How Changes to Charitable IRA Rollover and Donor-Advised Funds Will Impact Individuals and Family Donor Decisions
The Tax Cuts and Jobs Act of 2017 dramatically changed the income tax laws for individuals and families in 2018. As a result, donors to charitable organizations may want to make some adjustments to their annual donations to maximize the income tax benefits of their charitable gifts.
Before and after the tax act, donors who itemize their deductions receive a deduction for charitable gifts made during the year. To itemize deductions, donors must have itemized deductions that exceed the standard deduction. Donors whose charitable gifts alone do not exceed the standard deduction rely on other itemized deductions to reach the standard deduction threshold. The most common deductions that donors in Illinois rely on are the mortgage interest deduction and the state and local property tax deduction.
In 2017, before most of the tax act became effective, donors needed to have itemized deductions that exceeded $6,350 for individuals and $12,700 for married couples filing jointly. Beginning in 2018, the tax act increased the standard deduction to $12,000 for individuals and $24,000 for married couples filing jointly. Thus, donors must have itemized deductions that exceed these higher numbers to receive a deduction for their charitable gifts. The tax act also limits the state and local property tax deduction to $10,000. So donors may not be able to rely on their full property tax payments to exceed the higher threshold.
Donors can still receive the income tax benefits of their charitable gifts, but it does require some forethought. For donors who are over 70 ½ years old, the solution is simple: the charitable IRA rollover. The charitable IRA rollover is a distribution from an individual retirement account or retirement plan directly to a charity (as opposed to a distribution that is paid to the donor who passes it onto the charity). When a donor uses charitable IRA rollover, the distribution from the plan administrator directly to the charity counts toward the donor’s required minimum distribution for the year, but the charitable donation is not included in the donor’s adjusted gross income. So he or she doesn’t need a charitable deduction.
For donors who can’t use the charitable IRA rollover, donor-advised funds can provide a method that allows donors to receive the charitable deduction. Donor-advised funds (DAFs) are accounts held by nonprofits, where the donors can advise on where and when to distribute funds. Donors claim the charitable deduction in the year the money is transferred to the DAF even though the funds have not reached their final charitable destination. This allows donors to consolidate several years of charitable gifts into one year for their income tax returns.
For example, married donors usually give $2,000 per year to their favorite charitable organization. In 2018, they created a DAF and deposited $16,000 in it. The transfer to the DAF along with the amounts they paid in interest on the mortgage and their property taxes exceeds the standard deduction of $24,000. Thus, the donors can itemize their deductions in 2018 and deduct the full $16,000 of charitable gifts on their return. In 2018 and continuing through 2025, the donors will direct the DAF to distribute their $2,000 annual gifts to their favorite organization. Beginning in 2019, the couple will claim the standard deduction on their tax returns because they do not exceed the $24,000 threshold without a charitable deduction.
While using the charitable IRA rollover or a donor-advised fund might not be as straightforward as writing a check directly to a favorite charity, these methods allow donors to continue to receive the income tax benefits of their charitable gifts.
Raymond Prather is a partner at Prather Ebner LLP. Ray’s practice focuses on estate planning, advising tax-exempt organizations and consulting on tax issues in trust and estate litigation. Ray has advised hundreds of clients who require tailored estate planning advice due to contentious family dynamics, ownership in closely-held businesses and taxable estates.
Ray is a member of Lambda Legal’s National Legacy and Planned Giving Council and Advocate Charitable Foundation’s Planned Giving Council. Ray received his J.D. from the DePaul University College of Law.