Coming in at over 500 pages long and an expected cost of $1.4 trillion, the tax bill represents a significant overhaul to corporate and personal tax code. The bill not only slashes the tax rate on corporations from 35% to 21%, but also modifies standard deduction levels, and eliminates or limits other itemized deductions for tax filers among other things. Undoubtedly, the tax law will present new opportunities for effective financial planning in the years ahead.
However, in the immediate term, making charitable contributions before the end of 2017 just got more interesting. As a result of this tax legislation (likely be signed into law this week), many households might lose out on the full deductibility of future charitable contributions, starting in 2018. Therefore, it may be beneficial for many households to front end load future charitable contributions into 2017, potentially through a Donor Advised Fund (DAF).
Upping the Standard Deduction
Two new provisions of the tax bill will make it more difficult for households to reach a level of deductions where it makes sense to itemize:
- Standard deduction going from $6,350 to $12,000 per individual ($24,000 for a married couple); extra $1,300 if over 65 (single) and $2,600 (married and both over 65);
- Deduction for state, local, and property taxes will be capped at $10,000.
This means that, in effect, any married couple filing jointly (assuming under 65) that cannot meet the $24,000 deduction threshold with mortgage interest and real estate taxes (assuming no material deduction for medical expenses or other), will not be getting the full deductibility benefit of charitable contributions.
Let’s look at two simple examples to illustrate the point:
Example 1: Married Couple with Deductions at the Threshold
A married couple living (ages 47 and 43) pays $15,000 in real estate taxes, $9,000 in mortgage interest, and typically makes $4,000 a year in charitable contributions.
In this example, the couple’s total deductions would be $23,000 ($10,000 real estate cap, $9,000 mortgage interest, and $4,000 charitable), just under the standard deduction. However, had they not given to charity they would have received the same standard deduction regardless. So, they are, in effect, losing the deductibility of their charitable contributions.
In this example, it would have been more beneficial for the couple to give several years of future expected charitable giving to a DAF in 2017. In doing so, they would receive the full deduction for their charitable giving in 2017 (assuming enough income to offset), but not be required to grant the funds until some point in the future. This strategy preserves the deduction for their future charitable giving, rather than losing it to the higher standard deduction.
Example 2: Married Couple with Charitable Giving that Exceeds the Threshold
A married retired couple (ages 67 and 60) that pays $8,000 in property taxes, no mortgage, and gives $20,000 to charity each year.
In this example, the couple’s standard deduction would be $25,300 [$13,300 (over 65) + $12,000 (under 65)]. If this couple were to itemize in 2018 and beyond, their deductions would be $28,000 which clearly exceeds the $25,300 standard deduction level.
However, the couple would come out ahead if they were to make a significant charitable contribution in 2017; thereby capturing more of the charitable deduction as opposed to only $2,700 ($28,000 – $25,300) each year. This assumes the couple has enough income in 2017 to offset the deduction in 2017. They could make a $60,000 contribution to a DAF (3 years of planned charitable contributions) in 2017 and receive the full deduction. If not, they would be only receiving $8,100 if spread out over the next three years.
Better Act Fast
The bottom line is that if your real estate and mortgage interest do not exceed your standard deduction, then you might benefit from prepaying some of your future charitable contributions in 2017. Furthermore, a donor advised fund might be the best vehicle to do so since it will preserve your ability to make the grants at some point in the future. Another advantage is that the contributions to the DAF can be made in cash or appreciated long term securities (thereby sidestepping long term capital gains taxes).
Unfortunately, time is of the essence since these changes go into effect January 1, 2018 (assuming the bill becomes law). As always, we are available to discuss with you but you should also consult with your CPA or tax preparer to evaluate your particular circumstances to make sure this strategy is appropriate.