If a tax reform bill is signed into law before the end of 2017, taxpayers — especially the 40 million who now itemize their tax deductions — will have only a few weeks to take advantage of expiring tax provisions.
So, what are some tax-saving steps that taxpayers can take in the year 2017 before the changes take effect in 2018? Christopher Hoyt, a law professor at the University of Missouri (Kansas City) School of Law, recently answered our questions about year-end strategies.
Q: In a recent issue of the LISI Charitable Planning Newsletter, you noted that taxpayers, basically, should do whatever they can to claim larger itemized tax deductions for charitable gifts and state and local taxes on your 2017 tax returns. Why should taxpayers pay their state and local taxes in 2017, not 2018?
A: The number of taxpayers who itemize their tax deductions is projected to fall from 40 million under current law to about 9 million if the tax changes are enacted. So, the year 2017 might be the last year that they will get tax savings from their itemized deductions, such as charitable gifts and state and local income taxes. However, taxpayers who are subject to the alternative minimum tax (AMT) might not get tax savings from larger deductions for state and local taxes.
Q: Both the House and Senate bills retain the charitable income tax deduction. So why would those 30 million taxpayers who currently deduct their charitable gifts not be able to deduct those same gifts in 2018?
A: It’s a result of two proposed tax changes that would take effect in 2018. First, both the House and the Senate tax bills would increase the standard deduction to $24,000 for married couples, $12,000 for unmarried individuals, and $18,000 for head of household. The corresponding 2017 amounts are just $12,700, $6,350 and $9,350.
Second, both the House and the Senate tax bills would eliminate virtually every itemized deduction, except for 1) home mortgage interest, 2) charitable gifts and 3) up to $10,000 of property tax. Of greatest significance, people would no longer be able to deduct their state and local income taxes. The outcome for people who don't pay mortgage interest or property tax is that in future years they won't get any tax savings from the first $24,000/$12,000 that they donate to charities each year. And there will be no tax savings from charitable gifts if they donate less. They will instead take the $24,000/$12,000 standard deduction.
Q: Why should those who itemize their deductions in 2017 but will not itemize in 2018, accelerate their charitable gifts into the year 2017?
A: To get tax savings. In 2017, the cost of giving $100 to a charity is just $100 of income if you can deduct the gift. The tax deduction offsets the income. If you cannot deduct your charitable gifts in 2018, then the cost of giving $100 to a charity could require $150 of income: pay the charity $100 and pay $50 of income tax on the $150 of income (assuming a combined federal and state income tax rate of 33%).
Q: Who should consider using a donor-advised fund (DAF) for charitable gifts and why?
A: A gift to a DAF in 2017 permits the donor to claim a charitable income tax deduction in 2017 and then recommend grants from the DAF to other charities in 2018 and later years. They have always been great as a centralized charitable giving vehicle. For example, someone can donate a large block of stock to a DAF (which is then sold tax-free by the administering charity) and then the donor can recommend numerous small cash grants from the DAF to multiple charities. They will be especially appealing to the 30 million taxpayers who are still able to deduct their charitable gifts on their 2017 tax returns but who won’t get tax savings from such gifts in 2018 or later years. There are many organizations that administer DAFs, including your local community foundation and national donor advised funds.
Q: What are the best assets to donate to a donor-advised fund?
A: Appreciated stock, mutual funds, and ETFs which, if sold, would produce a long-term capital gain. You can claim a charitable tax deduction for the full value of the property and you have the added benefit that you will never be taxed on the growth of the investment’s value. The maximum tax deduction that you can claim in 2017 for such gifts is 30% of your adjusted gross income. Any excess amount is carried forward and deducted over the next five years.
Q: Can IRA account owners older than 70½ still make charitable gifts, a qualified charitable distribution or QCD, from their IRA?
A: The House and Senate tax bills make no change to the popular law that permits individuals over age 70½ to make tax-free charitable gifts from their IRAs. This will be very attractive in the year 2018 and in later years, especially for people who don’t itemize their deductions.
Q: Anything else worth noting?
A: Taxpayers should prepare themselves for either scenario. Be prepared to act in these last few days of 2017 to get the most tax savings that you possibly can get if the tax changes are enacted. If the legislation is never enacted, enjoy your extra free time.
Robert Powell contributes regularly to USA TODAY, TheStreet, and The Wall Street Journal. Got questions about money? Email Bob at firstname.lastname@example.org.