In light of the COVID pandemic, the CARES act has created new planning opportunities, including the ability to deduct up to 100 percent of your income for charitable contributions. This important incentive comes at a crucial time when the need is great. Planning your charitable giving, however, should be done in a way that avoids some unforeseen pitfalls and that takes advantage of strategies that can help both the donor and the recipient!
For those who are charitably inclined, 2020 may be the best year ever for reaping the tax benefits of your generosity.
For the more than 85% of taxpayers who take the ‘Standard Deduction’ (and otherwise would not reap a benefit from charitable giving), a $300 ‘above the line’ tax deduction for charitable donation was created for 2020 (and possibly years to come) by the CARES Act. This isn’t much, but it does seem to coincide with a year when more people seem to be giving to charities. Whether that is because of the tax break or simply because the pandemic and its impact on the economy has created more need is open for discussion.
More opportunity for the itemizers
Taxpayers who DO itemize their deductions will not be able to use that additional $300 deduction, but the CARES act didn’t leave them out. In fact, those taxpayers will have potentially a lot more ability to shelter income from taxation using charitable giving strategies.
When the Tax Cuts and Jobs Act (TCJA) of 2017 was passed, there was some concern about its potential negative impact on charitable giving. A near-doubling of the Standard Deduction resulted in vastly more taxpayers being able to use that deduction, negating the impact items they used to deduct, like mortgage interest and charitable contributions. One item included in the TCJA sought to ameliorate that impact: An increase in the Charitable Deduction limit from 50% of Adjusted Gross Income to 60%.
With the passage of the CARES act, that Charitable Deduction Limit now increases to 100% of AGI for the tax year 2020. Importantly, this extension of the deduction limit only applies to CASH gifts directly to a qualified charitable organization. In other words, it does not apply to gifts in-kind, gifts of appreciated stock, or donations to private foundations or Donor-Advised Funds.
Whether or not to take advantage of the 100% deduction, though, may be a more nuanced discussion, even for those with substantial means and charitable objectives. In the example below, Dan and Krys are sitting on a tidy amount of cash they’d like to donate to some local charitable organizations. While they’re interested in providing more ‘ongoing’ support to these agencies, they’re tempted to make a much more significant donation in 2020 to take advantage of the 100%-of-AGI deduction.
Here’s the breakout of their income:
Krys’ Salary: $115,000.00
Dan’s Salary: $ 50,000.00
Interest & Capital Gains: $ 10,000.00
Adjusted Gross Income: $175,000.00
In the case of Krys and Dan, let’s say they have non-charitable deductions of $30,000. As a result, their taxable income is estimated as follows:
Adjusted Gross Income: $ 175,000.00
Deductions: $ (30,000.00)
Taxable Income: $145,000.00
Making a donation of $145,000 will certainly reduce their taxable income to zero. How much will this save them on taxes? Let’s look at how their federal income tax is calculated:
10% of the first $19,750 = $1,975, plus
12% of the next $60,500 = $7,259.88, plus
22% of the next $64,750 = $14,245.
… For a total Federal tax savings of $23,479.88
One thing that Krys and Dan might want to take into consideration is that while they’re getting a deduction for all of the income in the 22% bracket, they’re also deducting income in the 12% and 10% brackets.
If, instead of contributing the whole $145,000 this year, what if they only contributed the amount this year that would eliminate all of their 22% bracket income, and do the same thing for next year (and likely the year after)? Assuming no major change in tax structure, they would save 22% of the $145,000 on federal taxes, or $31,900.
Spreading donation over three years saves $31,900.
Donating the whole thing this year saves $23,479.88.
… So Krys and Dan lower their overall taxes by almost $8,420 by NOT taking advantage of the 100% deduction limit in 2020!
Importantly, if Krys and Dan were intent on making sure they got as much money to the organizations they’re supporting as quickly as possible, they should use that as their primary metric, but by spreading the gift out a little (and in this case, making most of the gift within the next two months, this being written in November 2020), they can impact their tax obligation much more significantly.
Also, don’t forget the State
The impact of spreading donations out over future years can also be affected by State taxes as well. Many states are more strict than the IRS on limiting charitable deductions. Maine, for example, limits taxpayer Itemized Deductions to $30,500 in 2020. Again, on state taxes, the strategy of spreading charitable contributions over a number of years may reap more benefits, tax-wise, than clumping all charitable giving into 2020.
Another use of CARES Act limits – QCDs for under 70 ½
Another planning opportunity comes out of the enhanced limitations of the CARES act. In this example, Jo and Woody are already retired and age 66 and 67, respectively. They both live comfortably on Social Security and a pension, with their joint AGI at approximately $80,000. With no mortgage, they routinely take the Standard Deduction, which for this year, since they’re over 65, is $27,000.
Jo and Woody saved aggressively in their qualified employer retirement plans during their working years and have a substantial amount of money built up. They have already planned on using Qualified Charitable Distributions in the years when they face required minimum distributions, but they’re too young right now to use QCDs (you have to be over age 70 ½).
Jo and Woody would like to make a $100,000 contribution to their local hospital who is raising capital for a new cancer center. They don’t have nearly that much in regular savings, and they also realize that they won’t get the full benefit of the $100,000 gift even if they did, because they would only benefit, tax-wise, to the extent the gift exceeded what they would have been able to deduct for the standard deduction.
In light of the CARES Act, they decide to take the full $100,000 from their tax-deferred retirement plan. Instead of this pushing them into a higher tax bracket, they can deduct each dollar they took out, completely offsetting the federal tax impact from their gift.
Clearly, 2020 is a great year to focus on your charitable giving strategies. We face an opportunity to combine the benefits we get from knowing we’re helping our community with the good feeling we get from tax deductibility, and doing this at a time when need is most acute. It is certainly worth taking the time to give thoughtfully, both in researching your charitable targets and analyzing the full tax picture.