Key Takeaways
- Tax reform has decreased the households who itemize to about 10% of taxpayers. Those who don’t itemize may not realize tax benefits from charitable donations.
- Qualified Charitable Distributions help donors above age 70 ½ realize a tax benefit.
- Donors younger than 70 ½ should consider the timing of their contributions.
With Scottie Scheffler donning the green jacket Sunday, it’s no longer Masters week. Now, we move on to everyone’s second favorite spring tradition, tax week! We all love Augusta, GA, where cellphones are not permitted, and pimento cheese sandwiches are still only $1.50; they have a great formula, and it won’t change anytime soon. The IRS and the US tax code tend to evoke opposite feelings for most of us, but at Ballast, we believe that making the most of your tax situation is a tradition unlike any other.
Over the past few years, Congress has introduced some small tweaks to the tax code that result in major changes to how our clients approach a tax year. Back in 2017, tax reform doubled the standard deduction and capped state/local tax deductions, cutting the number of families eligible to itemize deductions in half. A typical family experience is outlined below.
|
Pre-2018 |
2019 and Later | |
|
Mortgage Interest |
$9,000 |
$9,000 |
|
State and Local Taxes* |
$18,000 |
$10,000 |
|
Charitable Donations |
$5,000 |
$5,000 |
|
Total Itemized Deductions |
$36,000 |
$24,000 |
|
Result |
Itemize |
Standard Deduction |
| $36,000 |
$25,900 |
State and local taxes, like property tax and state income tax, which are an earner’s biggest deduction, are now capped at $10,000. Thanks to this cap and the increased standard deduction, this family no longer itemizes deductions. This means that those $5,000 of charitable donations provided zero tax benefit. This family must donate $6,400 each year to itemize, and only donations above that amount reduce their tax liability.
Many families, especially retired couples, have found themselves in this predicament under the new tax code. Charitable donations that previously reduced their tax burden no longer provide any tax benefit. This is exacerbated as they begin to pay off their mortgages and stop working, reducing other deductions.
There is one option open to everyone below the threshold to itemize: make lump sum donations. For example, take a family that previously donated $500/month and had itemized deductions of $20,000. If they saved those donation dollars for the first year instead, they could donate $1,000/month in year two. Doing so would put them into the itemizing territory and allow them to benefit from some of their giving. We’ve used this strategy, combined with a Donor Advised Fund, to keep monthly donations for the charity’s level while maximizing tax benefits.
For those over age 70 ½, we have a great strategy that does not alter when you make your donations. Qualified Charitable Distributions¹ are donations made directly from an Individual Retirement Account (IRA) of someone aged 70 ½ and over. Everyone over 70 ½, with an IRA or Inherited IRA balance, can donate up to $100,000 from that account annually and not report the distribution as income. This type of donation can be used to satisfy Required Minimum Distributions (RMD) when they begin at age 72. Since RMD income is taxed if not donated, a retiree essentially gets a dollar-for-dollar deduction for IRA donations by excluding them from their income.
Further reform in 2020 made this Qualified Charitable Distribution strategy even more beneficial. The SECURE Act mandated that your children must distribute any IRA & 401k dollars they inherit within ten tax years of your passing. All else equal, this accelerated distribution schedule tilts our lifetime spending strategy toward spending IRA assets within your lifetime. Thus, anyone who must take RMDs, who makes charitable donations, and who falls under the threshold for itemizing deductions should consider this strategy. Even families who use their RMD for living expenses should consider if they also need to make charitable donations. They can give the same amount of dollars to their charity of choice and pay less tax, leaving them with extra money for their expenses or to continue with their generosity.
We believe these options are so important that we have changed our process for communicating RMD data with our clients this year. As you think about your income, charitable giving, and tax strategy this year, we encourage you to contact us to discuss options that may be a fit for your family.
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- IRS Publication 590-B outlines Qualified Charitable Distributions https://www.irs.gov/publications/p590b
