The 2017 tax act created a new 60% charitable deduction limit for cash contributions to public charities. The concept sounds great – it promotes charitable giving and allows a deduction to generous donors. However, obtaining optimal deductions will involve careful planning by donors and their advisors.
The new 60% charitable deduction limit refers to a donor’s contribution base, which roughly translates into adjusted gross income (AGI). Therefore, the new law allows a new contribution limit for cash contributions to public charities of up to 60% of a donor’s AGI for the year.
Cash Only. The new 60% charitable deduction limit applies strictly to cash — not real property, not appreciated assets, just cash. The deduction limits remain the same for gifting other assets, such as stock, real estate, and tangible goods. While donating appreciated assets is particularly attractive because the donor can avoid the capital gain tax on appreciation while still claiming the charitable deduction, such contributions are generally subject to the 30% AGI charitable deduction limit. For taxpayers wishing to maximize their charitable deduction, having cash on hand to take advantage of the 60% deduction limitation is generally the most efficient method of making the donation. For those who plan to bunch their charitable donations in the future, it can mean a great opportunity — both financially and for charitable impact.
Itemize Deductions. Charitable contributions are only deductible as an itemized deduction. In order to itemize, taxpayers need combined itemized expenses for the tax year to be greater than their standard deduction amount ($12,000 for an individual or $24,000 for a married couple for 2018) . Generally, itemized deductions in 2018 include medical/dental expenses (which include only those expenses paid which are greater than 7.5% of gross income); state and local income and property taxes (but not more than $10,000 each year); home mortgage interest (limited to interest on acquisition indebtedness of $750,000; $1,000,000 for debt acquired before 2018); charitable gifts (60% annual AGI for cash; 50%, 30% or 20% limits on other property items, depending on what type of charitable organizations the assets are given to and whether the asset is ordinary income property or capital gain property); and casualty losses (now limited to net losses suffered in a federally declared disaster area). Unfortunately, the 2017 tax act eliminated the deduction for miscellaneous itemized for tax years 2018 through 2026.
Still Giving. The potential for a smaller charitable deduction or none at all does not mean that people will stop giving to charities. Most people do not give for the deduction; they give because they want to support a worthy cause, receive recognition, respond to disaster emergencies, etc. The new law may, however, impact when and how people give so that they can take maximum advantage of the new charitable and itemized deduction landscape.
Bunching. There are a lot of well-intended articles out there suggesting “bunching” charitable contributions in order to make financial sense by maximizing the tax advantages of making charitable contributions. The different methods of bunching suggested include (i) making larger gifts in some years and no gifts in other years; (ii) using donor-advised funds to hold charitable funds for later, staggered distributions to charities; and (iii) saving to make a single charitable contribution every few years. While some observers may see these maneuvers as gerrymandering the system, others will see this as prudent planning to maximize an individual’s financial position and to allow that individual to donate more money to achieve charitable goals.
Example. Erica and Emile have an annual income of $125,000 in 2018. They are considering bunching their charitable donations this year in order to take advantage of the new charitable deduction limit. They are planning to use the standard deduction in the next two years. They paid no large medical bills, paid $10,000 in state and local taxes, and they have no mortgage interest to deduct in 2018. They could donate up to $75,000 cash ($125,000 x 60%) in 2018 and be able to deduct it all. What happens if they decide to donate $95,000 to a cause they strongly support? Since Erica and Emile can only deduct $75,000 of the charitable contribution, the rest of the deduction ($20,000) is carried over and can be used in the next five tax years. The following year, Erica and Emile have an income of $25,000 because they also volunteered for the charity. They make no charitable contributions, and the $24,000 standard deduction is more than their itemizable expenses, including the charitable deduction carryover. Therefore, they claim the standard deduction.
Calculating the carryover deduction, and applying it in following years, can be complicated. Because Erica and Emile are using the standard deduction in the second year, either a part or all of their carryover charitable deduction could be forfeited. To determine how much of the charitable deduction carryover is forfeited, the advisor must compare the amount that could be deducted had Erica and Emile itemized in the second year. Namely, the advisor must determine the lesser of:(i) the charitable contribution limit for the second tax year minus charitable contributions actually made in that year, or (ii) the amount of the carryover contribution. Since Erica and Emile have only contributed cash, the calculation does not need to include calculations for other types of property to a variety of nonprofit organizations. In Erica’s and Emile’s second tax year, this means that the charitable deduction would have been limited to the lesser of $15,000 [($25,000 x 60%) - $0] or $20,000 (carryover amount) had they itemized.
Under Reg. §1.170A-10(a)(2), $15,000 of the $20,000 carryover (the lesser of $15,000 or $20,000) is treated as if it were claimed, even though Eric and Emile choose the standard deduction. Therefore, $15,000 of the carryover is treated as if it were reported and deducted, and $5,000 remains available for use in the next four years. Thus, Erica and Emile essentially forfeit $15,000 of their overall charitable contribution deduction.
These regulations have not been updated since 1975 for changes in the law, but they are still the method the IRS follows to calculate charitable deductions. For an updated version of the Reg. §1.170A-10 example, including cash, ordinary income and capital property contributions to public charities and private foundations, see 863 T.M., Charitable Contributions: Income Tax Aspects in the Bloomberg Tax Estates, Gifts and Trust Series.
Bunching Beware! If you believe that your client may use the standard deduction in the years following a large charitable contribution, be careful not to exceed the 60% cash contribution limit. If your clients want to donate more in any particular year, he or she should be reasonably certain that he or she will be itemizing in the following years. While planning for charitable contributions for the coming years can create more bang for the charitable buck, it is also going to take some careful consideration and presaging about when a client will itemize and when he or she will use the standard deduction.
Kathleen Adcock joined Bloomberg BNA in 2013 as a tax law editor in the State Tax group before moving to Estates, Gifts and Trusts. Ms. Adcock was previously in private practice in estate planning, probate administration and tax controversy, and continues to practice pro bono in Maryland. Kathleen is the 2013 recipient of the J. Ronald Schiff Pro Bono Award presented by the Maryland State Bar Association Tax Section.
Ms. Adcock received her B.A. from Yale College at Yale University, her J.D. from the University of Baltimore, and her LL.M. in Taxation and Certificate in Estate Planning from the University of Baltimore. Kathleen also has an M.B.A. from the Merrick School of Business at the University of Baltimore with a concentration in financial analysis.