What to know about tax reform impacts on charitable giving
Following the enactment of the 2018 Tax Act, charities feared that the new law would lead to a drop in charitable giving by individuals. While taxes are certainly not the only reason people give, they impact incentives for charitable giving and often influence the timing, the amount and sometimes the method donors use to make those gifts.
The 2018 Tax Act included a number of fundamental changes that may affect charities directly and indirectly. Because of the tax law changes and the current economic environment, it’s critical advisors understand and address the impact of these changes when advising clients how to achieve their charitable giving goals in the most tax-efficient manner.
Early effects of the tax reform
Many donors are compelled to make charitable donations based on a desire to give back to their communities or support causes they’re passionate about, rather than for tax planning purposes. However, charities feared the latest changes in tax law would lead to a decline in charitable giving. New data supports these fears—individual giving declined 1.1% in 2018 to $292 billion (and, in fact, fell 3.4% adjusted for inflation). Some of the potential tax causes of this decline are listed below.
1. Increased standard deduction
The change expected to have the greatest impact on charitable giving is the approximate doubling of the standard deduction, which was accompanied by the elimination of the personal exemption. The Joint Committee on Taxation estimated that the tax reform would reduce the number of taxpayers who itemize from 46.5 million in 2017 to just 18 million in 2018. Because the charitable deduction is an itemized deduction, this provision is anticipated to have significant adverse consequences on charitable giving, generally because far fewer individuals will itemize their deductions. And, those who don’t itemize their deductions will not be able to take advantage of the charitable deduction.
2. Increased estate and gift tax exclusion
The Tax Act also doubled the estate and gift tax exclusion amount and generation-skipping tax exemption to $11.18 million for 2018. As a result, donors may not have as much incentive to provide charitable donations at death if they are not subject to estate taxes.
3. Modification of the income tax rate and reduction of the top bracket
The maximum income tax rate for individuals has declined slightly. Following these changes, the top rate in 2018 for single taxpayers making more than $500,000 and married individuals making more than $600,000 was 37% (from 39.6% in 2017).
4. Removal of other itemized deductions
Despite lower marginal tax rates, some taxpayers will end up paying more in taxes under the new laws because of the removal of a couple widely-used tax deductions. Previously subject to no limitations, the state and local tax deduction that allows taxpayers to deduct local tax payments on their federal tax returns was capped at $10,000 starting in 2018. And, the personal residence mortgage deduction for indebtedness incurred after December 15, 2017 was capped at $750,000.
This change will have the greatest impact on high-income filers—those same individuals who, prior to the 2018 tax reform, realized the greatest incentive from itemizing their returns by taking advantage of the charitable deduction. Although this loss in deductions could be offset by the decrease of the top federal income tax rate, the doubling of the estate tax deduction and the cutting of the capital gains rate, high-income filers may be less incentivized to give if they opt for the increased standard deduction instead of itemizing their returns.
5. Repeal of the “80/20 rule”
The new Tax Act also repealed the “80/20 rule” that allowed a charitable deduction for 80% of amounts paid to, or for the benefit of, an educational institution in exchange for the right to purchase tickets for seating at an athletic event in that educational institution’s athletic stadium.
Predicted impact on charitable giving
Tax incentives have been found to play a role in people’s giving decisions. Thus, it’s unsurprising that the new Tax Act has prompted more filers to claim the increased standard deduction, and decrease their charitable giving.
What actually happened?
Household giving in 2018 dropped $15.5 billion. On a more positive note, giving by foundations and corporations increased by 7.3% (an increase of 4.7% adjusted for inflation) and 5.4% (an increase of 2.9% adjusted for inflation) respectively. These increases may have been influenced by corporate tax breaks.
Giving to foundations, on the other hand, decreased by 9.1% in inflation adjusted dollars‡ in 2018. Giving by bequest totaled an estimated $29.71 billion in 2018, remaining relatively flat with a 0.0% increase from 2017 (a 2.3% decline, adjusted for inflation).
The emerging trend from the 2018 tax season is a decrease in the number of households of moderate means that are giving at all, while more of the money being given comes from those in the highest income tax bracket. If policymakers want to boost individual giving, they will need to address the tax treatment of charitable giving under the new Tax Act.
Alternate methods of giving—alternative methods to maximize tax deductions
For donors who are charitably inclined and others who are still likely to give, there are a few alternative vehicles to use, even after the 2018 Tax Act, to enjoy some or all the tax benefits they might have received in previous tax years.
Distributions from individual retirement accounts (IRAs) for donors who are over the age of 70½
IRA accountholders may use pre-tax money in their IRA to make direct donations to a nonprofit, religious organization or other qualified charity using the IRA Qualified Charitable Distribution (QCD) rule. This rule allows IRA accountholders to use the untaxed money in an IRA to donate to a charity tax-free. The money withdrawn from an IRA will stay out of the donor’s adjusted gross income provided that the transfer is made directly from the IRA to the charity. This can be especially useful for taxpayers over age 70½ who are required to take minimum withdrawals from their IRA or retirement plan. Amounts transferred from the taxpayer’s IRA to charity as a QCD count toward the taxpayer’s required minimum distribution for the taxable year.
Donors who still want to receive a tax break may consider “bunching” any planned charitable donations for the next several years into one large donation for a single year. If the charitable donation is greater than the donor’s standard deduction, the donor can claim the entire amount as an itemized deduction on their tax return for that year. The end effects of “bunching” on a recipient charity may be minimized by making gifts to a donor-advised fund.
Donor-advised funds are tax-advantaged investment accounts funded with cash or other assets used for charitable giving. These funds are structured similarly to a private foundation and afford donors a measure of control and involvement, although they’re not under the donor’s explicit control. These funds are typically quicker, easier, and cheaper to create than a charitable trust or a private foundation, and donors do not need to select the recipient charity at the year’s end. Instead, they can elect to defer that decision while still receiving the tax benefits in the year of the contribution despite having delayed the decision on the recipients.
Giving to avoid realization of capital gains
Taxpayers may choose to make charitable gifts of appreciated property to avoid capital gains taxes when faced with an income realization event or a desire for greater diversification. Under this strategy, individuals can donate appreciated property (typically common stock or a mutual fund) that they have owned for more than a year instead of writing a check or giving cash to a charity. By donating the shares of an investment that has appreciated to a charity, the donor will avoid reporting the gains as taxable income. This stems from the general rule that the donation of property held for over one year will receive a deduction equal to the donated property’s fair market value when such property is donated to a qualifying charitable organization.
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