Navigating charitable planning after the new tax law
Clients have been planning how to navigate the new tax law in areas such as charitable giving and deductions.
The Tax Cuts and Jobs Act of 2017 didn’t end up limiting the charitable deduction, as initially proposed, though the doubling of the standard deduction will provide less incentive for many tax clients to itemize deductions, and hence less need to claim the charitable deduction.
On the plus side, the new tax law increases the percentage limit for cash donations from 50% to 60%, which promises to benefit many donors next tax season. The law also repeals the Pease amendment’s limitation on itemized deductions for high-income taxpayers.
“The percentage limitation for contributions of cash to public charities was increased to 60%. That’s the amount you can write off in a given year, whereas it had been 50% in prior years,” said Steve Chidester, a partner in the private client and tax team in Rancho Santa Fe, California, at the international law firm Withers World Wide.
“Probably a bigger impact is Section 68 was repealed for 2018 through 2025,” he said. “That’s the limitation on itemized deductions, the so-called Pease amendment.”
High-net-worth clients might not be affected by the increase in the standard deduction in terms of the amount of their charitable giving, but it is still a good idea for them to plan ahead.
“I tell all donors that if they have a choice in what they want to give, if they’re intending to give to charity and they have a choice between giving cash or giving appreciated assets, they should almost always give appreciated assets, as stock for example rather than cash because there are really two tax benefits to be reaped by someone who is involved in charitable giving,” Chidester said.
“One is the income tax deduction, but the other one is avoiding the capital gain that’s inherent in an appreciated asset in the first place. When you give cash, you get only the first benefit because in order to get that cash you’ve already recognized some sort of taxable income to generate the cash, or someone did before they gave that cash to you,” Chidester said.
“Whereas if you can give a capital asset of appreciated stock, you don’t recognize the gain and you get the deduction,” he said.
Many donors are inclined to think that if they recognize the gain and get the deduction, the deduction will offset the gain and they are OK, Chidester said.
“That’s true, but wouldn’t you rather not recognize the gain and then get the deduction and be able to apply the deduction against different income? You can crunch the numbers and show how they’re better off,” Chidester said.
“That’s standard advice that I give to most of my clients,” he said.
Donors who are concerned about the doubling of the standard deduction can use strategies to bunch the charitable giving that would normally be allocated over a number of years and instead do them in a single year to get above the standard deduction amount by contributing to vehicles such as charitable lead trusts and donor-advised funds. The charitable bunching strategy can work well for some clients.
“Let’s say that you were going to contribute an amount each year that would be eclipsed by the standard deduction, so you get no tax benefit from making that gift. If instead of giving that amount each year, you can give five times that amount in a given year, the amount of the gift will exceed the standard deduction,” Chidester said.
“You’ll claim the itemized benefit for doing so, and then if you can give to a vehicle or an entity that allows you to have a voice in how those funds are disbursed over the five-year period, you achieve financially the same result for the charitable causes that you want to benefit,” he said. “The donor-advised fund does that, for example.”
However, to use that strategy, clients need to do some planning ahead about how much they are likely to donate from year to year and where.
“The problem is that in order to take advantage of it, you have to be able to come up with the asset that you’re willing to part with, five years of that asset that you’re willing to part with in year one. It requires an especially disciplined taxpayer to be able to do that,” Chidester said.
“High-net-worth individuals have always dealt with bunching issues, years in which they experience a particularly high tax bill if they sold the business, if they exercised the stock options, if they sold real estate. If they had high income for whatever reason, they go looking for an increased charitable deduction to offset against that increased amount of income,” Chidester said.
“Maybe for some high-net-worth families, maybe they make a substantial gift to their family foundation or they give to a donor-advised fund or by some other strategy deal with a bubble year of income,” he said. “Theoretically we could see that for people who would otherwise be dissuaded from giving by the increased standard deduction, but by and large those folks in my experience don’t have the level of wealth that makes them ideal candidates for this kind of bunching of charitable gifts.”
For taxpayers who tend to use the standard deduction or who will be more likely to use it when it doubles next tax season, they may still continue donating to their favorite charity no matter what deduction they can or cannot claim.
“To the extent that they have been contributing, despite the fact that they get no tax benefit from it, there’s no reason to believe that they will stop contributing. I saw one commentator who suggested that, from the fact that they get an increased standard deduction, that should give them a modest tax reduction, which frees up some cash to contribute,” Chidester said.
“I think there will be folks who will take this into account, especially in the early years, and say there’s no tax breaks for me in contributing, so I’m going to be less likely to contribute. But for the most part people in that category were not mainly contributing because of the tax deduction in the first place,” Chidester said.
“I think they were contributing because of their commitment to the charities they support,” he said.