Higher Wealth Donors
Data shows that 75 percent of charitable contributions by the very rich are never deducted. (This comes from an analysis of 10 years of actual tax return data by David Joulfaian at the U.S. Department of the Treasury.) Why? Because charitable deductions are limited to a fraction of income. Under the old law, cash gifts could be deducted up to 50 percent of income. Now, they can be deducted up to 60 percent of income. Sometimes people misunderstand the importance of this rule because they confuse wealth and income. In reality, higher wealth individuals often have relatively low taxable income. Assets can grow in value, but still generate little or no taxable income until the taxpayer actually sells them or takes a distribution from a tax-sheltered account like an IRA.
Consider the case of a 60-year-old retired taxpayer with a $1 million home, a $1 million dollar IRA and a $1 million stock brokerage account invested in growth stocks. Suppose that all assets increase by 10 percent in value during the year, growing from $3 million to $3.3 million. How much income do these assets produce? The home goes up in value, but that generates no income until the house is sold. The IRA is tax sheltered, so no income is reported from that growth until it is actually taken out of the IRA. Growth stocks pay little or no dividends, so there is no income until the appreciated stocks are sold. But what if the retiree spends $100,000 from assets. Does he have $100,000 of income? Not necessarily. Although the stocks overall grew by 10 percent probably some went up and some went down. If the retiree spends money by selling stocks that went down or stayed the same, there is no income to report. So, it is quite common for retirees to have high wealth and low income.
Now, suppose that all $100,000 the retiree spent came from a fully taxable ordinary income distribution from the IRA. Suppose his regular donations (probably transfers of appreciated assets if he has good tax advice) amount to 1.5 percent of his wealth ($3.3 million), or $50,000 in gifts. Now, he is considering making an additional $10,000 gift. What is the tax benefit? Under the old law, the tax benefit is $0. Even though the donor is giving just over 1.5 percent of his wealth, he is giving 50 percent of his income. Beyond this 50 percent, charitable deductions can’t be used. But, under the new tax law they can be, up to 60 percent of income. (The unused deductions can be carried over, but will still expire in five years assuming the taxpayer keeps making regular charitable gifts like this.) So, the new tax law changes this from a $0 deduction to a $10,000 deduction. Add a few zeros on to the wealth, income and donations in the example, and you begin to see why this might make a huge difference for some donors.
Those With Incomes In The Bubble Range
A reduction in income tax rates makes deductions, like the charitable deduction, less valuable. For example in 2017, the top federal tax rate was 39.7 percent, so a $100 cash donation could generate a federal tax benefit of up to $39.70. In 2018, this falls to 37 percent, so the same donation generates a maximum tax benefit of $37.00. But, rates didn’t fall for everyone.
For individuals making $200,000 to $416,700 (or married couples making $400,000 to $416,700), their 2017 tax rate was 33 percent, but their 2018 tax rate is now 35 percent. For this group in the “bubble,” the value of a charitable tax deduction has actually increased.
Those Affected By Pease Deduction Limitations
The Pease rule reduced charitable (and other) itemized deductions by up to 80 percent, depending upon the donor’s income. In 2017, these deductions were reduced by 3 percent of income exceeding $261,500 for individuals ($313,800 for married couples). For example, suppose an individual donor had $1 million of income and deducted only $30,000 in donations. In 2017 the charitable deduction from this gift would have be only $7,845, i.e., $30,000 less the Pease reduction of $22,155 [($1,000,000 income - $261,500 threshold) X 3 percent]. The deduction for the same gift in 2018 would be $30,000. A bump from a $7,845 deduction to a $30,000 deduction for the same donation can make a big difference for such high-income donors.