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Make the Most of One of the Few Deductions Left – Charitable Contributions

The new tax law has severely limited deductions for state and local taxes, and has completed eliminated miscellaneous deductions, leaving only medical, charitable, and home mortgage interest deductions as possible ways of reducing your taxable income.

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The new tax law has severely limited deductions for state and local taxes, and has completed eliminated miscellaneous deductions, leaving only medical, charitable, and home mortgage interest deductions as possible ways of reducing your taxable income.

The new tax law has severely limited deductions for state and local taxes, and has completed eliminated miscellaneous deductions, leaving only medical, charitable, and home mortgage interest deductions as possible ways of reducing your taxable income.

The standard deduction has also been impacted by the new tax law, however—nearly doubling from the year before. As a result, most people will opt to take the standard deduction, which means they will be unable to realize any income tax benefit from their formerly itemized deductions, including their charitable contributions.

That said, there are ways to maximize your charitable deductions, especially for those claiming the standard deduction moving forward.

When you receive a tax deduction for making charitable contributions, the government subsidizes a portion of your charitable gift.  For example, if you are in the 35% tax bracket and make a deductible gift of $1,000, your economic cost of making that gift is only $650 ($1,000 minus $350 tax savings).  If you no longer get a tax deduction for the contribution then your economic cost is the full $1,000.  Clearly, people make charitable gifts first and foremost to benefit a charitable cause and not for the tax deduction.  But the economics should be considered when planning to support your favorite charities.  Let’s consider the following example of a married couple’s deductions under the new tax law:

2019 2020 2021 2022 Total
Taxes (limited to $10,000)  $10,000 $10,000 $10,000 $10,000
Mortgage interest  $2,000  $2,000  $2,000  $2,000
Charitable contributions  $8,000 $8,000 $8,000 $8,000 $32,000
Total itemized deductions  $20,000 $20,000 $20,000 $20,000
Standard deduction  $24,000 $24,000 $24,000 $24,000
Deduction claimed  $24,000 $24,000 $24,000 $24,000 $96,000

In this example, the taxpayers will claim the standard deduction in each year, and will therefore receive no tax benefit from making the $8,000 annual charitable contributions.

A possible solution is to use a strategy called “bunching” whereby multiple years’ charitable contributions are made in one year with no gifts made in the intervening years.  For instance, what would happen if the taxpayers in the example above made $16,000 of gifts in 2019 and 2021but no gifts in 2020 and 2022?  The results would be as follows:

2019 2020 2021 2022 Total
Taxes (limited to $10,000)  $10,000 $10,000 $10,000 $10,000
Mortgage interest  $2,000  $2,000  $2,000  $2,000
Charitable contributions  $16,000 0 $16,000 0 $32,000
Total itemized deductions  $28,000 $12,000 $28,000 $12,000
Standard deduction  $24,000 $24,000 $24,000 $24,000
Deduction claimed  $28,000 $24,000 $28,000 $24,000 $104,000

As you can see, bunching leads to an additional $8,000 of deductions even though the total amount given to charity remains unchanged over the four years.  For a taxpayer in the 37% tax bracket, the tax savings would be $2,960 merely by doing a little planning.  This strategy can be combined with use of a donor-advised fund to more evenly spread the amount of funds passing to charity.

Remember too, as we discussed previously, that taxpayers who have an IRA and are over age 70 ½ can also make tax-free distributions directly to charity as another way of maximizing the benefit of their charitable contributions.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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