Fundraising Under the New 2018 Income and Estate Tax Laws

Fundraising under the new 2018 income and estate tax laws

2017 marked the 100th anniversary of the charitable income tax deduction.

2018 welcomes in the new world of income and estate taxes, and charitable deductions.

The new deduction rules of the Tax Cut and Jobs Acteffective January 1, 2018 offers an uncharted opportunity for tax and financial planning advisers and fundraisers.

Introduction: Every fundraiser must understand the basics of the Federalincome and estate tax and the effect of any state income or estate tax on gifting.Fundraisers must understand tax basics, if for no other reason but to not mislead donors on the deductibility of their gift.

Charity was quick to respond to the new law and indicate charitable gifting could decrease by $4.9 to $13.1 billion. (Indiana University study). There are about 143 million tax filers in the U.S., and approximately 48 million of those tax filers itemize their deductions. Under the new law, the prediction is those who itemized will fall more than half to 22 million. Annual charitable support runs about 2% of taxpayer’s discretionary income.

Any new tax legislation always creates questions for professional advisors and donors. It also offers new opportunities to educate donors on the impact of gifting to your mission. Your ability to educate donors may set your charity apart as others compete for discretionary donor gifts.

While countless studies have shown that tax incentives have always been low on the motivationscalefor giving,countless donors use all appropriate deductions to reduce their federal and state tax bills.

Fundraisers have been touting the deductibility of charitable gifts for ages. However, this may no longer be attractive or meaningful for most of your donors.

As a refresher, every tax act has provided a standard deduction. This is the amount a taxpayer subtracts from his or her adjusted gross income to calculate taxable income. The new law designates certain expenses that qualify as an “itemized deduction.” If the total of a taxpayer’s itemized deductions exceeds the standard deduction amount, then the taxpayer reduces adjusted gross income by the total. Let’s call this the standard deduction “threshold”.

For taxpayers who itemize, incurring a deductible expense such as a charitable gift reduces the after-tax cost of the gift.

Example: a taxpayer in the 24% marginal rate bracket who gifts $1000.00 as a deductible charitable expense results in an after-tax cost of $760.00. Tax savings are the government bonus for being charitable today.

Under the new tax act 90% of files are expected to claim the standard deduction whereas only 69% itemized in 2014. If this is true very few taxpayers will receive a tax benefit from incurring deductible gifts or expenses which exceed the “threshold”.

This article will first list the many changes of the Tax Cut and Jobs Act and will then suggest how fundraisers may position their programs so donors receive the maximum effect from their gifts.

Summary of major changes

New income tax rates:
New rates are: 10, 12, 22, 24, 32, 35, and 37%
A 3.8% Medicare tax is still applicable for passive income so the total rate for high income taxpayers with investment income could be 40.8%.

Tax filer are divided into filing status:
The income tax is applied differently depending on taxpayer filing status. Different income brackets are used for each filer’s status
Single filer
Joint and surviving spouse filer
Head of household filer
Married filing separately
Know the filing status of your donor, most will be single or joint filers

Capital gains rates were largely unchanged with most paying 10% or 15%,with a top rate of 20%

Standard deduction increased
The new laws double the standard deduction for most filers
Single, the deduction is $12,000
Single over 65,deduction is $13,600
Joint, the deduction is $24,000
Joint and one over 65,deduction is $25,300
Joint and two over 65, deduction is $26,600
The new law was designed to encourages individuals to use the standard deduction rather than itemizing their deductions with the increased thresholds.
To itemize taxes, ALL deductions must total more than the above threshold amounts which depends on the taxpayers filing status
Example: For a couple both over age 65, their deductions would have to total more than $26,600to itemize and receive a tax benefit.

What counts as a deduction:
State and local taxes but only up to $10,000, including state income and property taxes.
Mortgage interest up to the aggregate mortgage principal up to $750,000 down from $1 million under prior law.
No interest deduction for home equity line of credit, including existing borrowing, except if the loan is improving your home.
Medical expenses to the extent they exceed 7.5% of adjusted gross income (AGI).
Cash charitable gift are deductible up to 60% of (AGI), in prior years the limit was 50%
Appreciated asset gifts are still deductible up to 30% of AGI.
Note:there is a five-year carryforward of an unused deduction which exceeds the above limits but the carryforward amount plus other deductions must still qualify in future years to itemize, if not the taxpayer has lost this carry forward benefit.

For further details consider purchasing the 2018 Federal Tax Pocket Guide from R&R Newkirk to share with professional advisers and your board. It is an excellent resource and educational brochure.

What should fundraisers do?

How should fundraisers explain the impact of the new tax law? What gift strategies should your program include?

