The past year has been another challenging one for those who advise clients who would like to make significant charitable gifts. Fundamental changes in tax considerations, economic developments and the shifting demographics of the United States continue to interact in ways that make it harder to know what to give, when to make a gift and the appropriate vehicle to use to best accomplish the donor’s intent.
Legislative Uncertainty
Lack of action in Washington, D.C. on many of the issues that confront our nation affects all aspects of our society, including the voluntary funding of many vital services such as education, health care, religion, social services and the arts.
Innumerable technical corrections to the Tax Cuts and Jobs Act of 2017 (TCJA) have yet to be made some two years after its enactment. Among them are proposals to clarify the interaction among rules governing limits on allowable charitable contributions based on a taxpayer’s adjusted gross income (AGI). While the TCJA raised the AGI limit for deductions of cash to 60%, Congress inadvertently restricted this higher limit to situations in which only cash was contributed and not combinations of cash and appreciated non-cash assets. This has made it more difficult for some donors to determine the best mix of cash and other property to use to make gifts under their circumstances.
There’s also been proposed legislation in California and elsewhere at the state level that would threaten a donor’s ability to use donor-advised funds (DAFs) to provide desired anonymity when making charitable gifts. There are many reasons, including religious beliefs, why certain donors choose to give anonymously, and some believe that loss of that anonymity could have a chilling effect on these donors, leading to a reduction in giving.
The anticipation of the upcoming election in 2020 may also have adversely impacted philanthropy in 2019, and that impact may be expected to continue throughout this year. Given the degree of divisiveness in the electorate and the relatively large number of candidates who’ve been raising funds during the past year, history may show that political fundraising cannibalized charitable dollars to an unprecedented degree in 2019.
In a related development that may have served to exacerbate the impact of political fundraising, it’s now becoming increasingly clear that only approximately 10% of charitable households are still itemizing charitable deductions as a result of changes brought about by the TCJA.1 This development has tended to level the playing field for political and charitable fundraising, as the removal of tax incentives for charitable gifts from the equation for most prospective donors has eliminated a financial disincentive for political gifts versus charitable contributions. This may be another unintended impact of significantly reducing the tax incentive associated with charitable giving to Internal Revenue Code Section 501(c)(3) organizations for millions of middle and upper middle income Americans. The same is true for removing the additional cost for contributing to IRC Section 501(c)(4) and other quasi-political nonprofits that don’t qualify for tax-deductible contributions.
Where the wealthiest donors are concerned, two of the leading presidential contenders are putting forth proposals for special tax levies on wealth held by individuals in addition to traditional income and sales taxes. Recent polls reveal that as many as 74% of registered voters supported such plans.2 If a wealth tax were to be enacted, the net effect may be to chill voluntary support of charities, as what might otherwise be discretionary capital available for charitable gifts would be siphoned off to pay taxes to help meet demands for publicly funded services and infrastructure.
Still other proposals would revive past proposals put forth by politicians from both political parties to cap all deductions (including those for charitable gifts) at the 28% tax rate. This would require that deductible gifts and other expenditures be made from after-tax dollars for those in higher tax brackets, leading to a significant increase in the amount of pre-tax income required to make charitable gifts for those impacted.3
Deciding What to Give
Other ways the TCJA significantly altered the calculus employed in planning charitable gifts became increasingly evident in 2019. This involved greater realization by donors and advisors of the complex interplay between fair market value and cost of certain assets, the aforementioned changes in AGI limits and alterations in both tax rates and standard deduction amounts.
Many donors first learned at tax filing time in 2019 the full ramifications of their lack of understanding of the TCJA when they made their charitable gifts in 2018. With the help of advisors who in many cases had gained greater knowledge of the practical impact of the TCJA and much more broadly disseminated information online and in other forums, donors began to make better decisions in 2019 on which assets to use to fund their gifts.
With financial markets trading at record levels, there have been unprecedented amounts of appreciated assets available with which to fund gifts in 2019. In this context, non-itemizers began to understand in greater numbers the importance of making gifts of appreciated assets because they would bypass capital gains tax regardless of whether they itemized, and they wouldn’t have to use after-tax gifts of cash to fulfill their gift commitments.
