Tax reform put a dent in philanthropy, but
there are strategies clients can pursue to maximize tax benefits for their
donations
Nov
9, 2019 @ 6:00 am By Greg Iacurci
Charitable giving is undergoing a shift in the
wake of the 2017 tax law, and could see yet more changes in the coming months
and years as a result of legislation working its way through Congress.
Aside from a few tweaks, the tax law, which
provided the most sweeping reform to the U.S. tax code in a generation, didn't
address charitable giving directly. Yet, charitable giving by individuals is at
its lowest level since the financial crisis, and financial advisers point to
changes in the tax law as the reason.
Specifically, under the new law, fewer people
get a financial benefit from itemizing deductions on their tax returns —
meaning fewer people get a tax break from their donations to charity. According
to estimates from the Tax Foundation, 14% of taxpayers will itemize deductions
on their 2019 returns compared with 31% of taxpayers who did so before tax
reform.
"Twenty percent of the country lost the
ability to deduct charitable contributions," said Jamie Hopkins, director
of retirement research and vice president of private client services at the
Carson Group.
The Urban-Brookings Tax Policy Center
estimated 21 million taxpayers would stop taking the charitable deduction
because of the new law. The law raised the after-tax costs of donating by 7%,
according to the think tank.
There are several reasons for the falloff. For
one, the law roughly doubled the standard deduction in 2019 to $12,200 for
single taxpayers and $24,400 for married couples filing jointly and surviving
spouses, making it more advantageous for many taxpayers to take the standard
deduction instead of itemizing. It also lowered individual income tax rates,
reducing the value of all tax deductions. And it doubled the estate-tax
exemption, to $11.4 million for singles and $22.8 million for married couples
in 2019, which could result in fewer tax-motivated donations from wealthy
families.
The law also diluted or eliminated several
popular tax deductions for individuals. The biggest change was the imposition
of a $10,000 cap on deductions for state and local taxes, which used to be
unlimited. Additionally, taxpayers can only deduct interest on up to $750,000
of mortgage debt on new homes (the limit used to be $1 million) and can only
deduct interest on a home equity line of credit in more limited circumstances.
The law also eliminated deductions for "miscellaneous" items like tax
preparation and investment-adviser fees.
Consequently, overall giving among individuals
— the largest source of charitable contributions — fell by 3.8% on an
inflation-adjusted basis in 2018, to $292.1 billion, compared with the prior
year, according to Giving USA. Excluding the years 2008 and 2009, when the
country was in the throes of the Great Recession, annual charitable giving
among individuals hadn't declined that much since 1987.
By contrast, giving among other sources like
foundations and corporations was up 4.7% and 2.9%, respectively, when adjusted
for inflation.
"This is the new normal of where we
probably are on the numbers," Mr. Hopkins said about the reduced figures
among individuals.
Though taxes aren't the main reason people
donate to charity, and other factors such as market volatility in the fourth
quarter of 2018 likely contributed to the decline in charitable donations,
taxes do affect individuals' incentives to donate, said Una Osili, professor of
economics and philanthropic studies at the Indiana University Lilly Family
School of Philanthropy.
The decline is also notable considering the
strength of the U.S. economy last year, which would have typically propped up
donations, experts said.
But tax-year 2018 was the first year in which
individuals dealt with the bulk of income-tax provisions from the recent tax
legislation, which President Donald J. Trump signed into law in December 2017.
Giving cash to charities has, and continues to
be, the most popular method of individual philanthropy among clients, according
to advisers. The tax law made cash gifts a bit more lucrative — clients can now
deduct charitable cash gifts up to 60% of their adjusted gross income, whereas
it used to be 50%.
Donor-advised funds
However, other means of giving have become
more tax-efficient, and more clients are open to exploring them than in the
past, said Jeffrey Levine, CEO and director of financial planning at Blueprint
Wealth Alliance.
Advisers have seen donor-advised funds gain
the most traction as a financial planning strategy. These vehicles allow
clients to "bunch" several years' worth of charitable deductions into
one tax year, in order to help get over the hurdle of a higher standard
deduction, and then choose how and when those funds are distributed.