First,all nonprofits need to improve their multichannel marketing plans for annual and planned gifts. Remember, tax motivation for gifting is a low priority for most donors. Many donors already take the standard deduction and give out of pure charitable intent. Work on stating your mission clearly and show the impact of gifts on those you serve. The more personal examples you can use the greater the impact.

Second,the doubling of the standard deduction will limit the tax benefit of charitable gifts made by most filers.

Example1: Suppose a couple pays mortgage interest of $12,000 and incurs state and local taxes of $10,000 and also make annual charitable gifts of $1,000. Because the sum of these three deductions ($12,000 + $10,000 + $1,000 = $23,000) does not exceed the standard deduction ($24,000 threshold for joint filers under 65) the taxpayers receives no tax benefit for their gifts.

Example2: Change the status of the above taxpayer to single filer over 65 (threshold $13,600) and there is a $9,400 itemization benefit ($23,000 - $13,600 = $9,400) and the donor should itemize.

Third,bundling or skip-year giving. Senior taxpayers have been bundling their contributions for many years. Bundling is making as many gifts as possible in one year, skipping the next year and resuming gifts in the third year. The hope is by bundling gifts every other year the taxpayer will be able to itemize. While this does not help the charities’ cash flow it does benefit the taxpayer by reducing the cost of their gifts.

Example3: John has been gifting $10,000 per year for the last five years to various charities. To take advantage of the new tax law standard deduction threshold John decides to bunch his deductions so the net result is the following: Year-1 gift $20,000, Year-2 take standard deduction, Year-3 gift $20,000, Year-4 take the standard deduction, Year-5, gift $20,000.

Fourth,seeding future philanthropy. In recent years the acceptance and funding of donor advised funds (DAFs) have skyrocked. DAFs have received increased publicity from community foundations andthe commercial charities running donor advised funds. Fidelity Charitable alone collected over $8.5 billion during the 2017 calendar year. Fidelity’s experience echoes those of other big DAF providers that have release 2017 figures. These charities are advising donors to make gifts to donor advised funds (DAFs) now to receive the benefits of an immediate income tax deduction and/or avoidance of capital gains taxes. Funding happens when the taxpayeris in a position to afford increased gifting but does not want to gift the money to one or more charities today.

A gift to a DAF is deductible when made but the DAF is not required to distribute the proceeds to charities immediately. Instead, the assets will be invested and the DAF donor may dole out funds in succeeding years and/or may change charities along the way.

Many donors in their high-income pre-retirement years may be in an economic position to seed their philanthropy for gifting during their senior years when they are not working.

Some of the nation’s largest donor-advised funds (DAFs) tallied total contributions of some $7 billion last year and made grant distributions of almost $3.4 billion. Be sure you have a fundraising strategy that targets your DAF donors. DAFs are experts in handling complex gifts and turning them into current or future charitable support.

Example 4: In the above example 3 if the donor had a DAF he could use the DAF distributions in years when he took the standard deduction so the charity did not suffer with its gift cash flow.

Fifth,gifts of appreciated securities. With the stock market near historic highs, taxpayers should consider maximizing their gifts using appreciated property. The tax advantages for appreciated property gifts have not changed. Normally, appreciated property gift is commonly gifts of securities or real estate. The donor receives the full fair market value charitable deduction and avoids any capital gains tax on the gifted asset. These gifts are deductible up to 30% of adjusted gross income (AGI).

Example 5: Sara an active investor has accumulated 1,000 shares of Apple stock in her portfolio over the last 5 years. Her1,000 shares are currently valued at approximately $160,000. Her cost basis on the 10 shares of Apple she is gifting to charity is $60 per share. She gifts 10 shares and receives a charitable deduction of $1,600 and avoids any tax on the$1,000 capital gains associated with her gifted shares.

Sixth,IRA charitable rollover. Technically called a Qualified Charitable Distribution (QCD) in the tax law, non-itemizers who are receiving required minimum distributions (RMD) from their IRAs have another way to benefit when making charitable contributions.

Individuals over the age of 70 ½ may transfer up to $100,000 from their IRA to charity and avoid income tax on their distribution. By not paying income tax the effect is they receive a 100% “ghost deduction.” Additionally, the distribution to charity will count toward satisfying the RMD obligation. Also, there is nothing to prevent the taxpayer from claiming the standard deduction in the years they make a QCD.

To qualify under the QCD rules the transfer must be made directly to the charity and transfers to DAFs do not qualify.

Example 6: Phil’s required minimum distribution is $15,000 this year. Phil makes a $10,000 QCD and his remaining RMD of $5,000 will count toward his taxable income.

