Now that the dust is beginning to settle on the release of the Tax Cuts and Jobs Act, a big taxpayer concern I’ve encountered is the loss of a tax benefit from charitable contributions. But alas! In certain situations your tax benefit may not have disappeared for either individuals or business owners!
First thing is first: Why has there been a reduction in the tax benefit from charitable contributions?
Prior to 2018, if your itemized deductions (things like mortgage interest, state taxes, property taxes, charitable contributions, etc.) were over $6,350 single or $12,700 married filing joint, you received a deduction from your income for these items. Your charitable deductions not only helped others, but you were also lowering your personal tax bill! It was killing two birds with one stone!!
Under the 2018 tax reform however, the standard deduction was raised to $12,000 single or $24,000 married filing joint. Now in order to itemize and receive a benefit for your charitable contributions, you need to have significantly more deductions (around double) before you receive a benefit.
The other change that is causing substantial backlash in higher tax states is that your state and local tax deduction is now capped at $10,000. Specifically, state income, sales, and property taxes combined are limited to $10,000. And that is not $10,000 for just single. It is $10,000 for those filing as married as well! Keep in mind, even though tax reform may have lowered many people’s tax bills, it is still a tough pill to swallow that you may no longer receive a benefit from something you used to.
This means that now, in order to receive any benefit from their itemized deductions, joint filers would need the $10,000 in deductible taxes as well as more than $14,000 of other qualifying expenses such as mortgage interest, charitable contributions and medical allowed after the phase out.
Is there anything that can be done to salvage the benefit of the charitable contribution? Maybe! Let’s look at several options:
1. The first option is to bunch your charitable contributions into one year and to have very few in the following year. This strategy works by increasing the amount of deductible contributions in one year to get over the $12,000/$24,000 standard deduction. This option works well for taxpayers who are generally close to the new standard deduction limits. When you bunch your donations into a single year, you can consider issuing those donations at the beginning of January and the end of December to make the cash flow for both yourself and the organization similar to what it would have been before the new tax law. Just be sure the charity shows the correct date of the donation on the receipt.
2. A second option that has multiple benefits is donating appreciated stock. Under IRS rules, you are allowed to donate stock directly to a charity and not pay tax on any associated gains or increases in the value of the stock. This is in contrast to selling the stock for a gain, paying tax on the gain, and then donating cash to the charity. An example really drives home this point.
Consider that you would like to make a donation to your favored local charity and you have General Motors stock that is currently worth $5,000:
Based on the above example, when you donate the stock directly to charity, you pay a total of $720 LESS in tax and the charity receives $600 MORE in donations. This is the best of both worlds!
(Update! July 2019) 3. A third and often overlooked option is one that can be utilized by those who are taking the Required Minimum Distribution (RMD) from their IRA. Rather than taking your RMD and then donating the money to a charity (Which results in taxable income from the IRA distribution and an itemized deduction for the charitable contribution), you send the money directly to the charity from your IRA in what is called a Qualified Charitable Distribution (QCD). When you make a QCD your IRA custodian sends the money directly from your account to the qualifying charity. By doing this, the portion of your RMD that was directly contributed is no longer taxable. You get the benefit of a reduction of taxable income without the need to itemize along with helping your favorite charities!
4. A fourth option is only available if you have a business (not to be confused with a hobby) that flows the activity to your personal return (such as a Schedule C, LLC, Partnership, S Corporation, etc). Almost everyone has run across an event put on by a charity that was sponsored by a company or has seen an advertisement in a charity’s publication. But have you ever thought of having your business become a sponsor or advertising through your favored charity? As long as certain requirements are met, the charity can receive money from your business but it is no longer considered a charitable contribution for you personally but rather an advertising expense of your business.
Having the expenditure be considered an advertising expense has two added benefits:
It is deductible to your business; not as a personal itemized deduction. That means that it reduces your income and tax liability regardless of how close or far away you are from the $12,000/$24,000 itemized deduction thresholds.
Since the expenditure is decreasing your business income, it is also decreasing the amount of income subject to the self-employment tax (15.3% SE tax rate for most taxpayers. This is on top of the normal income tax rate). Meaning, not only do you reduce your federal and state income tax which for many is around 25-30% combined, but you also reduce the 15.3% SE tax that is on top of the income tax. For every dollar that is considered advertising, you are decreasing your tax liability by ~$.45. Thereby having the dollar you spent on advertising for a charity really only cost you $.55 after the tax benefit!!
Now to the catch, the IRS likely isn’t going to allow you to just take out a small ad in your local church bulletin and consider it a $10,000 advertising expense if your expectation is that the business would get little to no benefit from it. One of the main hurdles in deducting an expenditure as either a sponsorship or advertising expense is laid out in Reg. Sec. 1.170A(c)(5). The basic gist is that in order for an amount to be deducible as an advertising expense vs a charitable contribution you have to have a reasonable expectation of financial return in proportion to the amount spent.
If there is a reasonable business purpose as to why your business would sponsor a charity event or take out an advertisement with the charity, you may be able to claim a business deduction for it. Good “Rules of Thumb” include:
- Be sure you have a quality logo displayed
- Document the demographics of the audience for your listing or ad
- Document who you meet from the ad
- Document any follow up with people you met at the function
As always, keep it simple – A business expense is when you give something and get something in return. A charitable expense is when you give something with no expectation of return. Reasonably consider your motives in light of this and it will likely give you an initial indication as to whether the amount is advertising or a donation.
There are numerous other nuances to the above ideas that would need to be considered prior to either charitable bunching or the deductibility of a potential advertising expense. Hopefully this gives you some ideas of how you may be able to support your favorite causes and still receive a tax deduction!
Reg Sec. 1.170A(c)(5)
(5) Transfers of property to an organization described in section 170(c) which bear a direct relationship to the taxpayer’s trade or business and which are made with a reasonable expectation of financial return commensurate with the amount of the transfer may constitute allowable deductions as trade or business expenses rather than as charitable contributions. See section 162 and the regulations thereunder.
Would you like to discuss this topic further? Contact us at firstname.lastname@example.org or 716-633-7022.