Using this bunching strategy makes the most
sense if a client's itemized deductions, before charitable contributions are
factored in, are less than the standard deduction, said Lisa Featherngill, the
head of legacy and wealth planning at Abbott Downing. It has also become more
important to make charitable planning a multiyear exercise, she said.
For example, let's say a married couple filing
jointly has $100,000 of taxable income. The couple has $20,000 of itemized
deductions before charitable contributions. The couple plans to make $6,000 of
annual charitable contributions in both tax-year 2019 and 2020.
Making a $6,000 donation in each of those two
years, and itemizing both years, would yield $52,000 of combined tax deductions
over the two years ($26,000 of deductions each year). But let's say the couple
used a donor-advised fund to bunch $12,000 worth of charitable contributions
into 2019, and took the $24,400 standard deduction in 2020. That approach would
yield $56,400 of total deductions ?— $4,400 more ?— over the two years, which
equates to greater tax savings.
Donor-advised funds make sense especially for
clients who give to multiple charities, said Ms. Featherngill, a member of the
American Institute of CPAs' personal financial planning executive committee. If
a client is giving to one charity, like a church, however, it's easy to bunch
charitable contributions with using a donor-advised fund, she said.
Qualified distributions
Using qualified charitable distributions is
another planning maneuver that has become more valuable under the new tax law.
According to FreeWill, an online philanthropy and estate-planning service,
there was an average 74% increase in the number of QCDs made to charities last
year versus 2017.
QCDs allow a taxpayer over the age of 70½ to
give money directly to charities using money from a traditional individual
retirement account. Total annual QCDs can't exceed $100,000 for an individual.
These distributions are now the "only way to receive a meaningful income
tax benefit from charitable contributions" for many donors over 70 years
of age, according to a FreeWill report.
QCDs offer two large benefits: distributions
count toward satisfying an individual's annual required minimum distribution
and are excluded from the taxpayer's income.
For example, let's consider a client — a
retired married couple ?— with $100,000 of adjusted gross income and $20,000 of
itemized deductions before charitable contributions are included. The client
has a $12,000 RMD this year, and wants to give it to charity.
Using a QCD, the client would have $75,600 of
taxable income ($100,000 minus the standard deduction). However, if the client
were to take the $12,000 IRA distribution and then make a $12,000 charitable
contribution, the client's taxable income would swell to $112,000 and itemized
deductions would increase to $32,000 ?— for a net taxable income of $80,000.
The QCD here would decrease the client's net
taxable income by $4,400.
New rules
The SECURE Act, retirement legislation
currently being debated in Congress, could change how some wealthy clients give
to charity. The bill, which passed 417-3 in the House of Representatives and is
currently awaiting passage in the Senate, would eliminate the "stretch
IRA."
Non-spouse beneficiaries of inherited IRAs can
currently stretch account distributions over their life expectancies, granting a
potent estate-planning tool to wealthy families. But the SECURE Act would
compress those distributions into a 10-year time frame.
A charitable remainder trust could mimic the
tax benefits of the stretch IRA if the SECURE Act is passed, as some expect to happen
this year or next. The trust would be funded by IRA assets upon the death of
the account owner, and the trust would pay a regular income stream to
beneficiaries over their lifetimes (or another specified time period). A
predetermined charity would get the trust's remaining assets once beneficiaries
die.
"I would say this is the trust that most
closely replicates the benefits of a stretch IRA," Mr. Levine said.
"For those with larger IRAs, I could definitely see them incorporating
this."
Even absent the SECURE Act, the individual
income-tax provisions in the 2017 tax law are scheduled to expire in 2026, and
revert back to prior rules, unless Congress passes additional legislation to do
otherwise.
Protections for the purity of their retirement
advice last month. Now it's up to the nation's financial advisers to decide
whether they'll meet the letter — and spirit — of the historic investor
protection regulation.
No comments:
Post a Comment