As a result of the changes made by the Tax Cuts and Jobs Act, when they filed their 2018 tax returns, many taxpayers discovered that they are no longer itemizing their deductions. This means that the tax savings that previously resulted from their charitable contributions has disappeared. One way to recapture the tax benefits of charitable giving is to use a donor-advised fund to “bunch” charitable contributions. Using the donor-advised fund strategy also makes it more efficient to capture the tax benefits of donating long-term appreciated stock and simplifies the recordkeeping requirements for charitable contributions.
The Tax Cuts and Jobs Act was enacted in December 2017. Among the many changes included in the TCJA were the following two provisions that combined to greatly reduce the number of taxpayers (in particular, married taxpayers) who itemize deductions:
1 – The almost doubling of the standard deduction for a married couple from $13,000 in 2017 to $24,000 in 2018. For 2019, the standard deduction for a married couple will be $24,400; and
2 – The introduction of a $10,000 ceiling on the deduction for personal taxes, including state and local income taxes and real estate taxes.
As a result of these changes, married taxpayers without a mortgage generally will lose the tax benefits associated with the first $14,400 ($24,400 allowable standard deduction – less $10,000 deduction for personal taxes) of charitable donations for 2019.
Taxpayers can counteract the loss of the tax deduction for charitable contributions by prepaying their charitable contributions for 2020 (and potentially future years) in 2019. Although this strategy of prepaying charitable contributions in order to “bunch” the tax deduction is simple in concept, donors often perceive it to be impractical, as it requires them to commit several years of funds to a given charitable organization in lieu of responding to future requests for donations.
Enter the donor-advised fund. The donor-advised fund can be thought of as a charitable brokerage account that allows donors to make a contribution and receive a deduction in one tax year and then direct the disbursement of funds from the donor-advised fund account to charities in future years. Subject to the terms of the donor-advised fund agreement, donors can have an indefinite time period over which they can disburse the funds and can name a beneficiary to direct the disbursement of any funds remaining at their death.
Most donor-advised funds allow account holders to direct the investment of the funds held in the account among a predefined menu of mutual funds. Importantly, the donor-advised fund account is tax exempt, meaning the account holder is not required to report the income earned by the fund. As a result of the fund’s tax exempt status, taxpayers can gift long-term appreciated property to a donor-advised fund, which allows the taxpayer to not only avoid paying the capital gains tax on the appreciation but also to enjoy a charitable contribution deduction for the appreciated value of the stock.
Donor-advised funds also simplify the recordkeeping for charitable giving. Taxpayers only need to substantiate the lump sum funding of the donor-advised fund. While subsequent disbursements from the donor-advised fund are not deductible (and thus do not need to be reported on a tax return), most donor-advised fund sponsors provide an annual giving summary to assist donors in monitoring and planning their future charitable giving.
For further information on how a donor-advised fund strategy might benefit you, please contact a member of our Personal Tax Advisory Group here.