You probably already know what is bad about the new tax law for charitable deductions. A higher standard deduction means fewer itemizers. Non-itemizers don’t benefit from tax deductions, charitable or otherwise. For those still itemizing, lower tax rates means deductions are less valuable. But, hidden in the details of the new tax law are several changes that actually increase the value of charitable deductions for many donors.
Before looking at these increased benefits, let’s keep in mind that some of the biggest tax advantages for donations were left untouched. Donating appreciated stocks, bonds or other assets instead of cash still avoids all capital gains taxes regardless of whether or not a donor itemizes. If a donor doesn’t want to change her investment portfolio, she simply takes the cash she would have donated and uses it to immediately buy identical stocks, bonds or other assets to replace the donated ones. (There is no waiting period or “wash sale” rule for appreciated assets.) The portfolio doesn’t change, but the “new” asset now has 100 percent basis, meaning that no capital gains taxes will be paid on any past appreciation. This is a big win for the donor, but also for the charity because the donor is now thinking about gifts from assets (i.e., “the big bucket”) rather than simply gifts from monthly disposable income (i.e., “the little bucket”).
Donor advised funds were also left untouched. So, if the donor’s favorite charity doesn’t know how to accept stocks or bonds, the donor can simply gift them to a donor advised fund and then have a check sent to the charity.
In addition, donors age 70 ½ or older are better off to donate directly from an IRA. This qualified charitable distribution is better than a deduction because the income is never reported to begin with and the gift counts towards the required minimum distribution. This tax benefit is the same regardless of whether or not the donor is itemizing. Beyond the charitable tax benefits unaffected by the new tax law, for other donors, the tax benefits for giving have actually increased.
Higher State Income Tax Donors
With all the talk about federal charitable deductions, you might have missed that state charitable deductions have now increased in value. Let’s look at an example. Suppose a donor is lucky enough to be paying income taxes at California’s top tax rate of 13.3 percent. Under the old law, a $100 charitable deduction could be worth as much as $47.63 in reduced state and federal taxes. Under the new law, it can be worth as much as $50.30.
Here is why. The $100 gift generates a $100 charitable deduction at the state and federal level. This reduces state taxes by $13.30. In the old system, the top federal rate was 39.6 percent, so the charitable gift initially reduced federal taxes by $39.60. But, because state taxes were deductible and the donor paid $13.30 less in state taxes due to the charitable deduction, federal taxes also increased by $5.27 ($13.30 x 39.6 percent). On net, federal taxes went down by $34.33 because of the $100 charitable gift.
However, under the new tax law the deduction for state taxes is capped at $10,000. So, for many, a reduction in state taxes from the charitable gift now will make no difference in federal taxes. This means that for the same $100 donation, federal taxes will now decrease by $37.00 ($100 x 37 percent) rather than $34.33 (($100 x 39.6 percent) – ($13.30 x 39.6 percent) in the old law. Even with the lower top federal rate, this change in state tax deductibility more than compensates.
This same issue makes avoiding capital gains taxes by giving appreciated property now even more valuable than before. Last year, combined state and federal capital gains taxes were lower because state capital gains taxes were deductible. Now, for those already paying over $10,000 in state and local taxes, there is no additional federal deduction from the state taxes. For our donor at top California tax rates with a $1,000,000 zero basis asset, this means that selling the asset leaves them with only $629,000 left to invest (as compared to $681,801 last year). The net cost of donating that $1,000,000 asset instead of selling it just got cheaper.