Charitable giving is undergoing a shift in the wake of the 2017 tax law, and could see yet more changes in the coming months and years as a result of legislation working its way through Congress.
Aside from a few tweaks, the tax law, which provided the most sweeping reform to the U.S. tax code in a generation, didn't address charitable giving directly. Yet, charitable giving by individuals is at its lowest level since the financial crisis, and financial advisers point to changes in the tax law as the reason.
Specifically, under the new law, fewer people get a financial benefit from itemizing deductions on their tax returns — meaning fewer people get a tax break from their donations to charity. According to estimates from the Tax Foundation, 14% of taxpayers will itemize deductions on their 2019 returns compared with 31% of taxpayers who did so before tax reform.
"Twenty percent of the country lost the ability to deduct charitable contributions," said Jamie Hopkins, director of retirement research and vice president of private client services at the Carson Group.
The Urban-Brookings Tax Policy Center estimated 21 million taxpayers would stop taking the charitable deduction because of the new law. The law raised the after-tax costs of donating by 7%, according to the think tank.
There are several reasons for the falloff. For one, the law roughly doubled the standard deduction in 2019 to $12,200 for single taxpayers and $24,400 for married couples filing jointly and surviving spouses, making it more advantageous for many taxpayers to take the standard deduction instead of itemizing. It also lowered individual income tax rates, reducing the value of all tax deductions. And it doubled the estate-tax exemption, to $11.4 million for singles and $22.8 million for married couples in 2019, which could result in fewer tax-motivated donations from wealthy families.
The law also diluted or eliminated several popular tax deductions for individuals. The biggest change was the imposition of a $10,000 cap on deductions for state and local taxes, which used to be unlimited. Additionally, taxpayers can only deduct interest on up to $750,000 of mortgage debt on new homes (the limit used to be $1 million) and can only deduct interest on a home equity line of credit in more limited circumstances. The law also eliminated deductions for "miscellaneous" items like tax preparation and investment-adviser fees.
Consequently, overall giving among individuals — the largest source of charitable contributions — fell by 3.8% on an inflation-adjusted basis in 2018, to $292.1 billion, compared with the prior year, according to Giving USA. Excluding the years 2008 and 2009, when the country was in the throes of the Great Recession, annual charitable giving among individuals hadn't declined that much since 1987.
By contrast, giving among other sources like foundations and corporations was up 4.7% and 2.9%, respectively, when adjusted for inflation.
"This is the new normal of where we probably are on the numbers," Mr. Hopkins said about the reduced figures among individuals.
Though taxes aren't the main reason people donate to charity, and other factors such as market volatility in the fourth quarter of 2018 likely contributed to the decline in charitable donations, taxes do affect individuals' incentives to donate, said Una Osili, professor of economics and philanthropic studies at the Indiana University Lilly Family School of Philanthropy.
The decline is also notable considering the strength of the U.S. economy last year, which would have typically propped up donations, experts said.
But tax-year 2018 was the first year in which individuals dealt with the bulk of income-tax provisions from the recent tax legislation, which President Donald J. Trump signed into law in December 2017.
Giving cash to charities has, and continues to be, the most popular method of individual philanthropy among clients, according to advisers. The tax law made cash gifts a bit more lucrative — clients can now deduct charitable cash gifts up to 60% of their adjusted gross income, whereas it used to be 50%.
However, other means of giving have become more tax-efficient, and more clients are open to exploring them than in the past, said Jeffrey Levine, CEO and director of financial planning at Blueprint Wealth Alliance.
Advisers have seen donor-advised funds gain the most traction as a financial planning strategy. These vehicles allow clients to "bunch" several years' worth of charitable deductions into one tax year, in order to help get over the hurdle of a higher standard deduction, and then choose how and when those funds are distributed.
Using this bunching strategy makes the most sense if a client's itemized deductions, before charitable contributions are factored in, are less than the standard deduction, said Lisa Featherngill, the head of legacy and wealth planning at Abbott Downing. It has also become more important to make charitable planning a multiyear exercise, she said.
For example, let's say a married couple filing jointly has $100,000 of taxable income. The couple has $20,000 of itemized deductions before charitable contributions. The couple plans to make $6,000 of annual charitable contributions in both tax-year 2019 and 2020.
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Making a $6,000 donation in each of those two years, and itemizing both years, would yield $52,000 of combined tax deductions over the two years ($26,000 of deductions each year). But let's say the couple used a donor-advised fund to bunch $12,000 worth of charitable contributions into 2019, and took the $24,400 standard deduction in 2020. That approach would yield $56,400 of total deductions ?— $4,400 more ?— over the two years, which equates to greater tax savings.
Donor-advised funds make sense especially for clients who give to multiple charities, said Ms. Featherngill, a member of the American Institute of CPAs' personal financial planning executive committee. If a client is giving to one charity, like a church, however, it's easy to bunch charitable contributions with using a donor-advised fund, she said.
Using qualified charitable distributions is another planning maneuver that has become more valuable under the new tax law. According to FreeWill, an online philanthropy and estate-planning service, there was an average 74% increase in the number of QCDs made to charities last year versus 2017.
QCDs allow a taxpayer over the age of 70½ to give money directly to charities using money from a traditional individual retirement account. Total annual QCDs can't exceed $100,000 for an individual. These distributions are now the "only way to receive a meaningful income tax benefit from charitable contributions" for many donors over 70 years of age, according to a FreeWill report.
QCDs offer two large benefits: distributions count toward satisfying an individual's annual required minimum distribution and are excluded from the taxpayer's income.
For example, let's consider a client — a retired married couple ?— with $100,000 of adjusted gross income and $20,000 of itemized deductions before charitable contributions are included. The client has a $12,000 RMD this year, and wants to give it to charity.
Using a QCD, the client would have $75,600 of taxable income ($100,000 minus the standard deduction). However, if the client were to take the $12,000 IRA distribution and then make a $12,000 charitable contribution, the client's taxable income would swell to $112,000 and itemized deductions would increase to $32,000 ?— for a net taxable income of $80,000.
The QCD here would decrease the client's net taxable income by $4,400.
The SECURE Act, retirement legislation currently being debated in Congress, could change how some wealthy clients give to charity. The bill, which passed 417-3 in the House of Representatives and is currently awaiting passage in the Senate, would eliminate the "stretch IRA."
Non-spouse beneficiaries of inherited IRAs can currently stretch account distributions over their life expectancies, granting a potent estate-planning tool to wealthy families. But the SECURE Act would compress those distributions into a 10-year time frame.
A charitable remainder trust could mimic the tax benefits of the stretch IRA if the SECURE Act is passed, as some expect to happen this year or next. The trust would be funded by IRA assets upon the death of the account owner, and the trust would pay a regular income stream to beneficiaries over their lifetimes (or another specified time period). A predetermined charity would get the trust's remaining assets once beneficiaries die.
"I would say this is the trust that most closely replicates the benefits of a stretch IRA," Mr. Levine said. "For those with larger IRAs, I could definitely see them incorporating this."
Even absent the SECURE Act, the individual income-tax provisions in the 2017 tax law are scheduled to expire in 2026, and revert back to prior rules, unless Congress passes additional legislation to do otherwise.
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