By Nicole Gopoian Wirick, JD
The Tax Cuts and Jobs Act (TCJA) of 2017 slashed tax rates for several income tax brackets, reducing effective tax rates for most taxpayers. However, income is only one part of the income tax equation. Deductions are another part.
The TCJA changed the way many Americans claim their income tax deductions. Before we review these changes, please remember that taxpayers have an option when it comes to deductions: Take the standard deduction based on their tax filing status or itemize on their Schedule A, whichever is greater.
In an attempt to simplify tax filing, the TCJA almost doubled the standard deduction to $12,000 ($12,550 in 2021, indexed for inflation) for individual filers and $24,000 ($25,100 in 2021, indexed for inflation) for those married filing jointly, with the hopes that most taxpayers would simply take the standard deduction.
The Act also capped the previous (largely) unlimited SALT (State and Local Tax) deduction at $10,000, making it even more difficult to reach the threshold for itemization. The SALT deduction cap is particularly detrimental for high income earners and those living in high income tax states.
For most taxpayers there’s little remaining opportunity to take itemized deductions on their Schedule A with one exception – charitable giving.
However, for many mainstream Americans who generously donate to meaningful charitable causes, there’s minimal opportunity to deduct these donations via itemized deductions because they must exceed the $12,550 (single)/$25,100 (married filing jointly) threshold in 2021 in order to itemized. For the taxpayer who gives $10,000-$15,000 per year to charity they might not be able to deduct their charitable giving any longer.
This is one area where a donor-advised fund (DAF) might be a fantastic planning tool. Here’s how it works:
A donor makes an irrevocable transfer of securities or cash to a DAF, taking a deduction immediately upon the transfer. The assets transferred are then held in the DAF and invested, depending on the gifting time horizon, until the donor makes a grant to qualified 501(c)(3)s of their choice.
To maximize deductibility on the Schedule A, a donor might want to consider lumping several years’ worth of gifts to their DAF. Let’s look at a hypothetical example:
Donors Don and Donna generally give about $10,000 each year to the Alzheimer’s Association because Donna’s mother was impacted by the terrible disease and Donna was her primary caregiver. Although Don and Donna are both high-income earners, their SALT deduction is now capped at $10,000. They are relatively healthy and do not have significant medical expenses, they have no mortgage interest to deduct because they own their home outright, and they have not suffered a personal casualty or theft loss. In this instance, Don and Donna’s itemized deductions would be $20,000 ($10,000 SALT plus $10,000 to charity). They would elect to take the standard deduction of $25,100 in 2021.
Now let’s say Don and Donna decided to open the Don and Donna Donor-Advised Fund and transfer $50,000 into it in 2021. Don and Donna lump 5 years’ worth of donations ($10,000 x 5 = $50,000) into their DAF, receiving the full $50,000 deduction in the year of transfer.
In 2021, Don and Donna can deduct $60,000 on their Schedule A ($10,000 SALT plus $50,000 charitable donation). In 2022, 2023, 2024, and 2025, Don and Donna would continue to take the standard deduction of $25,100, indexed for inflation.
Even though Don and Donna lump five years of donation into one year for the purposes of making the transfer to their DAF, they do not have to make a grant to their desired charity/charities in the year of the transfer. They can grant $10,000 per year for the next five year to Alzheimer’s Association, or any qualified 501(c)(3) charity of their choice. Or they could grant $5,000 in one year and $15,000 in the next. Don and Donna have discretion on when to make grants once the DAF is funded.
In 2026, Don and Donna will decide if they plan to continue their charitable giving and might consider making another $50,000 transfer to their DAF, deducting $60,000 in 2026 before returning back to the standard deduction.
Lumping several years’ worth of charitable gifts is a great way to take advantage of itemization on a taxpayer’s schedule A.
If Don and Donna transfer cash to their DAF, their donation is deductible up to 60% of their adjusted gross income (AGI). However, if Don and Donna transfer appreciated assets, their donation is deductible up to 30% of their AGI. Any unused deductions can be carried forward for five years.
Since a transfer to a donor-advised fund is deductible in the year of the transfer, regardless of when grants are made, it may also be an excellent tool to offset higher income years, like selling a business or doing a Roth IRA conversion.
Here are two additional potential tax benefits that are beyond the scope of this article that may be worth considering:
Capital Gains Management
If Don and Donna have highly appreciated stock shares, those might be ideal to transfer to their DAF. Let’s say Don and Donna bought a stock in their revocable living trust for $100 per share and the stock is worth $125 per share today. Don and Donna get the full $125 per share deduction but don’t pay capital gains tax on the $25 per share gain.
Estate Tax Management
By transferring assets to a donor-advised fund, Don and Donna have made an irrevocable gift to a separate legal entity. Therefore, the assets transferred to their DAF are not counted as part of their estate for estate tax purposes.
As you review your tax situation and projected income over the next few years, consider a DAF as a planning tool to lump gifts and take deductions on your Schedule A, especially in high income years. Please don’t forget to talk to your CPA and estate planning attorney regarding your unique situation.
About the author: Nicole Gopoian Wirick, JD, CFP®
Nicole Gopoian Wirick, JD, CFP®, is the founder and president of Prosperity Wealth Strategies in Birmingham, Michigan. Nicole is a fee-only financial planner who believes a successful advisory relationship involves compassionate conversations and planning tenacity.
Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.
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