Granada Tax Blog

The popularity of donor-advised funds is largely due to the 2017 tax reform.

In short, the new legislation made two important changes with respect to tax deductions:

• The deduction for state and local taxes is now limited to $10,000.
• The standard deduction essentially doubled to $12,200 (single), $24,400 (married) or $18,350 (head of household) for taxpayers under age 65. (The figures above are for 2019.)

How does this impact charitable giving? I’ll provide a simple example:

Tom and Betty pay $14,400 in state and local taxes. They don’t have a mortgage so there is no interest to deduct. They give $11,000 annually to their church and other charities.

When Tom and Betty prepare their itemized deductions on Schedule A of their tax return they will only claim $10,000 of the $14,400 in state and local property taxes paid as a result of the new limit. And they will claim $11,000 in charitable giving for a total of $21,000.

Because the standard deduction of $24,400 exceeds the total of their itemized deductions ($21,000), they will claim the standard deduction instead. As a result there is no tax benefit associated with their state/local taxes or their charitable contributions.

Accountants have suggested that charitably-inclined taxpayers accelerate or “clump” their donations in order to increase the tax savings. If Tom and Betty were to “clump” two years of donations they would give $22,000 in 2019 and nothing in 2020.

If Tom and Betty give $22,000 in 2019 they will add that amount (subject to income limitations) to their $10,000 in allowable state/local taxes and have total itemized deductions of $32,000. Because $32,000 of itemized deductions exceeds the standard deduction of $24,400, they will deduct $32,000 on their 2019 tax return.

The benefit of “clumping” can be magnified if taxpayers are interested (and permitted per income limitations!) to donate a large amount in one year and nothing for the next few years.

Returning to Tom and Betty, in 2019 they donate $55,000 to satisfy five years of intended gifts. They deduct $55,000 + $10,000 or $65,000 on their 2019 return. For 2020, 2021, 2022 and 2023 they will simply take the standard deduction and not bother itemizing because the standard deduction offers higher tax savings. By accelerating or clumping the charitable contributions in 2019 Tom and Betty have significantly increased the tax savings associated with their charitable giving.

The problem that arises is that taxpayers aren’t necessarily interested in making such large payments to their current church or favorite charity. They want to retain the flexibility to designate the recipients, amounts and timing of their gifts.

Enter the donor-advised fund. When taxpayers fund a donor-advised fund they make an irrevocable (and thus tax-deductible) contribution to a fund. They may name it the Tom and Betty Charitable Fund. As the donors to the fund they advise as to the ultimate distribution of the fund’s assets to the qualified charities of their choosing.

Tom and Betty are thus more comfortable donating $55,000 to satisfy their intended gifting for the foreseeable future. They will deduct the full $55,000 on their 2019 tax return (again subject to income limitations) and distribute funds to their church and charities as desired in the future.

The $55,000 is invested so any appreciation avoids taxation and allows for additional gifting. Any investment losses impair your future giving but do not reduce your tax deduction.

For icing on the cake, consider donating highly appreciated securities. When highly appreciated securities are contributed to a donor-advised fund both the donor and the fund avoid capital gains tax. This can be an excellent way to diversify a concentrated position and improve cash flow.

Feel free to call or email with questions.

——

The articles presented on this blog are general in nature and should not be assumed to be applicable to your situation. In addition, tax law changes daily and the articles on this blog are not updated to reflect these changes. Anyone receiving any part of the information on this blog should not rely on or act or refrain from acting on the basis of any matter or information contained in this blog without seeking appropriate tax, legal or other professional advice. The transmission and receipt of information contained on this blog does not form or constitute a client relationship. Nothing in this blog constitutes legal advice. Opinions rendered by tax professionals are not authority.  You agree to hold Asheville, NC-based CPA and Enrolled Agent Brendan Willmann forever harmless from any liability for your use or failure to use the information, advice, referrals, or suggestions provided by this blog at any time.