In another development, a growing number of taxpayers over age 70½ began to take advantage of the opportunity to direct up to $100,000 of individual retirement account assets to make charitable gifts with those funds not reported as income on their tax returns. Those who didn’t itemize deductions learned that not reporting the income used to make these gifts was the same as reporting the income and fully deducting it. They also learned that gifts made in this way qualified as all or part of their required minimum distributions from their IRA, and these amounts also didn’t swell their AGI for purposes of many other income tests, thus saving additional taxes that might otherwise be due.
Given the large numbers of Baby Boomers now passing the age of 70½, we expect ever-increasing numbers of donors to begin making all or a portion of their gifts from IRA assets.
Special Gift Vehicles
Perhaps the greatest “winner” in the charitable tax planning sweepstakes for 2019 was the DAF. While final numbers won’t be available for a number of months, anecdotal evidence points to the fact that 2019 might be one of the largest, if not the largest year ever, for gifts in the form of DAFs.
This is in part because one of the most popular ways to cope with the inability to itemize deductions that’s emerged is the bunching of charitable and other deductions in ways that maximize tax savings over a multi-year period. Taxpayers who wouldn’t have otherwise been able to itemize charitable and/or other deductions learned that by giving every other year, they could enjoy greater tax savings over time. For example, an individual could give nothing in 2019 and take advantage of the standard deduction. He could then make two years of gifts in 2020 and be able to save tax, because his total deductions would then exceed the amount of the standard deduction, resulting in what could be significant tax savings compared with level charitable gifts over the same two-year time frame.
DAFs funded with the aforementioned unprecedented amount of appreciated securities, real estate and other appropriate assets made it possible to bunch gifts of appreciated assets to offset income and/or the gains from the sale of other investments while also benefiting from savings from charitable gifts that might not otherwise be possible. The cash flow to charity need not be adversely affected, as a donor could spread distributions evenly over a multi-year period.
Charitable remainder trusts (CRTs) served similar tax planning purposes whereby a donor could enjoy immediate capital gains and income tax savings while enjoying income for some period of time. Immediate or future irrevocable assignments of a portion of the CRT income to charity from such trusts could also serve to move charitable gifts outside a non-itemizing donor’s income stream, resulting in additional tax savings.
Such vehicles also allowed donors to create a source from which to generate additional tax savings in the future when all or a portion of CRT corpus that may have grown on a tax-free basis could be used to make future tax-deductible gifts.
Finally, recently released Internal Revenue Service data is now making it apparent that a relatively large percentage of the highest income taxpayers (incomes of $500,000 or more) are also no longer itemizing.4 For this reason, 2019 has seen an increased interest in charitable lead trusts among this group of non-itemizers. For example, rather than having to earn over $158,000 pretax in the highest federal bracket to yield $100,000 to donate from non-deductible after tax dollars, they’ve learned that they can fund a $1.5 million charitable lead annuity trust (CLAT) distributing 6.7% a year to charity and thereby effectively transfer just over $100,000 to charity using only that amount of what would otherwise have been their income. As an added benefit, the assets remaining in the CLAT at its termination can be earmarked for the eventual enjoyment of heirs who may now be minors, while minimizing or completely eliminating any federal gift or estate tax that could otherwise be due on that amount.
Here Comes the Future
Fasten your seatbelts for what promises to be an exciting ride over the next few years as we see how multiple interrelated changes in U.S. society will continue to reshuffle the philanthropic planning deck.
Stay tuned as your philanthropic editorial board monitors developments and reports them over the coming year.
Endnotes
1. Robert F. Sharpe, Jr., “The Impact of Tax Reform on Charitable Giving … The First Clues are Emerging,” Trusts & Estates (November 2019).
3. For more on how currently proposed legislation may impact philanthropy in the future, see reports published by the Alliance for Charitable Reform at acreform.org/newsletter.
4. “Filing Season Statistics, Mid-July Filing Statistics by AGI,” 2018, www.irs.gov/statistics.