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Over 70 & Charitably-Minded? Here's How to Leverage the TCJA

If you are a charitably-minded investor who is  age 70½ or older, and you have money in individual retirement accounts (IRAs),  the Tax Cuts and Jobs Act of 2017 (TCJA) may provide some worthwhile planning opportunities to cut your tax bill more so than in prior years. 

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How can charitably-minded seniors leverage the TCJA? Let's walk through a few scenarios.

For the past several years, investors with IRAs who are older than 70½ and subject to taking required minimum distributions (RMDs) have had a particularly useful choice when making charitable donations. 

The tax code currently allows this group to make a qualified charitable donation (QCD) of up to $100,000 directly from the IRA.  By making a contribution to charity in this manner, the contribution amount counts toward fulfilling the RMD requirement for the year of the donation and the amount of the donation does not get counted into adjusted gross income (AGI).  This process remains the same for 2018, and is not directly impacted by the TCJA. 

A few other processes are.

 

How the Tax Cuts and Jobs Act changes things

The TCJA comes into play for two reasons. 

The first reason is because of the increased standard deduction (from $6,350 to $12,000 for single filers and from $12,700 to $24,000 for couples married filing jointly). 

The second are the new limitations on deductions, including:

  • Deductions for state and local (property) taxes which is capped at a combined total of $10,000 beginning in 2018.
  • Elimination of miscellaneous deductions (e.g., advisory fees, tax preparation fees, and others).
  • Elimination of deductions for interest on home equity loans not used to buy, build, or materially improve the home.

The net result of these changes is that many filers may be better off taking the standard deduction rather than itemizing deductions. 

Because charitable contributions would normally be an itemized deduction, a donor who uses the standard deduction would not receive any tax benefit by making a charitable contribution.    

The following table illustrates this scenario:

Deductions
Taxpayer A / "Few deductions"
State Income Tax $11,010
Property Tax $7,300
Subtotal

$18,310

Lesser of SALT or $10,000 $10,000
Plus: Mortgage Interest no mortgage
Plus: Itemized Deductions Before Charitable Contribution

$10,000

Deductions Subtotal

$22,000

Standard Deduction (MFJ) $24,000
Greater Deduction (Itemized or Standard) $24,000
Deductible Portion of Charitable Contribution None

Taxpayers who have other itemized deductions may find their charitable contribution gives them enough deductions to make it worthwhile to itemize deductions, but they may not receive the full tax benefit of the charitable contribution. 

Others may have enough itemized deductions to meet or exceed the standard deduction and may still realize full tax benefit of the charitable contribution.   

The following table compares three scenarios to illustrate this point:

Deductions
Taxpayer A / "Few Deductions"
Taxpayer B / "Some Deductions"
Taxpayer C / "More Deductions"
State Income Tax $11,010 $11,010 $11,010
Property Tax $7,300 $7,300 $7,300
Subtotal $18,310 $18,310 $18,310
Lesser of SALT or $10,000 $10,000 $10,000 $10,000
Plus Mortgage Interest no mortgage $6,000 $14,000
Itemized Deductions Before Charitable Contribution $10,000 $16,000 $24,000
Charitable Contribution $12,000 $12,000 $12,000
Deductions Subtotal $22,000 $28,000 $36,000
Standard Deduction (MFJ) $24,000 $24,000 $24,000
Greater Deduction (of Itemized or Standard) $24,000 $28,000 $36,000
Deductible Portion of Charitable Contribution none $4,000 $12,000

With some strategic planning, a taxpayer whose charitable contribution provides little or no tax benefit may be better off by making a qualified charitable donation (QCD) directly from their IRA, as we’ll illustrate in the following scenario.

In this scenario, imagine a taxpayer who is married filing jointly with the following characteristics: 

  • They have income from interest on investments plus Social Security totaling $84,000.
  • They also have an IRA worth $1.5 million and are required to take a first year distribution of $91,240.
  • Their itemized deductions apart, from their charitable contributions, consist of $11,010 in state income tax, and $7,300 in property tax.
  • They are considering making a $12,000 charitable contribution, either by writing a check from their checking account, or by making a QCD.

