The Tax Cuts and Jobs Act (TCJA), effective January 1, 2018, represents one of the most significant changes to the US Tax Code in decades. One area in which TCJA appeared to formally change little was the tax deductibility of charitable gifts. Other changes under TCJA, however, particularly those resulting in a dramatic reduction in the number of taxpayers who itemize, have had a profound impact on charitable giving and require new strategies for charitable gift planning. This article will explore those changes and suggest opportunities to maximize the tax benefits of charitable giving under the new law.
Charitable Giving and the Tax Code
According to the Giving USA Foundation, Americans donate more to charitable causes every year on a per capita basis than do citizens of any other country. The US Tax Code encourages such giving. A deduction from income for tax purposes has been part of the Tax Code for almost as long as the modern income tax itself. The US Tax Code first allowed the deduction in 1917 to address concerns that the very wealthy—who were the only ones subject to the income tax at the time—would reduce their charitable giving in response to being taxed. As more taxpayers gradually became subject to the income tax, the charitable deduction was effectively limited in 1944 when the standard deduction was introduced. As an itemized deduction, only those taxpayers who itemize their deductions may take the charitable donation deduction; taxpayers who use the standard deduction no longer take itemized deductions such as the charitable donation deduction. Before the passage of TCJA, approximately one-third of taxpayers itemized their deductions. TCJA decreased the number of itemizers substantially.
At first glance, TCJA did little to change the historical framework for charitable giving. TCJA actually increased incentives somewhat for those able to make substantial contributions by raising the maximum amount a taxpayer may deduct from adjusted gross income (AGI) for cash donations to public charities and certain private foundations. Before TCJA was enacted, the ceiling was 50 percent; now it is 60 percent. The pre-TCJA limit of 50 percent of AGI for certain non-cash contributions still applies, as does the 30 percent limitation for donations of appreciated securities. Complex ordering rules apply if a taxpayer’s contributions are subject to more than one of these limits, but generally cash contributions subject to the 60 percent limit will reduce the deductibility of non-cash contributions. Any amounts unable to be deducted may still be carried forward for up to five years. TCJA also removed the limitation on itemized deductions for high income taxpayers. Previously, taxpayers with adjusted gross income above $266,700 for single filers and above $320,000 for married couples had to reduce their itemized deductions, including charitable deductions, by three percent of every dollar of taxable income.
Offsetting these increased incentives, however, TCJA significantly reduced the number of taxpayers eligible to take a charitable contribution deduction by changing the provisions related to whether a taxpayer itemizes. TCJA increased the standard deduction from $6,350 to $12,000 for single filers and from $12,700 to $24,000 for married filers. TCJA also capped the state and local tax (SALT) deduction at $10,000 for both single and married filers, leading to tax increases for some.
To illustrate, a married couple with $9,000 in property taxes and $16,000 in state income taxes under TCJA can now deduct only $10,000—not $25,000—because of the SALT cap. If they have less than $14,000 in other qualifying itemized deductions, such as charitable donations, this couple therefore will no longer itemize and will instead take the standard deduction. These changes—increasing the standard deduction while capping SALT deductions—had the net effect of reducing the number of Americans who itemize by approximately 28.5 million, from roughly 30 percent of all taxpayers to 10 percent, according to the Congressional Joint Committee on Taxation.
Impact on Charitable Giving
What effect will these changes have on charitable giving? Before TCJA, individual Americans donated an estimated $300 billion per year. The elimination of the ability of millions of taxpayers to deduct their charitable contributions, combined with a tax increase for some, was estimated by the Congressional Budget Office as likely to reduce charitable giving by 4.6 percent, or approximately $13 billion. Yet such dire results appear not to have occurred—or at least not yet. According to a study by the Fundraising Effectiveness Project of the Urban Institute, overall charitable giving in 2018 actually increased by an inflation-adjusted 1.6 percent, though this is much less than the eight percent increase from 2016 to 2017. An analysis by Giving USA indicates an even more modest increase of only 0.7 percent, with a 3.4 percent drop in donations by individuals offset by increases in corporate and foundation gifts.
It is difficult, however, to isolate TCJA’s effect on charitable donations given other potential influencing factors. TCJA’s disincentives to charitable giving may have been offset by the generally good economy and the fact that some Americans, particularly the very wealthy, received significant tax reductions through TCJA. Stock prices throughout much of 2018 continued to rise, at least until the very end of the year. A strong stock market encourages charitable gifts of appreciated stock, as will be discussed further below.
Additional factors supporting increased charitable giving include growing numbers of baby boomers reaching age 70 ½ and donating the required minimum distributions from their retirement accounts to charity, a popular provision unchanged under TCJA. It is also likely many Americans did not even realize until they prepared their 2018 tax returns in 2019 that they no longer qualified to itemize and their charitable giving therefore provided no tax benefit. Presumably as well, many people are motivated to donate to charity primarily because they support the organization’s purpose, not because of tax incentives.
Yet TCJA’s impact is clearer when analyzing the numbers in greater depth. Donations under $250 were down 4.4 percent from 2017, while donations between $250 and $999 were down four percent, according to the Association of Fundraising Professionals. Donations of $1,000 and up increased by 2.6 percent.
So how is a practitioner (particularly one who does not prepare her clients’ tax returns) to know who might need to change their charitable gift planning? Those most likely to have lost their ability to itemize would be residents in states with both an income tax and relatively high property values. The top candidates are those residing in higher SALT states, including California, New York, New Jersey, Connecticut, Maryland, Delaware, Virginia, and Oregon, although every state with an income tax likely has some affected taxpayers.
