November 7, 2018
The holiday season is fast approaching. It’s the time when people traditionally make gifts to charities. Generally, year-end donations increase the charitable deduction you can claim on the personal tax return you’ll file the next year. But 2018 is different from most previous tax years.
From 2018 through 2025, the Tax Cuts and Jobs Act (TCJA) nearly doubles the standard deduction to $12,000 for single filers and $24,000 for joint filers. The TCJA also reduces or eliminates several itemized deductions.
As a result, millions of taxpayers who previously itemized deductions will instead claim the standard deduction for 2018, thereby eliminating the tax benefit from their charitable donations. Does it make more sense for you to itemize deductions or to take the standard deduction on your 2018 return? The answer to this question will determine your overall strategy for the rest of the year.
For those who will continue to itemize, it’s important to be creative at year end. Here are five ways to maximize the tax savings from your donations.
1. Bunch Donations
You can “bunch” donations in the tax years that you plan to itemize deductions, thereby exceeding the standard deduction amount. That way, you can reap tax rewards for your generosity by making donations that you can write off as itemized deductions.
If you expect to itemize deductions for 2018, consider increasing your charitable gift-giving at year end. You can generally deduct the full amount of cash contributions made this year, up to 60% of your adjusted gross income (AGI). Prior to the TCJA, the limit was 50% of AGI. Any excess is carried over for up to five years.
If you expect to claim the standard deduction for 2018, you might consider postponing large charitable gifts to 2019 or beyond, when you may be itemizing deductions. That way, you can still derive tax benefits for your donations.
2. Gift Property with Low Tax Basis
If you donate appreciated property to charity, your current deduction for those contributions is limited to 30% of your AGI. Any excess may be carried over for up to five years.
The value of the donation depends on how long you’ve owned the property. If you’ve owned donated property for more than a year, it would have qualified for a long-term gain had you sold it instead of donating it. In this situation, you can deduct its full fair market value on the date of the donation. However, if a sale of the donated property would have resulted in a short-term gain, you can deduct only your basis (generally, your initial cost).
Therefore, it makes sense to donate property with a low basis that you’ve owned longer than one year. For instance, suppose you acquired artwork for $5,000 in 2016 that’s now worth $15,000. If you donate the artwork to a charity in 2018, you can deduct $15,000. The appreciation in value from the date of acquisition to the date of the donation ($10,000) will never be taxed.
Conversely, you might decide to hold onto high-basis property, rather than donating it. Similarly, don’t donate low-basis property you have owned less than a year. Keep it until you qualify for a deduction based on the property’s full fair market value.
3. Set Up a Donor-Advised Fund
With a donor-advised fund, you can earmark money for future charitable gifts while qualifying for a tax deduction on your tax return. The money is invested and grows until it’s distributed to the designated charitable recipients.
Typically, a sponsoring financial institution manages the fund. It usually requires an initial minimum deposit of at least $1,000. In addition, you may have to pay annual fees to cover administrative and other expenses.
A donor-advised fund allows you to choose the qualified charitable organizations that will benefit from your generosity. Your recommendations are reviewed by staffers who verify that the charity is eligible to receive deductible contributions. Once the grant is approved, the money is sent to the specified charity, indicating that you’ve donated to the organization. Alternatively, gifts may be made anonymously.
The usual tax rules for charitable contributions apply. For instance, under the TCJA, current deductions to a donor-advised fund, when combined with other cash donations, are limited to 60% of AGI, with a five-year carryover for any excess.
4. Establish a Charitable Trust
A charitable remainder trust (CRT) can generate tax benefits in a year in which you expect to itemize deductions. How does it work? The CRT pays out income at regular intervals to the designated income beneficiary or beneficiaries (typically, you, your spouse or both). The trust terminates upon your death or a specified term of years. Then the remainder goes to the charity. The main tax benefits are as follows:
- You can claim a charitable deduction based on the value of the remainder interest.
- There’s no capital gains tax due on the value of any appreciated property transferred to the trust. The appreciation in value remains untaxed forever.
- The property is removed from your taxable estate.
A CRT can be structured as a charitable remainder annuity trust (CRAT) or a charitable remainder unitrust (CRUT). In either event, the term of the trust can’t exceed 20 years. With a CRAT, the payment must be a fixed amount equal to at least 5% of the initial value of the trust property, while a CRUT requires payment of a fixed percentage of not less than 5% of trust assets.
5. Transfer Funds from Your IRA
People age 70½ or older can choose to transfer funds directly from an IRA to a qualified charitable organization. Although the contribution isn’t deductible, it’s not subject to income tax, either. But because the donated IRA money would otherwise be taxed when you withdraw it, this treatment equates to a 100% deduction for the amount donated to charity.
The maximum amount you can transfer each year is $100,000. If your spouse has one or more IRAs set up in his or her own name and is also age 70½ or older, your spouse is entitled to a separate $100,000 annual limit.
To qualify for this tax break, the distribution must go directly from the IRA trustee to the charitable organization. In other words, the funds cannot pass through your hands on the way to the charity.
The transfer also counts as a required minimum distribution (RMD). Taxpayers age 70½ or older are required to take RMDs from their IRAs every year. So, you can effectively replace taxable RMDs with tax-free transfers to charity.
There’s still time in 2018 to make moves that can cut your tax bill. Contact your tax advisor to review your personal situation and help modify your charitable giving strategy based on today’s tax law. If itemizing deductions is part of your tax plan for 2018, that could be a good reason to be especially generous this holiday season.