Based on the above assumptions, this couple would save approximately $2,200 in federal income tax by making the QCD instead of writing the check from their checking account.

If they write a check directly to charity, they receive no tax relief from the charitable contribution since their itemized deductions are less than the $24,000 standard deduction. 

By contrast, if they make the charitable contribution as a QCD, the $12,000 counts toward their RMD, meaning that they reduce their adjusted gross income by $12,000.

They can also take the standard deduction of $24,000. 

The following table illustrates the difference in outcomes for this scenario:

 
$12,000 Itemized
$12,000 QCD*
 
Income
     
Interest $36,000 $36,000  
Social Security $48,000 $48,000  
IRA RMD $91,240 $79,240  
Adjusted Gross Income $175,240 $163,240  
Deductions
     
State Income Tax $11,010 $11,010  
Property Tax $7,300 $7,300  
Lesser of SALT or $10,000 $10,000 $10,000  
Charitable Contribution $12,000 None  
Deductions Subtotal $22,000 $10,000  
Greater Deduction (Standard or Itemized) $24,000 $24,000  
     
Difference
Taxable Income $151,240 $139,240 ($12,000)
Federal Income Tax $16,244 14,044 ($2,200)

*QCD applies toward RMD

BUT WAIT! THERE'S MEDICARE

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An additional bonus from the QCD: Reduce annual medicare premiums

We’ve discussed how making a charitable contribution via a QCD can result in potential tax savings.  There is yet another potential benefit of the QCD: the potential to reduce the taxpayer’s annual Medicare premiums. 

Medicare premiums are based on a two-year look back at the taxpayer’s adjusted gross income. 

To illustrate, here is a chart of premiums for 2018:

If your yearly income in 2016 (for what you pay in 2018) was...

You pay each month (in 2018)

File individual tax return
File joint tax return (MFJ)
File married & separate tax return

$85,000 or less

$170,000 or less

$85,000 or less

$134

above $85,000 up to $107,000

above $170,000 up to $214,000

Not applicable

$187.50

above $107,000 up to $133,500

above $214,000 up to $267,000

Not applicable

$267.90

above $133,500 up to $160,000

above $267,000 up to $320,000

Not applicable

$348.30

above $160,000

above $320,000

above $85,000

$428.60

 Source: Medicare.gov

Because QCD’s count toward your RMD, a QCD can lower your adjusted gross income for the year. By lowering your AGI, you may also be able to reduce your Medicare premium. 

Using the assumptions from the prior example, here’s an illustration of how that might work:

 
$12,000 ITEMIZED
$12,000 QCD*
 
INCOME
     
Interest $36,000 $36,000  
Social Security $48,000 $48,000  
IRA RMD $91,240 $79,240  
Adjusted Gross Income $175,240 $163,240  
DEDUCTIONS
     
State Income Tax $11,010 $11,010  
Property Tax $7,300 $7,300  
Lesser of SALT or $10,000 $10,000 $10,000  
Charitable Contribution $12,000 None  
Deductions Subtotal $22,000 $10,000  
Greater Deduction (Standard or Itemized) $24,000 $24,000  
     
DIFFERENCE
Taxable Income $151,240 $139,240 ($12,000)
Federal Income Tax $16,244 14,044 ($2,200)
Annual Medicare Part B Premium (Multiplied twice, based on AGI) $4,500 $3,216 ($1,284)
Total (Tax + Medicare) $20,744 $17,260 ($3,484)

 *QCD applies toward RMD

Final words

Making a qualified charitable donation can be a useful strategy for qualified charitably-inclined taxpayers over age 70½ with IRAs subject to RMDs. 

In addition, it’s important to note that a QCD must be made to a qualified charitable organization or organizations; they cannot be used to make a contribution to a Donor Advised Fund nor a private foundation. 

Ask your financial planner and tax professional to review the merits of this strategy as it applies to your financial goals and circumstances.

If you don't have a financial planner yet, download our interactive workbook and clarify your objectives:

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Topics: Retirement Planning, Financial Planning