If you used to itemize your deductions, last year’s massive tax law changes may affect the optimal way for you to make charitable contributions. Three major modifications in the law are responsible for the changed situation:
(1) The 2018 standard deduction increased substantially. It’s $12,000 single/ $24,000 married, which is significantly higher than in 2017. For those over age 65, the standard deduction increases to $13,600/$26,600 (assuming both members of the couple are over 65).
(2) The deduction for state and local taxes is capped at $10,000, regardless of whether you are single or married (a clear marriage tax penalty in a bill that is otherwise very friendly to families, especially if you have children – go figure).
(3) The provision for Qualified Charitable Distributions (QCDs) was made “permanent” in the new law, meaning taxpayers no longer need to wait until December to find out if Congress will extend the provision.
The combination of (1) and (2) means the standard deduction will now apply to a significant number of individuals who itemized deductions in the past. Charities have their fingers crossed that these people will not reduce their contributions because they have “lost” the deduction for them. It also means that the group of people who benefit from “doubling up” contributions changes.
The “doubling up” strategy involves developing a contribution schedule that crosses two calendar years. If your itemized deductions are less than the new standard deduction but greater than 50% of it, you might benefit by moving all deductions you can from year 1 to year 2 (or vice versa). For example, let’s say you routinely make $10,000 in contributions each year and under the new law that means you will take the standard deduction. Instead, make no contributions in year 1, and on January 1 of year 2, donate the carryover $10,000. Then donate year 2’s $10,000 sometime before the end of the year. If the $20,000 donation is sufficient to allow you to itemize in year 2, then you’ve converted some nondeductible contributions into deductible ones and reduced your overall taxes.
Also effective is delaying optional medical expenses (in standard deduction years) or pushing them forward (in itemizing years). To a lesser extent, timing the payment of real estate taxes or state income taxes might also help.
What’s up with Qualified Charitable Distributions?
Making the QCDs permanent means anyone who must take the Required Minimum Distributions (RMDs) from an IRA and donates to 501(c)(3) organizations might benefit. Once you turn age 70-1/2, current rules on IRAs, 401(k)s and the like require you to take certain minimum annual levels of distributions or pay a huge tax penalty. As with any such distribution, RMDs are taxable to the extent they do not reflect a return of nondeductible contributions.
QCDs apply only to standard IRAs and allow you to DIRECTLY donate up to $100,000 per individual to qualified 501(c)(3) charities and exclude the donation, to the extent it was taxable, from income. What’s the benefit?
(1) If you take the standard deduction, this provision allows you to effectively deduct what would otherwise be nondeductible contributions. A clear win.
(2) Even if you do itemize, making a QCD reduces your adjusted gross income. That reduction may help you avoid the Medicare High-Income Surcharge, possibly reduce the proportion of Social Security benefits that are taxable, and reduce the limit before medical expenses can be deducted.
(3) Because you’ve reached the age requirement for RMDs, you were going to have to take money from your IRA anyway, and this might be the most efficient way to do it.
What are the rules for QCDs?
(1) You must have reached age 70-1/2 before the distribution is made.
(2) It must come from a regular or rollover IRA, not a SEP or Simple IRA in which employer contributions are still being made. They can’t be from a 401(k) or 403(b).
(3) The receiving organization must qualify as a 501(c)(3) organization (not all charitable organizations do, and private foundations and donor-advised funds are not eligible)
(4) The contribution must come directly from the IRA. If you cash out the IRA and make a contribution with those funds, it will not count. Many IRAs offer a check-writing privilege and that technique will work because the check is coming directly from the IRA. Otherwise, you’ll have to donate securities from the IRA.
(5) Had you not used this technique and instead deducted the contribution in the normal manner, it must have been entirely deductible (e.g. you can not receive any benefit from your deduction—so make sure to reject that coffee mug from NPR and turn down those tickets to the charity ball.)
Since 401(k)s and 403(b)s do not qualify for QCDs, and if you make considerable charitable donations to 501(c)(3) organizations, you can consider rolling over the qualified plan into an IRA to take advantage of the QCDs.
Increasingly, states income taxes use different rules than Federal income tax law. Any analysis of your contribution strategy must include how any change affects your state income tax in addition to the federal effects.
If you are approaching 70-1/2, QCDs are one more thing to think about as you determine whether to take your initial RMD in the year you turn 70-1/2 or wait and take it by April 1 of the following year.
We’re talking taxes here, and these are my understandings of the rules. I’m not a lawyer or accountant, and I’m not providing any advice. You really must check with your own tax advisor before making any decisions (or make sure to do your homework).