Example 7: Phil’s required minimum distribution is $15,000 this year. Phil takes his entire RMD as a QCD and distributes it to two of his favorite charities. His taxable retirement income from his IRA is $0.

Example 8: Phil’s required minimum distribution is $15,000 this year. Phil takes his entire RMD as a QCD and distributes it to two of his favorite charities. In addition, he makes a $5,000 QCD to another charity to reduce his IRA balance which could potentially reduce future RMD amounts. There is no carry forward of QCD for future years.

Planned gifts and the charitable deduction

There are only three types of gifts. Outright gift covered above, split interest gifts and estate gifts. Split interest gifts are commonly charitable gift annuities and charitable remainder trusts.

A charitable gift annuity and charitable remainder trusts both create a charitable deduction and provide lifetime income. The payments from gift annuities are guaranteed by the issuing charity.Payments from charitable trusts are not guaranteed and mostly depend on the fair market value of the trust assets or the annual income generated by the trust assets.

Example 9: A single donor age 75, establishes a gift annuity with $25,000 cash. The payment rate is 5.80% and the charitable deduction is $12,148. If the charitable deduction plus other deductions carry the taxpayer over the standard deduction threshold $13,600 (single filer) the taxpayer should itemize.

Example 10:A joint filer taxpayer couple both age 75 establish a charitable gift annuity with $10,000 cash. The two-life payment rate is 5.00%, and the charitable deduction is $4,251. To itemize, the taxpayers’ other deductions must exceed $26,600. It is unlikely these taxpayers will itemize but the tax-free payment ($350.00 of $500.00) makes the effective rate on this gift annuity equal to a 6.80% return.

Example 11: John and Sara, ages 68 and 62, are considering funding a charitable remainder trust with 20 acres of waterfront property John inherited 20 years ago from John’s parents. At the time of inheritance John’s basis was $4,000 per acre but the property has increased to $20,000 per acre. The sale of land inside the CRT will avoid any capital gains tax on the sale of the appreciated land and provide a charitable deduction.

John decides to keep 10 acres in his name for a future sale and transfer10 acres today in the CRT so it may sell them. This helps him plan for his retirement years. John’s adviser suggested a 5% charitable remainder trust. The value of the land is $200,000 and the cost basis is $40,000. The charitable deduction for the CRT is $67,070 and since it is over their threshold of $25,300 John and Sara will itemize their deduction up to 30% of their AGI with a five-year carryforward of any unused deduction.

Estate gifts and the charitable deduction

The threshold for triggering estate, gift or generation-skipping tax was raised from $5.49 million to $11.2 million per person. A married couple with proper planning may shelter $22.4 million from estate taxes. The tax rate on estate assets over the exemption amount is set at a flat 40% on any excess. The exemption amount sunsets in 2026.

The annual exclusion amount for current gifts to family and friends is $15,000 per person or $30,000 per couple.

More than 50,000 estates were subject to estate taxes as recently as 2001, when the estate exemption amount was $675,000 and the tax rate was 55%. Since 2001 with the increase in the exemption amounts the IRS has seen a decrease to less than 12,000 estate filing in 2015. The IRS estimates less than 1% of estates will be subject to estate taxes under the current exemption amounts.

New regulations post a challenge to estate planning professionals as income tax planning becomes paramount. Professionals must continue to work with clients to produce high impact, integrated plans for efficient giving. The wealth advisor who is exposed to strategic philanthropy options can empower clients to take a more proactive and thoughtful approach to both current giving and estate transfers.

This does not mean estate planning should be forgotten. For individuals to remember charity in their estate plans they must actively include a bequest in their will, trust and/or change the beneficiary designation of their retirement plans or life insurance.

Many donors will have different goals for their estate planning than they did previously. As they return to the planning table and structure new plans, charities must continue to reinforce the impact of their mission and actively promote estate inclusions as a part of your donor’s plans.

Summary

The interplay of the new tax law’s increase in the standard deduction and restriction of itemized deductions provides new opportunities for charities to explain the impact of gifts on their mission. Many taxpayers might wish to reconsider whether it makes sense to incur deductible expenses, or shift such expenses to other years, to minimize the taxes they pay under the new system. Because individual circumstances differ, fundraisers must be careful in predicting the impact of gifts on the taxpayer’s using the government benefits of the charitable deduction. Take time to educate both professional advisers and donors on the new opportunities to make tax smart gifts.

You don’t have to revise how you accept gifts, but charities should consider providing some guidance for donors on the deductibility of their gifts. Perhaps consider the following notation on your gift receipts or in your donor letters.

“Gifts to (charity) are deductible as a charitable contribution to extent provided by law and your personal situation.”

ABOUT JAMES E. CONNELL