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George F. Bearup, J.D. Senior Legal Trust Advisor

6-Jun-19

Philanthropy after the 2017 Tax Act

Overview of Impact:

  • 90% of all taxpayers will no longer itemize their income tax deductions; the number of itemizers will drop from 30 million to 5 million.
  • Only 5% of taxpayers will have their state income tax deduction limited by the $10,000 per taxpayer state and local taxes (SALT) deductible amount. This dollar limit however will finance most of the income tax breaks that arise from the 2017 Tax Act. The dollar limitation on the SALT deduction is estimated to generate about $668 billion over the next 10 years.
  • Due to the doubling of the standard deduction and the loss of most income tax deductions, and the $10,000 SALT limitation, it is estimated that the drop in charitable giving will be about $13 billion per year.
  • With the doubled federal transfer tax exemption amount, it is estimated that the amount of testamentary charitable giving will drop by about $4 billion per year, since most estates will no longer receive an estate tax benefit from a charitable bequest.

2017 Tax Act Changes:

Standard Deduction: The standard deduction is effectively doubled: $12,000 per individual, $24,000 per married couple. This means fewer individuals, will itemize their income tax returns and thus not gain an advantage from claiming the charitable income tax deduction.

Rate Reduction: Income tax rates are reduced, while income tax brackets are spread wider. The top income tax rate drops to 37%. Larger taxable incomes will be required before higher income tax brackets will be encountered. This means the incentive to make lifetime charitable gifts to reduce current income tax liabilities will be less.

Cash Gifts- Greater Deduction Limit: The limit on the income tax charitable deduction for cash gifts increased to 60% from 50% of an individual’s reported adjusted gross income. This means that a larger charitable income tax deduction can be claimed in a year that cash is gifted without having to ‘carry-forward’ the excess charitable income tax deduction to future tax years.

Transfer Tax Exemptions Doubled: The federal estate and gift tax exemption for an individual is doubled (until 2026) to $11.4 million. This means that the incentive to use a charitable bequest at death to reduce federal estate tax liabilities will no longer be needed for many individuals.

Qualified Charitable Distributions Encouraged: The larger standard deduction amount and the $10,000 limitation on the deductibility of state and local taxes (SALT) will encourage greater use of the Qualified Charitable Distribution opportunity using a traditional IRA. This means that using an IRA, as the source of charitable giving will result in a 100% income tax deduction for those gifts.

Practical Implications Arising from the 2017 Tax Act- “Bunching, Boosting, and Bypassing”

Less Giving? Fewer lifetime charitable gifts if there is no corresponding income tax deduction available since more individuals will not itemize their tax deductions relying, instead, on the larger standard deduction?

More Giving? With lower income tax rates and broader income tax brackets, individuals may have more after-tax disposable income from which they can make charitable gifts.

Bunching Gifts: Charitably inclined individuals may only make charitable gifts every few years, but in larger amounts. This will enable them to bunch their deductible charitable gifts into one calendar year in order to be able to itemize their tax deductions for that single calendar year, i.e. make the charitable gifts more than the standard deduction amount for that one year.

Boosting Gifts: A related strategy is to boost gifts by completing larger gift commitments to a single charity, in a single year, rather than over an extended pledge-payment period.

Accelerate Charitable Bequests: Because the federal estate tax was effectively eliminated for most individuals, at least until 2026, those individuals who included charitable bequests in their Wills and Trusts should accelerate those death-time gifts to lifetime gifts. A lifetime charitable gift could provide some income tax relief as it is tax deductible, while there will no longer be any estate tax savings by delaying the charitable gift until the individual’s death.

Giving Opportunties that Continue to Exist After the Tax Act

Gift Appreciated Assets: Congress did not change the rules with regard to the gift of appreciated assets to charities. An individual still can receive substantial income tax benefits from donating stock and other appreciated assets that have grown sharply in value to a charity. The individual will avoid the capital gain that would have been incurred had he/she sold the appreciated asset while the gain in the asset’s value is fully tax deductible.

Donor Advised Funds: Donor advised funds could be used to receive a large, deductible gift in one calendar year (bunching), yet the funds can be distributed to charities over the next several years (albeit with no income tax deduction in those future years.) That large charitable gift can result in itemizing income tax deductions for the year of the gift to the donor advised fund.

Gift of Remainder Interests in Homes and Farms: An individual can gift the remainder interest in their principal residence or a farm to a charity and receive a large current income tax charitable deduction (bunching) for the value of that gifted remainder interest. This is a way to bunch a large charitable gift into one calendar year, thus permitting itemization of that large charitable gift, yet the individual’s use of the home until the individual’s death. Practically speaking the charitable gift actually takes place on the individual’s death, but the individual claims a current deduction.

