went up
- Exemptions went away
For more details about the whole tax bill, see this article from the Journal of Accountancy. here for more details.
In this post I want to specifically talk about the new (higher) standard deduction amounts and how they might impact your own tax situation. First, let's start with some basics. A deduction is something that can lower your taxable income. In simplified terms, you start with your income (from your job, rental income, investment income, etc.), then you apply a deduction (a subtraction) to that income to get to your "taxable income". Once you've got your taxable income, you can use the tax rates calculate your tax due.
The main thing to know is that the new standard deductions amounts are:
- $24,000 for married filing jointly
- $12,000 for single filers
What does that mean for you? Well, one of the first things you'll decide when filing your taxes next April 2019 (or earlier if you aren't a procrastinator) is whether to itemize your deductions or just take the standard deduction. With the new higher standard deduction rates (2017 deduction amounts were $12,700 for married filing jointly and $6,350 for single filers), a lot more people will simply take the standard deduction rather than itemizing.
Let's run through some examples to make this a little more tangible. Let's say your total income is $145,000 for 2018. Let's say you are married filing jointly, and have the following deductions for 2018:
$11,000 mortgage interest
+ $4,000 state income tax
+ $3,000 property tax
+ $2,000 charitable contributions
= $20,000
The total of all these deductions is $20,000. Since that's less than the $24,000 standard deduction, you'll just take the standard deduction instead of itemizing on your tax return.
Let's look at another example for someone married filing jointly:
$17,000 mortgage interest
+ $5,000 state income tax
+ $6,000 property tax
+ $1,000 charitable contributions
= $29,000
In this case, it looks like your itemized deductions add up to $29,000. There's a slight wrinkle to this since there is now a cap on SALT deductions (state and local, which includes state income tax and property tax) of $10,000. So in this case, the $5,000 in state tax + $6,000 in property are capped at $10,000. So, total itemized deductions are $17k + $10k + $1k for a total of $28,000. In this case, you'd be better off itemizing your deduction of $28,000 rather than taking the $24,000 standard deduction. Higher deduction = lower taxable income = more tax savings.
What if you end up right on the bubble, really close to the $24,000 standard deduction? You might be able to employ some strategies to make the most of your situation, by "bunching" your deductions so that one year you take the standard deduction, and the next year you itemize, then back to standard the following year, etc. Rinse and repeat.
How would this work in practice, and why bother? Let's go through another example for someone married filing jointly:
$13,000 mortgage interest
+ $4,500 state income tax
+ $4,000 property tax
+ $2,000 charitable contributions
= $23,500
Now your itemized deductions are $23,500, just under that standard deduction amount of $24,000. In this situation, by taking the standard deduction, you are almost wasting your itemized deductions (you are just taking the standard, so no need to itemize). One strategy to get around this is to bunch your itemized deductions where possible into one year. Let's say instead of making your $2,000 donation to charity every year, now you make a $4,000 contribution every other year. So, in the first year, your deductions look like this:
Year 1
$13,000 mortgage interest
+ $4,500 state income tax
+ $4,000 property tax
+ $0 charitable contributions
= $21,500
Total itemized deductions are $21,500 so you opt to take the standard deduction of $24,000.
Year 2
$13,000 mortgage interest
+ $4,500 state income tax
+ $4,000 property tax
+ $4,000 charitable contributions (double your normal amount since you contributed $0 in Year 1)
= $26,500
Now your total itemized deductions are $26,500. So this year (Year 2) you'll want to itemize your deductions and reduce your taxable income by the additional $2,500 ($26,500 - $24,000) every other year. Some people even take this further bunch their charitable contributions into once every 3 or even every 4 years to really maximize the impact of their deductions on those years.
How can you make this work in actual practice? Well, there are a few approaches.
Space Out Your Donations (Jan/Dec)
You could just space out your donations differently. Let's say you normally make a $2,000 donation to your favorite charity every December. Instead, you could push off that December donation to January. Then you also make another $2,000 donation that following December. Now you've got $4,000 in donations in the same tax year (January and December), but to the charity, the donations were spaced out almost a year apart. You could continue to make a donation in January and December every other year.
Use a Donor Advised Fund
Another approach is to use a Donor Advised Fund to help smooth out your donations and maximize your deductions every few years. See this IRS resource to learn more about Donor Advised funds. A Donor Advised Fund is a charitable account that holds your funds until you direct the fund where to make your donation(s). You get the tax deduction as soon as you add funds to your Donor Advised Fund. Note that you don't get a second deduction when they send the funds to the charity of your choice.
Confused? Let's run through an example:
Let's say you want to make a $2,000 donation every year to your church. Instead of giving directly to your church every year (or trying to set up a January/December donation schedule every other year), now you set up a Donor Advised Fund. You donate $4,000 to the Donor Advised Fund this year, and $4,000 every other year going forward. You get a tax deduction in the same year you contribute money to the Donor Advised Fund. The money will sit there until you direct the Donor Advised Fund to send a donation to your church (or whatever your charity of choice is). You could instruct the Donor Advised Fund to contribute $2,000 every year to your church. You get your bigger tax deduction every other year when you contribute to the Donor Advised Fund, and the charity still receives your donations on a normal, annual schedule.
One other nice benefit of a Donor Advised Fund is that in addition to donating cash directly to your Donor Advised Fund, you can also donate shares of a stock or a mutual fund. To make the most of this, you'll want to donate a stock or mutual fund that has gone up in value since you bought it. When you donate shares to your Donor Advised Fund, you don't have to pay the capital gains tax that is normally associated with selling appreciated securities. It's a double tax win in this case: you avoid the capital gains tax and still get to take your charitable tax deduction for the value of the stock or mutual fund when you donate it to the Donor Advised Fund. Win-win!
If you give to charities every year and find yourself right on the bubble of the new standard deduction amounts ($12k single, $24k married filing jointly), you'll definitely want to explore ways to maximize your deductions. If you are interested in learning more about any of these tax strategies, please reach out to me for a free 30-minute call to discuss your situation.
Important Disclosure: Please note that these are overly simplistic examples and none of this should be taken as tax advice. Please consult a CPA or other tax professional to find out how this specifically impacts your tax situation.
Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Alyssa Lum, and all rights are reserved. Read the full Disclaimer.