A household’s income provides another measure. According to the Tax Foundation, before TCJA, approximately 76 percent of households with income between $100,000 and $200,000 itemized. After TCJA, only 22 percent did so. For households earning over $200,000, the pre- and post-TCJA percentages for itemizing went from 96 percent to 49 percent.
The effect of these changes on a particular charity will depend in large part on its donor base. In general, high-dollar donors have historically tended to direct their gifts to nonprofits associated with the arts and education, particularly universities. Donors of smaller amounts have tended to benefit religious institutions or so-called basic needs organizations such as food banks. Indeed, donations by individuals to religious organizations dropped by 3.9 percent in 2018 and those to the United Way by six percent, according to Giving USA. The scale of such impacts are likely to be greatest in those areas with the most taxpayers affected by TCJA’s new rules.
Planning opportunities do remain for those taxpayers whose charitable giving is motivated at least in part by tax consequences. Perhaps the simplest such method is to bunch into one year those donations that a taxpayer otherwise would have made over two or more years. Some taxpayers may have already done this at the end of 2017 when they realized they were about to lose their ability to itemize, perhaps contributing to the eight percent increase in giving that year.
For an example of how bunching works, think of the married couple noted above with property and state income taxes capped at $10,000. If that same couple also paid $9,000 in deductible mortgage interest (also subject to new limitations under TCJA) and normally made charitable gifts of $3,000 per year, they may now wish to bunch two years of donations into one. Total charitable giving of $6,000 in one year would put them over the $24,000 threshold to itemize, with $10,000 in capped state and local taxes, $9,000 in mortgage interest, and $6,000 in charitable donations totaling $25,000 in deductions. Presumably, this couple would then make no charitable donations the following year and simply take the standard deduction.
Another strategy to bunch donations while also allowing distributions over subsequent years would be to use a donor-advised fund (DAF). A DAF would allow our hypothetical couple to contribute their $6,000 in year one but still distribute $3,000 of it in year two. Federal tax law credits a donor’s donation in the year made to the DAF, not the year the DAF distributes the funds to charity.
Many taxpayers already appear to have recognized the benefits of DAFs, with new accounts having increased steadily in recent years. DAFs, managed by investment advisors, are also convenient vehicles for gifting appreciated stock. Such a gift benefits the donor by setting the value of the donation at the stock’s fair market value at the time of the gift. This allows the donor to forego recognizing the appreciation that would otherwise be taxed as capital gain.
For example, let’s assume a donor owns stock purchased for $10, which is now worth $100. If the donor wanted to make a charitable gift of $100, the donor could redeem the stock and receive its $100 value. But this would also require the donor to pay tax on the $90 of gain. But, if the donor simply gifted the stock directly to the charity, the donor would receive a charitable deduction of $100 without having had to first pay tax on the gain.
Certain states’ lawmakers have also established tax incentives for charitable giving. Colorado allows taxpayers to deduct charitable giving in excess of $500 from their income even if the taxpayer does not itemize under federal law. Other states, such as Montana, provide tax credits for donations to certain state or local endowments.
Owners of pass-through business entities who formerly deducted their business charitable contributions on their individual returns have also been negatively affected by TCJA’s reduction in the number of itemizers. These owners may now wish to continue to support local nonprofits but to do so through deductible business marketing or advertising expenses. An example could be sponsoring an event or a sports team where the business name would be prominently displayed. As with any business expense, it must be reasonable and directly related to the business purpose. Likely factors the IRS would consider would be the exclusivity and frequency of the promotion.
Such a strategy is likely to have potential pitfalls for nonprofits to the extent providing advertising or marketing to a for-profit business could be considered unrelated business income. This is likely to become an evolving area of the tax law, and both businesses and nonprofits should proceed cautiously. What remains certain, however, is that with fewer taxpayers now qualifying to itemize their charitable donations, nonprofits should make no claims about a donation’s tax deductibility. A solicitation letter or acknowledgment may still indicate that an organization qualifies as tax-exempt, but it should direct any determination regarding tax consequences to a donor’s tax advisor.
Estate Tax Changes
Although the above discussion focuses on TCJA’s effective elimination of the charitable deduction for most taxpayers, the new law made significant changes to the federal estate tax that will likely impact charitable giving as well. TCJA doubled the federal estate tax’s unified credit and retained its automatic inflation adjustment. For 2019 this means an individual may transfer $11.4 million free of federal estate tax (the rate of which remained unchanged at 40 percent). Married couples are also still able to transfer a deceased spouse’s unused portion of the credit to the surviving spouse.
The increased unified credit will probably reduce the amount of charitable giving at death, though the extent of the effect is uncertain. Donors who preferred to give to charity as an alternative to paying federal tax will now have a much higher limit before needing to be concerned about doing so. For example, a will or trust drafted with a formula clause such that any amount of a decedent’s estate that would be subject to federal tax would instead be donated to charity will now be triggered in far fewer instances. Under the new limits, taxable estates are expected to decrease from 0.2 percent of all estates to less than 0.1 percent, according to the Tax Policy Center.
For those clients who still wish to make charitable gifts, it may therefore be more advantageous to do so during life rather than at death. This would generally be true for those who still itemize their charitable deductions. Gifts made during life would thus provide current income tax benefits and could help with transferring appreciating assets out of an estate. Such a strategy would be especially useful if the estate tax unified credit reverts to pre-TCJA levels. TCJA’s provisions related to individual taxpayers, including those for the estate tax, are set to sunset after 2025.
Although TCJA made relatively minimal direct changes to the tax treatment of charitable giving, it nevertheless had a significant effect on millions of taxpayers who now will no longer be able to reap the tax benefits of charitable gifts as easily as before. Understanding the interplay between deductibility and donations to charity both during life and at death provides new challenges for the charitable giving planner. This holds true whether the client is a potential donor or the charitable organization.