In my 25 years as a CPA, I rarely advised a client to claim the standard deduction when filing tax returns. Many taxpayers were better off itemizing because the sum of their allowable itemized deductions exceeded the amount of the standard deduction. This may change under the Tax Cut and Jobs Act of 2017 (TCJA), passed in December of 2017. Starting in 2018, it is estimated that 90% of taxpayers will take the standard deduction (up from 70% in prior years). Let it be said that many readers of this article will find themselves in the category of the 10% who continue to itemize because the sum of their itemized deductions will continue to exceed the standard deduction year after year. But some readers may find themselves taking the standard deduction.
The primary provisions of the new law which drive this change include:
an increase in the standard deduction from $13,000 to $24,000 (couples filing jointly) and from $6,500 to $12,000 (single filers);
a cap of $10,000 on the deduction of state and local taxes (SALT);
preservation of the mortgage interest deduction—please note, mortgage limits have changed;
preservation of the charitable contribution deduction;
and the elimination of most other itemized deductions.
The combination of the increase in the standard deduction and the cap on SALT deductions will result in many taxpayers finding that itemized deductions no longer outweigh the standard deduction. For those taxpayers, previously popular deductible items such as state and local income taxes, property taxes, mortgage interest and even charitable contributions will become useless with regard to tax planning. And while most taxpayers will likely see lower tax bills under the new law, not being able to use those popular deductions will be a disappointment for many. Here are a few planning ideas that might help taxpayers make use of some of those deductions after all.
“Bunching” of Deductions and Charitable Contributions
Taxpayers whose itemized deductions fall short of exceeding the standard deduction threshold but are still close might consider bunching multiple years’ worth of charitable contributions, property tax payments and a portion of state tax payments into a single calendar year. The sum of these bunched deductions would exceed the standard deduction threshold, allowing the taxpayer to itemize their deductions. In the next tax year, the taxpayer would claim the standard deduction and would defer (to the following year) making the same payments and contributions that they itemized in the first year. The taxpayer is alternating years—itemizing in year one, taking the standard deduction in year two, itemizing in year three and so on. For taxpayers in the category described above, bunching and deferring deductions may result in greater overall deductions and a lower tax bill over a multi-year period.
Donor Advised Funds
Taxpayers who are hesitant to double their charitable contributions in a single year might consider opening a Donor Advised Fund (DAF). A DAF permits a taxpayer to donate cash (or preferably, appreciated stock held for at least one year) to a charitable account (DAF) in the current tax year and take a deduction equal to the fair market value of the gift in the current tax year. The taxpayer can then dole out the money from the DAF to charity over a multi-year period by making “grant recommendations” to the non-profit entity serving as custodian of the DAF. You can read more about these funds here.
Qualified Charitable Distributions (QCD)
Taxpayers over the age of 70½ are eligible to annually contribute up to $100,000 directly from an IRA to a qualified charity (note that “qualified charity” in this case does not include Donor Advised Funds). The QCD is excluded from income and thus is not permissible as a deduction. In essence, the taxpayer is making a charitable contribution using pre-tax money. Notably, the QCD does count toward the taxpayer’s IRA required minimum distribution.
Prior to the new tax bill, this strategy was not always a “slam dunk.” When comparing the QCD to gifting after-tax (non-IRA) assets, such as appreciated property (stock), we often determined gifting after-tax assets provided a better tax benefit. Giving after-tax assets enables the taxpayer to 1) take a tax deduction equal to the fair-market value of the gift and 2) avoid paying the capital gain tax on the appreciated asset. But under the new law, those taxpayers now using the standard deduction and therefore no longer itemizing will almost always favor using the QCD to meet charitable giving goals. In a “have-cake-and-eat-it-too” kind of way, this allows the taxpayer to enjoy both the standard deduction and the ability to avoid being taxed on that portion of their IRA distribution that is given directly to charity.
In summary, some taxpayers may benefit from a bunching strategy—alternating between taking the standard deduction one year and itemizing deductions the next. With proper planning this strategy may maximize overall deductions over a multi-year period resulting in lower tax bills. Using a Donor Advised Fund may facilitate the bunching of charitable contributions and allow the taxpayer to control the timing of grants to charity. And finally, for those taxpayers who are over 70½ and who find themselves taking the standard deduction, a Qualified Charitable Distribution may provide significant tax savings as well. Please let us know if you would like to discuss which of these planning ideas makes the most sense for your tax situation. As always, please also consult with your tax advisor.
Curious about how the Tax Cut and Jobs Act of 2017 (TCJA) will impact your tax bill? Click here to find out.
Read about the impact of the tax bill on your estate planning here.
For an extended summary of the Tax Cut and Jobs Act of 2017 click here.
This information is believed to be accurate but should not be used as specific investment or tax advice. You should always consult your tax professional or other advisors before acting on the ideas presented here.