Tax reform implications for your clients' charitable giving
A former IRS agent shares his perspective on the Tax Cut and Jobs Act and its potential effect on charitable giving. Learn strategies to help clients give more efficiently in the current tax environment.
Congress recently passed the most sweeping tax code overhaul in decades. The Tax Cuts and Jobs Act went into effect on January 1, 2018 and some experts suggest there could be a significant impact on charitable giving. Here’s a summary of what you need to know to guide your clients.
1. Shifted tax brackets and rates
Many of the income levels on the tax brackets have shifted and the tax rates have been lowered for most brackets.
- Will result in lower taxes for the majority of individuals, since more income will be taxed at lower rates
- More disposable income may result in more charitable giving for some households
Hear Hayden Adams (CPA, Director of Tax and Financial Planning at the Schwab Center for Financial Research, and former IRS agent), and Kim Laughton (President of Schwab Charitable) discuss the new tax law and implications for charitable giving.
2. Increased standard deduction
The standard deduction nearly doubled.
- Less Americans are expected to itemize and more will take the standard deduction
- However, most HNW clients will continue to itemize, so they are less likely to be affected by the changes
- Some people will be on the margin of itemizing and could benefit from concentrating giving in one year
- Those who no longer itemize will lose the tax benefits associated with charitable giving deductions, which may reduce some people’s incentive for giving
3. Less itemized deductions
- Many itemized deductions were eliminated or reduced.
- Those who continue to itemize may not be able to deduct as much (which could result in higher taxes for some)1:
- No deduction for home equity lines of credit (HELOC) unless it's used to improve the home
- Deduction for state, local, and property taxes limited to $10,000
- Deduction for mortgage interest expenses limited to $750,000 of acquisition indebtedness2
- No deduction for miscellaneous itemized expenses, such as advisor fees and tax preparation fees
- Charitable giving is one of the few deductions that was not eliminated or capped
- Some households may want to increase charitable giving levels to offset the loss of other deductions or to push them over the edge of itemizing
4. Increased estate tax exemption
The federal estate and gift tax threshold was doubled.
- The increased estate tax threshold means that fewer families will be subject to estate tax
- Fewer HNW clients may be motivated to make charitable donations to offset estate taxes
5. Changed adjusted gross income (AGI) limits related to giving
The AGI limitation for cash contributions was increased and the Pease limitation was removed.
- Donors are now allowed to deduct cash contributions of up to 60% of their AGI (up from 50% in the past)
- The previous limit on itemized deductions has been removed (the Pease limitation reduced the value of itemized deductions by 3% of AGI over a certain threshold)
- Some donors will be able to deduct more donations than ever before
6. Reduced taxes for corporations and pass-through businesses
The federal tax rate for C corporations has been changed to a flat 21%, and S corporations and other pass-through businesses may receive a new 20% deduction on net income.
- Entrepreneurs and businesses large and small are likely to benefit from the numerous changes to the tax code
- Pass-through entities like S corporations or partnerships may be able to take a new 20% deduction against qualified business income (however, certain personal service businesses such as doctors, lawyers, and CPAs have limits affecting this deduction)
- Higher profits for businesses could potentially fuel more philanthropic initiatives and charitable giving
In short, charitable giving could be impacted overall by tax reform, but will be a relative bright spot for itemizers and those on the cusp of itemizing. Especially for ultra-high-net-worth households, tax reform has created opportunities to increase giving.
Tax-smart charitable giving strategies to explore in light of new tax law
So how can you support your clients with their philanthropy given the new tax environment? There are three simple strategies you can suggest to help donors make a bigger impact with their giving:
- Donor-advised funds (DAFs) remain a great tool to maximize the tax benefits of charitable giving; clients who don’t already have a DAF account should consider opening one
- Donors can contribute appreciated assets held for more than a year to charity and avoid paying capital gains taxes on the sale of the assets, potentially resulting in larger donations (this tax benefit did not change)
- Those on the cusp of itemizing can concentrate their charitable deductions in one year to maximize their tax benefit (see case study below)
Here is an example of how some households could maximize the impact of their charitable giving by alternating between itemizing one year and taking the standard deduction the next.
In option 1, a married couple on the cusp of itemizing would be better off by taking the $24,000 standard deduction each year, but they would not get the tax benefit of their donations.
In option 2, the same couple can opt to double their charitable giving every other year, so they itemize deductions one year and take the standard deduction the next, which will reduce their taxes overall.
A great way to implement this strategy may be to utilize a donor-advised fund (DAF). DAFs allow donors to concentrate their charitable contributions in higher income years and then support their charities of choice over time. Watch a video to learn How a donor-advised fund works.
While there are some elements of the law that could reduce the tax incentives for charitable giving, it is best to consider the net effect of all the tax law changes combined. Taking everything into consideration, the majority of taxpayers should end up with more money in their pockets to support worthy causes, and many mid to higher income households could see significant tax benefits by increasing their charitable giving.
Moreover, tax incentives are an important but often secondary consideration when it comes to charitable giving. Over the long term, we believe donors will continue to be motivated primarily by achieving their philanthropic missions.
For more on this topic, view the on-demand webcast. Schwab Charitable offers a simple, efficient, tax-smart solution for clients, and valuable support services for advisors. To learn more, call Schwab Charitable at 800-746-6216, visit schwabcharitable.org or follow us on LinkedIn.
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