MONEY TALKS – Trump taxes, formally known as the Tax Cuts and Jobs Act (TCJA), were passed at the tail end of 2017 and went into effect on January 1st, 2018. This sweeping tax reform was the most progressive tax law change since 1986. The TCJA most notably made small reductions in individual income tax rates and significantly reduced the tax rates for corporations. However, while the newly reduced tax rates were beneficial for most everyone, the TCJA did not come without any adverse changes. Most notably was the new cap of $10,000 on state and local income taxes. This means that taxpayers who formerly reported state income and real estate taxes as itemized deductions on their tax return were now severely limited on how much they could deduct. As a result of the new ceiling on the state and local tax deduction, many taxpayers were forced to take the standard deduction rather than itemize as they had done in the past. Consequently, since charitable donations are only deductible for taxpayers who itemize, many taxpayers were unable to deduct the charitable donations they had made. Luckily there is a viable solution for those who are charitably inclined and want to reduce their tax liability – a Donor Advised Fund.
What is a Donor Advised Fund? - A Donor Advised Fund, or DAF, is a charitable investment account for the purpose of supporting charitable organizations of your choice. Those funds can be invested for tax-free growth and you can recommend grants to virtually any IRS-qualified public charity. It’s important to note that you are eligible for an immediate tax deduction as soon as you make a donation, just as you would by donating to another public charity. However, once the funds are in the DAF, you have complete freedom to initiate grants at your leisure. Meaning you could space your charitable grants out over 10 or 20 years if you like.
Eliminate Future Capital Gains - One significant advantage that a DAF has is the ability to donate appreciated securities. Donating long-term appreciated securities potentially allows you to eliminate future capital gains, which would lower your overall tax liability and ultimately provide a higher benefit to the charities of your choice. For example; supposed you purchased a mutual fund for $10,000 in 2000. In 2019 the fund is now worth $30,000. By donating the appreciated security you are getting a $30,000 deduction for something you only paid $10,000 for and saving $3,000 in long-term capital gains taxes that would otherwise have been paid at some point in the future on the $20,000 gain (assuming a 15% LTCG rate).
Tax Deductibility - Contributions to a Donor Adviser Fund are a “below the line” deduction, meaning the deduction is reported on Itemized Deductions-Schedule A and therefore does not affect your Adjusted Gross Income (AGI). Nevertheless, for those who itemized their deductions, it does lower your taxable income. Your tax deduction may depend on the type of donation. If you donate cash; via check or wire transfer, you're generally eligible for an income tax deduction of up to 60% of your adjusted gross income (AGI). If you donate securities, you can take an income tax deduction in the amount of the full fair-market value, up to 30% of your AGI.
Use a DAF to Lower Your Taxes - Since the TCJA limits the amount of state and local taxes you can itemize, many tax payers receive a larger benefit by taking the standard deduction. This effectively eliminates the deductibility of charitable donations since they are only reportable for taxpayers who itemize on Schedule A. Traditionally the four major deductions taxpayers claim on their Schedule A are medical expenses (over 7.5% of AGI), state and local taxes, mortgage interest, and charitable donations. The 2019 standard deduction for a married couple filing jointly is $24,400. Presuming state and local taxes paid are $10,000 or higher, a married couple would need over $14,400 in medical expenses, mortgage interest, and charitable donations for it to be advantageous for them to itemize their taxes. This is where a Donor Advised Fund can come in handy. Circling back to the aforementioned example, suppose medical expenses do not exceed 7.5% of AGI so they are not deductible and mortgage interest was $9,400, charitable donations would need to exceed $5,000 to trigger an itemized return. Surely a $5,000 charitable donation would be a sizable donation for even the most generous individuals. That being said, many taxpayers routinely donate $1,000 - $2,000 per year. This is where the DAF comes into play. Rather than donate a marginal amount year over year without receiving a tax deduction, consider making a large contribution to a DAF in one year and then not making any donations in subsequent years. Doing so would allow you to get the benefit from your charitable donations in one year by itemizing and in subsequent years you could take the standard deduction. Remember contributions to a DAF are deductible in the year they are donated, but the funds themselves can be gifted over several years. Essentially by front loading your charitable donations, you can qualify for a larger tax deductions without disrupting your annual gifting strategy.
As with any tax law changes there are always loopholes that allow savvy taxpayers to work the system. Using a Donor Advised Fund to bunch your deductions in one tax year can be very beneficial, especially when combined with other charitable gifting strategies such as donating used clothing, household goods, and furniture to Goodwill or the Salvation Army. Charitable gifting strategies along with good tax planning can help reduce your tax burden and ensure you don’t pay the government more than you are legally obligated to pay.