Tax reform, as well as economic and demographic developments, have had an effect.
For those who advise clients on the charitable dimension of their estate and financial planning, the past year has been largely characterized by the gradual process of adjusting to changes brought about in the Tax Cuts and Jobs Act of 2017 (the Act). Important economic and demographic developments had both independent and related impacts on charitable gift planning as well.
Tax Unsimplification in Practice
On the tax law front, planners were confronted with a complex set of challenges when initially attempting to determine the tax ramifications of their clients’ charitable gifts under the Act.
The threshold issue was whether donors would be able to continue itemizing their gifts if they were accustomed to doing so under prior law. Determining this was complicated by the Act’s doubling of the standard deduction.
The impact of the new higher standard deduction was clouded by the fact that the ability to itemize now depends to a much greater extent than before on the taxpayer’s marital status, age, the amount of state and local taxes (SALT), the property used to make his gift and whether the taxpayer owned a home and if it was or wasn’t mortgaged.
“Bunching, Boosting and Bypassing”
It became clear in the immediate wake of the Act that many individuals would be well-served by bunching their deductible expenses in some years, thereby exceeding the standard deduction amount and enjoying tax savings in those years that may otherwise never be available. Because charitable gifts are more in the discretion of a taxpayer than mortgage interest, SALT and certain other deductions, the careful consideration of the amount and timing of charitable transfers became central to managing the bunching process.
As the year unfolded, other strategies began to emerge. Beginning in the Fall of 2017 and into 2018, we saw a tremendous increase in the use of donor-advised funds (DAFs).
Under this approach, instead of bunching deductions by periodically making larger gifts directly to one or more charities, donors could use DAFs to bunch gifts while smoothing out their giving over time by advising the DAFs to make regular gift amounts in years they couldn’t itemize their gifts.
A related strategy we refer to as “boosting” involves completing larger gift commitments, in most cases to a single charity, in a single year rather than over an extended pledge period as might have been the case in the past.
This strategy can be especially effective for those who are retired with significant investment holdings but with a lower adjusted gross income (AGI) limit than in their working years. They may also have no mortgage interest deduction and wouldn’t typically be able to deduct their charitable gifts, SALT and perhaps other deductible expenses.
Under these circumstances, making a large gift that exceeds their AGI limit for the year of the gift can serve to boost them above the standard deduction for that year as well as future years when they can carry forward the unused portion of their charitable deduction.
For example, consider the case of a 68-year-old single taxpayer with assets of $4 million and an AGI of $100,000. He gives $100,000 worth of highly appreciated securities and enjoys a charitable deduction of 30 percent of his AGI, or $30,000. He can then deduct the $30,000 plus $10,000 in local taxes against his combined federal and state tax rate of 28 percent, resulting in tax savings of $7,392 beyond what he would enjoy if he took the standard deduction of $13,600 for an individual age 65 or over. He’s also allowed to carryforward $70,000 worth of unused charitable deductions and save the same additional amount in the following two tax years and a smaller amount in the third year.
Finally, advisors have been discovering ways to bypass income taxes by making charitable gifts from funds that aren’t considered part of their AGI in the first place. A prime example is directing gifts to charities totaling up to $100,000 per year from traditional (and in some cases Roth) individual retirement accounts. These funds aren’t reportable as income under federal law, but they can still be used to offset one’s required minimum withdrawal.
Other examples include permanently assigning a portion of income from a charitable remainder trust (CRT), making interest-free loans within Internal Revenue Service regulatory limits and making gifts of qualified appreciated assets that result in bypassing tax on capital gains even though the amount of the gift wasn’t itemized.1
Revisiting Estate Gifts
Now that over 99 percent of estates won’t be subject to federal estate taxes (or state estate taxes in most states), many practitioners began advising their clients during 2018 to revisit testamentary gifts that may have been included in plans created under prior law.
In some cases, it can be wise to leave assets to heirs with the request that they make desired contributions to charities that would otherwise result in no estate tax savings if they remained as testamentary charitable gifts.
Under this approach, the donor retains full access to the assets during lifetime while, in effect, bequeathing the ability to enjoy charitable income tax savings to heirs. In some cases, especially when larger amounts are concerned, this gift may make it possible for heirs to use the charitable gifts to boost their income over standard deduction amounts for one or more years as described above.2
Others may choose to accelerate testamentary gifts by instead making inter vivos split-interest gifts. Examples would include CRTs, charitable gift annuities (CGAs) and gifts of real estate with retained interests for life or a period of years.
Such gifts, especially when funded with appreciated assets, can result in significant income tax deductions that can be part of boosting strategies that offer tax savings for non-itemizers in one or more years, as well as the ability to bypass capital gains taxes.
Under the tier structure of reporting income from CRTs and favorable reporting of CGA payments, a significant portion of such payments may be taxed at lower capital gains rates or excluded from income as tax-free return of trust corpus or the actuarially determined investment in a CGA.
