Charity in the Age of Trump

The Charitable Tax Deduction

According to the most recent Giving USA report, American individuals, estates, corporations, and foundations give more than $400 billion to charity each year. For a U.S. tax resident, making cash and non-cash contributions to qualified charities often results in reducing taxable income, dollar for dollar. However, Trump’s new tax law has somewhat reduced this benefit, so it’s important to understand it and learn to execute tax contributions tax efficiently.

The basic equations for calculating taxes are as follows:

Taxable Income = Income – Deductions

Taxes = [Taxable Income x Tax Rate] – Credits

One basic objective of the Tax Intelligent Investor is to minimize taxable income as much as practical without violating any rules or regulations.

It is important to realize that the deductions component can take two different paths. On the one hand, a taxpayer can use what’s called the standard deduction, which in 2019 is $12,200 for single filers and $24,400 for married filing jointly (MFJ) filers. The second option is to use the sum of the itemized deductions. Some of the common itemized deductions are:

• State and Local Taxes: Payments made to state and local authorities. Examples are the payments made during the taxable year to the California Franchise Tax Board (FTB) or the City of New York.
• Property-Based Taxes: Those assessed on vehicles and real estate holdings are the most common.
• Mortgage Interest: Interest expense for a primary plus second home up to the mortgage limit.
• Charitable Deductions: Cash and non-cash donations to 501(c)(3) and other qualified charities.

In Excel speak:

• Deductions = maximum (standard_deduction, itemized_deductions)

As you might have inferred, if the standard deduction happens to be larger than then the sum of itemized deductions, charitable contributions have no effect on taxes (ouch!). Charity only matters—from a tax perspective—when one is itemizing on the tax return.

The New Reality

Before the passage of the Tax Cuts and Jobs Act, many high-income earners and even low-income earners living in places like California, New York, and New Jersey almost always used “itemized deductions.” High state income taxes and/or high property taxes were the driving factors that pushed taxpayers into itemized deduction land. As a result, contributions to charity almost always saved on taxes.

However, a couple of key changes to the tax code have made the decision to contribute a little more challenging. Specifically:

• A cap on the State and Local Income Taxes (SALT) deduction
• A cap on the mortgage interest deduction
• An increase to the standard deduction

Regardless of the amount paid for SALT, taxpayers can now only use up to $10,000 (a real party spoiler for my fellow Californians and Bay Area residents!). According to a recent TurboTax article, the average SALT deduction taken in New York was more than $21,000. Consequently, the average New York taxpayer who has historically claimed the SALT deduction is now seeing his or her deductible amount cut by more than half.

Mortgage interest has also been capped, starting in 2018, at up to $750,000 of debt from a home purchase. Previously, taxpayers could potentially deduct interest on up to $1 million of mortgage debt, plus up to $100,000 of debt from a home equity loan. ¡No más!

Finally, the standard deduction has increased dramatically compared to previous years. For example, in 2017, the standard deduction for an MFJ filer was $12,700. In 2019, the standard deduction jumped to $24,400. Combined with the $10,000 limit on SALT, more and more people fall under the standard deduction scheme. This means that fewer charitable contributions apply. In fact, a recent article cited that only about 5% of taxpayers are expected to itemize deductions starting in 2018 compared to 30% in previous years.

Tax-Efficient Strategies

So what can donors do to both achieve the goal of giving to a worthy cause and minimizing their tax burden? The decision to donate to charity used to be a simple one for many taxpayers. Every situation is unique, but some strategies that we have worked with on behalf of our clients are as follows:

• Spread the love over several years: For example, let’s say that you want to give $5,000/year to your favorite charity, such as The Rising Farmworker Dream Fund (shameless plug), and your itemized deductions without charitable deductions hover around $20,000, making you a sitting duck for the standard deduction. One strategy is to potentially skip one year and combine gifts in the following year. Giving $10K will surely put you above the standard deduction threshold. The key is to understand under what circumstances would itemized deductions apply and to give under that scenario.
• Consider giving appreciated investments: Donating appreciated investments is a sound strategy for maximizing the tax benefits of charitable contributions. The basic idea is that, under certain conditions (see: www.myecfo.com/the-tax-triple-play), you can get both a deduction on Schedule A and avoid having to pay the “built-in” capital gains taxes. Like the previous point, accumulating appreciated investments is a time-waiting strategy. You could take your Vanguard S&P 500 index fund or Google stock and donate after it has appreciated significantly over the next few years. (As some of our clients tell us. “Google stock is always going to go up!”)
• Look into Donor-Advised Funds: A donor-advised fund is like a charitable investment account for the sole purpose of supporting charitable organizations that you care about. In a year where income and thus marginal tax rates are high, you could front-load charitable contributions and let the funds grow tax-free. This money can then be distributed over long horizons, and you can stop worrying about the standard deduction.

To summarize, under the Trump world of taxes, it’s a bit more complicated to estimate the tax impact of giving. With marginal tax rates reaching near 50% for some taxpayers, analyzing the timing of charitable contributions is key. Giving to important causes is good. Giving and simultaneously reducing your tax bill makes the altruistic act even sweeter.

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