Each year on this federal holiday honoring the Rev. Dr. Martin Luther King Jr., people across the United States volunteer at their favorite nonprofit services provider. Others opt to donate to charitable causes that support the goals of Dr. King and MLK Day. Here's a look at how recent tax law changes have shifted some of those donation choices and giving methods.
Charities cheered when they were spared the limitations imposed by the Tax Cuts and Jobs Act (TCJA) on many popular itemized deductions.
There even was celebration of a change that allows the charitably inclined, particularly the very wealthy, to give even more to public charities.
But the TCJA's revisions that did make it into law have proved problematic to some other donors.
Donation deductions basically untouched: For the most part, taxpayers who make charitable gifts must still follow the long-standing tax rules that govern whether a donation is tax deductible.
Top of this list is the requirement, unchanged under the TCJA, that donors itemize in order to claim a tax deduction.
However, the new tax law's combination of substantially larger standard deduction amounts and restrictions on remaining itemized deductions means that fewer people now will fill out a Schedule A.
That means many taxpayers now will find their charitable gifts no longer do them any tax good.
And that has shifted their donation strategies.
Here's a look at two of the most popular donation deduction shifts under the new tax law, bunching donations into alternate tax years and using donor advised funds, or DAFs.
Alternate-year donation bunching: Tax deduction bunching is not a new tax strategy. Here you simply time your deductible expenses so that they all fall into one tax year so that they are make a more effective tax write-off.
Basically, you want to accumulate enough deductible expenses into one tax year so that they exceed your standard deduction amount. Then the next tax year, you take the standard deduction.
Here's how it would works:
As a single taxpayer in 2018, you had potential itemized expenses of $4,500 in state and local taxes and $6,000 in deductible mortgage interest. That $10,500 total on Schedule A is less than the standard deduction $12,000 for 2018 so you opted not to donate last year and will claim the standard amount this filing season.
In 2019, however, you make a $2,000 to your college's general scholarship fund, which is double what you usually would contribute since you didn't donate last year. This $2,000 charitable gift, plus state and local taxes this year of $5,000 and mortgage interest of $5,500, comes to $12,500.
That's more than the 2019 standard deduction of $12,200 for single taxpayers, so you itemize in 2020 when you file your 2019 return.
Then, also in 2020, you go back to no charitable gifts and claiming the standard deduction, which likely will be a bit larger due to annual inflation adjustments.
File, rinse, repeat.
This alternating your deduction choice, itemizing — and making your charitable donations — in one year and then forgoing charitable gifts in the next (or whatever tax time frame fits your needs) and claiming the standard deduction allows you to control and maximize your deductible expenditures.
And yes, this rotation of deduction choices is fine with the Internal Revenue Service.
You get to decide each tax filing season which deduction method you want to use. The IRS joins your tax professional and tax geeks like me in advising you to always select the one that will give you the best tax break.
The one drawback for dedicated givers of this alternating deduction method is that it means their favorite charities must make do in the skip years even if the give-year gifts were larger. It forces these charities to adjust to sometimes dramatic variable annual cash flow situations.
To address this concern, some folks shift to DAFs.
Donor advised fund (DAF) renewed interest: DAFs are an old philanthropic option that are getting new looks thanks to the TCJA changes.
DAFs are a more structured way of giving that in recent years have seen growing interest and contributions. In 2017, more than $29 billion was put into DAFs, which then distributed more than $19 billion in grants to qualified charities, according to the National Philanthropic Trust's 2018 Donor Advised Fund Report. Both amounts, notes the report, were record highs.
"Taxpayers looking for ways to exceed the higher standard deduction set by the 2017 tax law might consider pooling several years' worth of charitable donations into a single contribution to a DAF," suggests Andrew Friedman, tax attorney and principal and founder of The Washington Update.
So what exactly is a donor advised fund? Technically, it's an investment, but many folks view it as a philanthropic flexible spending account. It's a way to stash tax-favored cash and then use allowable distributions to support designated charities.
On its most basic level, a DAF is a mini-foundation. But where, per a 2017 Foundation Source survey, the average family foundation managed $5 million in assets, the average DAF account was $292,000. But getting started often takes just a few thousand dollars, meaning DAFs are accessible to a larger number of participants.
You establish the DAF — and yes, there are limits depending on where you decided to create it, such as a minimum amount to start a fund or to distribute from it, and you do turn over control of donations to a board (but, as the name says, you get to advise here) — and then the charities get gifts from it instead of directly from you.
DAF donation and deduction benefits: As far as taxes, contributions you make, either in cash or assets, to a DAF are tax deductible for the tax year in which made.
This tax consideration means you might want, especially in the fund's early years, to contribute in the tax years in which you are getting the benefit of itemized deductions.
But the beauty of a DAF is that it can make gifts to your favorite nonprofits in the off-years where you normally would not be giving to nonprofits if you simply were bunching your donations.
Note that IRS no-double-dipping rules mean you don't get another deduction for the DAF distributions, but your favorite charity won't suffer in your itemizing skip years since your gifts then will come from your DAF.
Also, depending on your investment choices, DAF contributions can potentially grow tax-free. This gives you the ability to make greater charitable gifts from the fund through the years.
Obviously, all charitable gifts and any tax considerations are dependent on each taxpayer's personal and financial situation.
But if you're committed to continuing to make donations and maximize their tax deduction potential, consider these options. They could benefit both you and your favorite charities.
You also might find these items of interest:
- Boxing Day tips for cool and charitable cats
- 5 ways to determine whether a charity is naughty or nice
- Giving (and Getting) With a Donor Advised Fund: (Austin Woman Worth column)