Another option gaining more attention is the use of non-grantor, non-reversionary charitable lead trusts (CLTs). Whether or not a client needs the estate tax relief offered by this tool, payments from a CLT flow outside the donor’s taxable income stream, effectively simulating the receipt of the income followed by a fully offsetting charitable deduction. This option can be a very effective way to deal not only with the case of a non-itemizer but also with clients who itemize their charitable gifts but regularly exceed AGI limits on those deductions.
Economic Factors in 2018
Investment markets hit record highs in 2018 and maintained those levels at press time.
As noted above, a number of very effective charitable gift planning tools are best fueled by appreciated securities, real estate and other long-term capital gains property.
From a planning standpoint, giving appreciated assets can result in significant tax savings in the year of the gifts and perhaps future years, while not requiring the use of income that can be expended for other purposes. In fact, the amount of cash available to the taxpayer may actually increase when tax savings from the gift are realized.
Over the past year, it’s become increasingly clear that gifts of appreciated assets are an especially good choice, particularly for those who don’t itemize their charitable gifts. That’s because capital gains tax savings are realized whether or not there’s a deduction because there’s no sale or exchange that would trigger capital gains for the donor, and the charity is exempt from tax when the donated property is sold.
Giving appreciated securities while using cash that would otherwise have been donated to repurchase the same security or diversify holdings free of capital gains tax will also appeal to clients who would like to rebalance their portfolios in light of recent market advances. This charitable giving option doesn’t require a donor to time the market; it simply offers a way to adjust to conditions as they now exist.
While the jury is still out on overall giving trends, it’s possible that increases in giving in 2018 as a result of investment market gains could more than overcome any reductions in giving caused by cutbacks as a result of higher standard deductions and lower marginal tax rates.
Baby Boomers Booming
Over 10,000 Baby Boomers passed the age of 65 every day in 2018, and this trend will continue for the foreseeable future.
IRS and other figures3 indicate that donors over the age of 65 are by far the most generous among the U.S. population. They’re also more likely to encounter AGI limits and make their gifts in the form of non-cash assets due to lower AGI in retirement and a greater portion of their assets held in the form of investment properties.
They’re also entering retirement years in times of lower interest rates and yields on securities investments. As a result, many are looking for ways to enrich their charitable golden years with increased income and tax savings in retirement.
Split-interest charitable gifts can offer a way to convert low yielding appreciated property into a source of greater income while bypassing capital gains taxes and enjoying immediate income tax savings based on the entire value of the assets used to fund the gift.
The combination of tax law changes, economic conditions and the aging of the donor population continued to intertwine in 2018 in ways that may foretell the future of philanthropic planning now and for the next 15 to 20 years.
What to Look for in 2019
The only certainty for 2019 is that demographic trends that were baked in following World War II will continue to impact our society in many ways including trends in philanthropy.
Economic and tax conditions are much less predictable with economic developments perhaps holding the greatest prospect for unexpected change.
While many predict that there’ll be no significant tax law changes in 2019, this may not be the case. News reports following the 2018 elections have hypothesized that the unpopularity of the 2017 tax law changes were a factor in Democratic party gains, and these are among the same states that a number of Republican senatorial candidates must defend in 2020.
These include high tax states where the SALT limitations have resulted in higher taxes for upper income moderate voters who may further shift their voting preferences in 2020 as the impact of the SALT limits become more broadly known. Because of that, it’s possible that we may see some bipartisan legislation in 2019 that could roll back the SALT limits. Stay tuned.
Another possible fix for the elimination of the charitable deduction for many donors in the wake of higher standard deductions is the introduction in 2018 of an above-the-line deduction (in reality, an exclusion from AGI) for a certain amount of charitable gifts. While there’s broad support for such a provision, there’s disagreement over whether it would be subject to a floor or a ceiling other than the
30 percent of AGI limits for property gifts or 60 percent for gifts of cash.
Speaking of the 60 percent of AGI limit for cash ushered in by the Act to replace the prior limit for cash of 50 percent, there was an unintended drafting glitch that apparently results in the 50 percent of AGI limit for cash gifts being maintained if any gifts of property are made in the same years. A correction of this problem that would allow 30 percent of AGI for property gifts to be combined with 30 percent of AGI for cash gifts to reach the maximum of 60 percent has been included in a proposed bipartisan technical corrections act.
Endnotes
1. Robert F. Sharpe, Jr., “Tax Reform: Who Really Benefits in Terms of Charitable Giving?” Trusts & Estates (March 2018).
2. Robert F. Sharpe, Jr., “Charitable Alchemy—Turning Reduced Taxes Into Increased Tax-Favored Giving,” Trusts & Estates (September 2018).
3. See Internal Revenue Service SOI Tax Stats, “All Returns with Donations, All Donation Types,” 2015, www.irs.gov/statistics/soi-tax-stats-individual-noncash-charitable-contributions.