The Problem: The tax bills passed by the House and Senate would both nearly double the income tax standard deduction for individuals (to $12,000) and couples (to $24,000) and would eliminate deductions for state income taxes. The impact of this: Most people will not be able to itemize their deductions. It’s expected the percentage of those deducting charitable donations would fall precipitously from 26 percent to 8 percent. Here’s a link to an analysis in New York magazine. Here’s another link to an analysis by the Tax Policy Center.
Let’s take a quick example to demonstrate how the tax bills would impact a typical couple. A couple has income of $150,000. In 2017, the couple’s standard deduction is $12,700. They paid state income taxes of $11,000, property taxes of $5,000, and made charitable contributions of $5,000. Their income and property taxes, over which they had no choice, total $16,000 and far exceed their standard deduction of $12,700. Thus, they got the benefit of deducting their charitable contributions of $5,000. In other words, every dollar of charitable contribution saved them tax on a dollar of income. They are in the 25% federal tax bracket, so the $5,000 contribution saved them $1,250 in taxes.
In 2018, assuming their income and state and local taxes are the same, their situation would be as follows: Their income for 2018 would be $150,000, their state income tax would be $11,000, their property tax would be $5,000. If the tax bills become law, their state income tax would not be deductible and they would have a standard deduction amount of $24,000. Thus, their total itemized deductions, other than charitable, would be just $5,000, their property taxes. In other words, they could only deduct charitable contributions to the extent they exceed $19,000—far more than the $5,000 they typically make. So, they will take the standard deduction and will get no tax benefit from making the charitable contribution. In fact, the first $19,000 of charitable contributions would see absolutely no tax benefit.
The Solution: However, by planning ahead, they can take the deduction in 2017, where it will still provide a tax benefit. The couple could establish a Donor Advised Fund in 2017 and make a contribution to it. Here’s a link to more information from Fidelity, which has the country’s largest donor advised fund.
With a Donor Advised Fund, the couple makes a contribution this year, and they continue to advise regarding the investment and distribution of the funds to charity in future years. So, let’s say the couple has a history of making a $5,000 contribution to their alma mater each year. They can direct the same $5,000 contribution to their alma mater from the fund. Assuming the investment returns just barely cover the fund fees, they can continue making the contributions for six years before the fund would be exhausted. Meanwhile, they got the tax benefit of their $30,000 contribution up front, in 2017.
Again, if they contributed $5,000 each year, they would have seen no tax benefit after 2017 (under the proposals). By making the contribution in 2017, they would be able to make the contributions when they are still deductible. They could have made the contribution to their alma mater all in 2017. But, with the Donor Advised Fund, they can decide in later years to whom they will give their charitable donation yet still get the deduction up front.
We don’t know if the tax bills will pass, or what the final provisions might be. However, if you make a contribution to a Donor Advised Fund, you’ll be sure to get your deduction this year. In my next blog, I’ll look deeper at the operation of the Donor Advised Fund.
Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com
- Donor Advised Funds: Too Good to Be True? - August 10, 2021
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Wait, so the only reason a person should contribute to a charity is for the tax deduction? If they are truly motivated by saving money how, in your example of giving $5,000 in order to save $1,250 in taxes, do they actually save money? Could there be another reason people give to charities? Are people solely motivated by the impact their spending will have on their income tax liability?
So, with your “typical couple,” in 2017, they had to keep records and substantiate itemized deductions of $21,000. In 2018, with no record keeping, they get to deduct $24,000 from their taxable income plus their marginal tax rate goes from 25% to 22%!
Am I wrong?
Gordon, Thanks for reading the blog. I, personally, will contribute to charity regardless of the tax deduction. However, the after-tax cost of giving will go up and that will be a disincentive for some people. Thanks again for reading the blog. Happy Holidays!