Charitable Gift Annuities: Charitable gift annuities are still viable and often used when the individual wants to help a charity but is still fearful of outliving his/her money. The charitable gift annuity avoids paying capital gains taxes on the sale of an appreciated asset like securities.

Charitable Remainder Trusts: Charitable remainder trusts (annuity or unitrust versions) will continue to be useful. The trust- (i) avoids paying a capital gain when an appreciated asset transferred to the trust is sold by the trust; (ii) assures a lifetime income stream to the beneficiary; (iii) protects the trust’s assets from the beneficiary’s creditors; (iv) creates a large current charitable income tax deduction (bunching) equal to the value of the remainder interest in the trust; and (v) assures the charity that it will receive the balance of the assets in the trust on the beneficiary’s death.

Qualified Charitable Distributions from IRAs: Qualified Charitable Distributions will become even more popular as individuals move into their retirement years. An individual over the age of 70 ½ is able to transfer up to $100,000 a year from their traditional IRA directly by the IRA custodian to designated charities (other than donor advised funds.)

  • The distribution satisfies the individual’s annual required minimum distribution (RMD) obligation for the calendar year.
  • The distribution is not included in the individual’s taxable income for the year (so the distribution from the traditional IRA is the equivalent to a 100% income tax deduction.
  • The distribution is not tax deductible as a charitable contribution by the individual.
  • The amount distributed to charities is not included in the individual’s income, thus reducing their taxable income to lower marginal income tax brackets, which may keep the individual out of higher marginal tax brackets and away from the 3.8% Medicare surtax.
  • The individual claims the benefit of the larger standard deduction amount ($12,000 or $24,000) for the year in which the non-taxed charitable distribution from their IRA is made.

Tricks and Traps with Qualified Charitable Distributions (QCD)

Age: The individual must actually be age 70 ½ when the distribution is made from their IRA.

Traditional IRAs Only: Distributions can only be made from traditional IRAs (SIMPLE and SEP IRAs, too) but not 401(k) accounts. Note, however, that funds in a 401(k) account could be rolled into a traditional IRA from which a QCD could then be made.

Inherited IRAs: Inherited IRAs can be used to make QCD, if over age 70 1/2.

Pledges: Charitable pledges can be satisfied with a QCD.

After-Tax IRA Contributions Not Eligible: If the traditional IRA contains after-tax contributions, the after tax portion will not qualify as a QCD.

Roth IRAs: While a Roth IRA could be used for a QCD, it is an unlikely candidate for such distributions, as Roth IRAs have no RMDs for their owners, and inherited Roth IRAs, while subject to RMDs, are not taxable.

Timing is Critical: When RMDs are required to be taken from an IRA, the first dollars distributed from the IRA are RMD dollars. Only RMD dollars can be used for QCD. Consequently, in a year when RMDs must be taken, it is best to first use the distributions from the IRA as QCDs, and not wait until the end of the calendar year.

Use Cash: While individual stocks and other assets held in an IRA can be the subject of a QCD, it is better to use cash in order to avoid questions as to the value of the assets transferred. [Note, the failure to take the RMD triggers a 50% penalty of the amount not taken so ascertaining the correct value of what was distributed is critical to avoid the penalty.]

Wire Transfers, Not Checks: If the QCD is made at the end of the calendar year, it is better to wire transfer funds from the IRA and not use a personal check. The check might not be received by the charity until the next calendar year; the check must clear the bank account prior to the end of the calendar year to satisfy the RMD for the year (again, trying to avoid the 50% penalty.)

Legacy Act Proposals?: One Bill pending in Congress, the Legacy IRA Act, would: (i) lower the minimum age of the QCD donor to 65 years from 70 ½ years; (ii) permit the direct transfer to a charitable remainder trust or charitable gift annuity, touted as a life-income plan for the ‘middle class’; and (iii) permit a transfer of up to $400,000 (not $100,000) if the donor was over age 70 ½, $100,000 directly to the charity, with the balance contributed to the life-income plan.

Donor Advised Funds? Another Bill now discussed the Senate would permit a QCD to donor advised funds, but the ‘trade-off’ would be far more reporting required from the donor advised fund, along with required distributions from the donor advised fund over a relatively short period of time.

Take-Away:

The impact of the new higher standard deduction is clouded by the fact that that the ability to itemize income tax deductions now depends to a much greater extent than before on an individual’s marital status, age, the amount of state and local taxes (SALT), the property that is the subject of the gift, and whether the individual owns a home and if the home is subject to a mortgage.