Many years ago, I made a personal commitment to give back to my community: U.S. based farmworkers. This commitment stems from my belief that I should reinvest (with dividends and interest) both the money and time given to me over my educational career. Although my contributions vary from year to year, I strive to employ a 10/10 strategy —10% of my time and 10% of my income.
I will always give, but how I give has certainly evolved in the age of Trump. Today, it is much more difficult to achieve maximum tax efficiency from charitable donations. In this article, I’d like to demystify how the charitable deduction works and how to implement sound tax strategy to achieve maximum benefits. As I’ve emphasized in other articles, there is no honor in giving the government more money than it requires; understanding the intricacies of this common deduction is key to achieving that objective.
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:
In Excel speak:
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.
However, a couple of key changes to the tax code have made the decision to contribute a little more challenging. Specifically:
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.
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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