In the movie “The Hunger Games: Catching Fire,” game managers cause a man-made island to spin around, disorienting contestants and forcing them to recalibrate their actions. The U.S. government just did the same thing to taxpayers with the Tax Cuts and Jobs Act (TCJA), which changes many familiar rules related to deductions and can affect the way you account for charitable donations.
If you aren’t prepared, you could end up paying more tax than necessary. In this post, we’ll review a few simple rules about deductions, then look at the new law’s impact on charitable donations and discuss how to navigate in the new environment.
You already know the basics of deductions. When we compute our taxable income, we subtract either our itemized deductions or the standard deduction, whichever is greater. Common itemized deductions include the interest we pay on our home mortgage, our property taxes, our charitable contributions, and a few other expenses.
Two significant changes in the TCJA are likely to cause the number of taxpayers who itemize to drop from about 30 percent to below 10 percent. That’s because some of the expenses we have historically included in our itemized deductions are no longer allowed, including:
- State and local taxes (state income taxes and general sales taxes)
- Interest on home equity loans
- Certain job expenses
- Tax preparation fees
- Investment fees and expenses
This is not a complete list, but already you can see that for many of us, the total of itemized deductions is going to be lower than it has been in previous years.
At the same time, the standard deduction is going way up. For the 2017 tax year, it is $12,700 for a joint return or $6,350 for an individual return. But in 2018, it will rise to $24,000 for a joint return or $12,000 for a single return.
The combination of these two changes means that for many taxpayers, the total of itemized deductions will now be lower than their standard deduction; therefore they will stop itemizing and switch to the standard deduction.
But the impact doesn’t end there. We need to look at how the new law affects the deductibility of our charitable contributions.
If we have charitable gifts, whether they’re for $100 or $10,000, we add them to our other deductible expenses, and if the total exceeds the standard deduction, we deduct them. The after-tax cost of our gifts will be 100 percent minus our marginal tax rate. It’s a fabulous system—we get to help out the charities we like and the U.S. government subsidizes our generosity.
But what if the total of our itemized deductions, including our charitable contributions, is less than the standard deduction? Then we don’t get any subsidy for our gifts.
That’s probably not a big issue for those who give a few hundred dollars each year. It’s also not a problem for those who give tens of thousands of dollars a year, since they likely will have enough deductible expenses to make itemization worthwhile.
But what about those of us who give, say, $5,000? When we add this amount to our other deductible expenses, we may come up just short of the standard deduction. Is there any way we can get a subsidy?
Yes, there is. It is called “charitable clumping” (or sometimes “charitable stacking” or “charitable lumping.”) Instead of giving $5,000 a year to a charity every year for five years, you can give $25,000 in a single year. That takes you over the standard deduction amount, providing a subsidy for your giving.
I know what you’re thinking: “Great—I give a big donation to my favorite charity to cover five or 10 years, then they think I have stepped up my giving and the ‘asks’ go into overdrive.”
Well, that could happen. But fortunately, there’s another way to lump your giving into a single year, yet meter out the donations over a longer timeframe without causing any misunderstanding of your intentions. You can do that with a donor-advised fund.
Charles Schwab and Fidelity run two of the nation’s biggest donor-advised funds. You can donate to them using cash, or better yet, appreciated mutual funds or stocks. You get a charitable deduction when you contribute the money to the fund. You can also choose how the money is invested and give as little or as much as you want over whatever time period you choose.
By making a significant one-time contribution to a donor-advised fund, you will receive the government subsidy for your charitable giving. For the years in which you do not give to the donor-advised fund, if your itemized deductions don’t pencil out, just use the new, much larger standard deduction.