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.

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.

Conclusion

So, did the new tax act reduce the value of charitable tax deductions? The answer, it turns out, is not “Yes.” Instead, the answer is, “It depends.” For some, the value has gone up. For some, it has gone down. These effects are complicated because the people for whom the benefits of giving have gone up (high income, high wealth) are fewer in numbers, but these people generate a disproportionately higher share of charitable dollars. Additionally, lower tax rates and higher standard deductions mean more disposable income. More disposable income means more opportunities for donations. Thus, rather than the new tax law representing a “sky is falling” scenario for charitable giving, it is instead a mixed bag of good and bad. 

Russell James, J.D., Ph.D., CFP, is a professor in the Department of Personal Financial Planning, Texas Tech University.