The Tax Cuts and Jobs Act passed at the end of last year did not bring good news to the non-profit sector. Historically, taxpayers could either itemize deductions such as mortgage interest, charitable donations and state and local taxes or take a standard deduction. In an effort to simplify and reduce taxes, the new tax act doubles the standard deduction to $12,000 for individuals and $24,000 for married couples. These higher limits mean that fewer taxpayers will see the benefit of deducting charitable donations on their returns.
Non-profit entities across the country are bracing for the impact of these changes. The Tax Policy Center has estimated that the percent of households claiming charitable deductions will drop from 21% to 9% (see chart below.) While estimates vary, the total amount of charitable donations is expected to drop on the order of 5% or $15 billion this year. Religious institutions that have historically received a large number of small donations are expected to experience the biggest hit. Research facilities and universities, non-profits favored by large wealthy donors, should be less affected.
The good news is that there are several strategies (some old, some new) for those wishing to make charitable donations and receive a tax benefit. If you are in the habit of giving many small amounts over time, consider lumping your gifts together in one year to take advantage of itemizing. This approach only makes sense if the total of all your eligible deductions exceeds the standard amount. A Donor Advised Fund (DAF) can be particularly helpful if you go this route. Individuals can establish these funds with a custodian such as Charles Schwab and fund them with cash or securities. The tax deduction can be taken upfront and donations to favorite charities spread over time.
Donating securities that have a low cost basis remains a tax efficient way to gift as well. Under this approach, the donor avoids the capital gains tax that would result from selling the securities themselves and, if they itemize, also receive a tax deduction for a portion of the gift. Funding a DAF with low cost basis stock combines tax efficiency with the operational ease desired by many donors.
Finally, a law passed in 2015 allowing some donors to tap their IRAs for gifts has come into renewed focus under the new rules. First, some background. The IRS requires IRA owners to take distributions in the year they turn 70 ½. Many retirees forget, however, that distributions from all qualified retirement plans other than Roths are taxed at ordinary income tax rates. The 2015 rule change allows IRA owners over the age of 70½ to gift up to $100,000 each year to charity from their IRAs without counting the distribution as taxable income. Several caveats are in order. First, donors using this Qualified Charitable Distribution (QCD) approach are not eligible for a charitable tax deduction. Second, QCDs must be made directly to a qualifying charity. DAFs and other grant making organizations such as foundations do not fall into this category. Third, donors may use IRAs (traditional or inherited) and inactive retirement plans like SEPs or SIMPLEs as a source of such funds but not 401(k)s or 403(b)s.
Many taxes, such as those related to Medicare premium surcharges, Social Security income and capital gains, are based on income. QCDs reduce taxable income and, therefore, can be helpful to individuals hoping to avoid these taxes.
The relative benefits of these various gifting approaches depend significantly on each donor’s situation. Reviewing them with your tax preparer will ensure that you select the correct one and that the proper documentation is included with your return.