Charitable giving is going to decline by about five percent as a direct result of the Tax Cuts and Jobs Act that Congress enacted last fall. This is the consensus judgment of both liberal and conservative economists. Incentives matter and the loss of the tax deduction for charitable donations made by 21 million families is going to depress giving.
I wrote a column about this issue a few months ago in the Peninsula Pulse under the headline, “The Impending Decline in Charitable Giving”.
There is little we at the Door County Community Foundation can do to influence tax policy in Washington. However, community foundations across the country are trying to help mitigate the impact of the new tax law by essentially “restoring” the deductibility of donations lost to many families. Essentially, we are combining a common community foundation tool called a Donor Advised Fund with a tax strategy accountants refer to as “bunching.”
Setting up your own Donor Advised Fund at a community foundation is similar to having your own private foundation, only without all the legal and accounting costs associated with setting up your own corporation. As a donor, you make a contribution into your Fund at the community foundation and are generally entitled to a tax deduction in the same year your donation is made. You then have the community foundation pay out that money to your favorite charities over time.
There’s nothing new or radical about Donor Advised Funds. Community foundations across the country have been offering them for decades as a simpler, cheaper, more tax-efficient alternative to a private foundation. However, the new tax law has made a Donor Advised Fund an invaluable tax planning tool when we combine it with the tax strategy known as bunching.
Under the old tax laws, bunching was a common practice in which a taxpayer would bunch multiple years of property tax payments, state income tax withholding, or even deductible medical expenses into a single year to maximize deductions in a high income year. Under the new tax law, many families will benefit by applying this concept to charitable donations. Essentially, you bunch several years of charitable gifts into a single year through a Donor Advised Fund at a community foundation.
Let’s consider the hypothetical example of John and Jane Smith. The Smiths have done well in life and typically donate $10,000 each year to the charities they love, including John’s alma mater in Illinois, their church in Florida, and several small charities Jane loves here in Door County.
On their 2017 tax return, the Smiths claimed itemized deductions of $23,000. They deducted $6,000 in mortgage interest, $7,000 in state and property taxes, and $10,000 in charitable gifts. Unfortunately in 2018, under the new tax law, the higher standard deduction of $24,000 means the Smiths will no longer be able to itemize their deductions. Hence, they are not entitled to any tax deduction for the $10,000 they contribute to charity every year.
For a couple like the Smiths, bunching several years of charitable gifts into a single year through a community foundation is the perfect tax planning tool. They can combine multiple years of charitable donations into this tax year to exceed the standard deduction.
So the Smiths visit the Door County Community Foundation and create the John and Jane Smith Donor Advised Fund. After conferring with their advisors, the Smiths decide to bunch five years of future charitable gifts into this tax year and thus contribute $50,000 into their Donor Advised Fund today. As a result, the Smiths claim $63,000 in itemized deductions on their 2018 tax return. It’s the same $6,000 in mortgage interest and $7,000 in state and property taxes, but it now includes a single $50,000 charitable gift to their Donor Advised Fund.
Then the Smiths use their Donor Advised Fund to pay out $10,000 in contributions every year over the next five years, including to John’s alma mater in Illinois, their church in Florida, and several small charities Jane loves here in Door County. If the Smiths prefer, the money in their Donor Advised Fund can even be invested during those five years so they’ll have even more money to give away to charity. Regardless, neither the distributions from their Donor Advised Fund, nor any earning on it, have any tax implications for the Smiths. They claimed their $63,000 in itemized deductions in 2018.
In the following four tax years of 2019 to 2022, the Smiths then claim the standard deduction on their tax return. Finally, in 2023, the Smiths might decide to do it all over again and replenish their Donor Advised Fund by bunching the next five years of contributions into 2023, thereby repeating the cycle. This simple tax strategy gives the Smiths an additional $78,000 in tax deductions over 10 years.
Bunching charitable gifts through a Donor Advised Fund at your local community foundation is an incredibly powerful tax planning tool for generous families. The savings is can magnified if the donation into your Donor Advised Fund is in the form of highly appreciated stock. In that case, you’d also avoid the capital gains taxes that would otherwise be due.
Of course, I’m neither an attorney nor an accountant so goodness knows you shouldn’t take my word for it. Talk with your professional wealth advisor to determine whether bunching charitable gifts through a Donor Advised Fund might be a good tax planning tool for your unique situation. Then call the Door County Community Foundation, or whatever your local community foundation might be, if a Donor Advised Fund is the right tool for you.
This article, written by Community Foundation President and CEO Bret Bicoy, originally appeared in the Peninsula Pulse.