• Nov 16, 2018

    Charitable Gifting Advice from a CPA (Part 1)

    Jim DeLucciaBy Jim DeLuccia, manager, PICPA communications

    MoneyLife100Application of the Tax Cuts and Jobs Act of 2017 has been a significant undertaking for CPA tax practitioners, but the law has also been critical for personal financial planners, especially as it relates to advising clients about charitable gifting. To help explain the planning opportunities arising from the law, I interviewed Marsha Rubin, CPA, CFP, a financial adviser with Wharton Investment Consultants in Wilmington, Del. This is part one of a two-part blog. This post covers qualified charitable distributions as a charitable-giving tax strategy for those age 70 ½ and older. Part two offers tax-beneficial giving strategies for those not yet 70 ½.

    Marsha Rubin, CPA, CFP

    Marsha Rubin, CPA, CFP
    Financial Adviser
    Wharton Investment Consultants

    PICPA: What are the changes in the Tax Cuts and Jobs Act that have greatly affected charitable gifting?

    Rubin: There are changes to tax law that are really going to affect whether someone is going to be able to itemize or not, and that may affect whether they are going to want to make charitable contributions the way they used to. We have much larger standard deductions now – $12,000 for a single person, $18,000 for head of household, and $24,000 for married filing jointly. Plus, each married taxpayer who is over 65 gets $1,300 added to the standard deduction; if they're unmarried or blind, it's $1,600 each. So there are now some hefty standard deductions out there that people will likely take versus itemized deductions. Compounding that issue, we know a lot of itemized deductions have been cut. For people who have their investments professionally managed and have heavy investment fees, they will be in for a big surprise when they file their 2018 tax returns. I think most people are aware of the changes in the $10,000 maximum people can deduct for state and local taxes, which again makes it a lot harder for people to benefit from itemized deductions. All of this is going to mean that charitable contributions aren't going to be viewed as favorably as they were in the past. Charities know their big donors are going to keep giving what they're giving, but it’s unclear what the little donors will do.

    Given these changes, what is your favorite tax management strategy in the charitable arena?

    One that I like only applies to people who are older than 70 ½ – it's the qualified charitable distribution (QCD). These distributions were first allowed in 2006, and they were supposed to be temporary. And because they were temporary, the IRS wasn't required to change the 1099R, which is the form where you record IRA distributions and 401(k) distributions. Eventually, in 2015, QCDs were permanently instated, and they are a definite part of the current tax law.

    QCDs are IRA distributions that are paid directly to a public charity, so the distribution isn't considered income. Suppose you've got a client who has a $10,000 required minimum distribution for 2018, and they want to give $2,000 to their favorite charity – Philabundance, for example. They would take a $2,000 QCD that goes to Philabundance, then they would only have an $8,000 IRA distribution. On the tax return, the 1099R is going to say $10,000 came out, but the tax preparer is going to take the $2,000 QCD out, so only $8,000 is taxable. That means you get to take that $2,000 off the front of the return, where it's worth a lot more than at the end of the return as an itemized deduction.

    But this strategy has parameters:

    • You have to be 70 ½ at the time of the distribution – not 70 ½ in the year you take the distribution, but rather you have to have passed 70 ½ before the distribution.
    • The money has to go to a public charity, an IRS 501(c)(3) organization, and you can't give it to a donor-advised fund or private foundation.
    • It must come from an IRA. You could, theoretically, roll some money from a 401(k) into an IRA and then take it from the IRA (or a 403(b) into the IRA), but the money cannot come directly from a 401(k) or 403(b) plan – it's illegal.
    • There's a limit each year – taxpayers can take a maximum of $100,000 each of these distributions.
    • The last requirement is big: you can't write a personal check to the charity you are gifting to. You can't take a required distribution, put it in your checking account, and then write a check. Every custodian handles QCDs differently, so I can't give you an exact view on what this process will look like because it depends on the custodian. Most of them, however, will cut a check for the QCD amount, make it out to the charity, and mail it to you. Then you forward the check to the charity, and you self-report this action on the tax return.

    With QCDs you get a deduction – whether you itemize or not – before you get to adjusted gross income (AGI) because you’ve lowered your AGI for that year. Even if you do itemize, you might get extra benefits out of it, like a lower deductible for medical expenses.

    Speaking of medical expenses, do QCDs affect Medicare cost formulas since they are tied to AGI?

    Making a QCD could make a big difference in your Medicare costs, but this is an area that is a little confusing for most clients. Every fall, Medicare looks at your tax return from two years before, and they adjust your Medicare Part A monthly payments for the next year.

    For example, in fall 2017, Medicare looked at the AGI on your 2016 tax return, and added to it your tax-free income for 2016 (creating what is referred to as Modified AGI), which determines how much you pay for Medicare in 2018. If they looked at the modified AGI from 2016 and it was over $85,000 for an individual (or $170,000 for those filing jointly), then you will have to pay more for Medicare than the standard lowest amount. Medicare reviews five brackets of income, and the top bracket is $85,000-$160,000 of modified AGI for an individual ($170,000-$320,000 for those married filing jointly).

    In 2018, you would pay the least amount – $134 per month – for Medicare if you had modified AGI under $85,000. However, it can go all the way up to $428.60 per month, per person, so the difference between the lowest and highest payment is about $3,500 per person per year.

    This presents a couple of planning issues. I had a married-couple client a few years ago who decided that they wanted to give a lot of money to a child for a down payment for a new home. They took a $150,000 distribution out of their 401(k) plan – they didn't ask me about that decision! They figured they had to pay taxes on it, and they bit that bullet. But when they got their Medicare bill, they almost died. It was much higher than what they had been paying because of the effect on AGI of that big distribution. If they had spread it out over two years, which they could have easily done since it was near the end of the year, they would have paid a lot less.

    And the Medicare cost determination is not a sliding scale. If you're just $1 over the AGI in a bracket, you're going to pay the higher amount. So, depending on what your AGI is compared to the table amount, you could be on the cusp of going to a much higher Medicare payment. A QCD might work very well here, and could be the deciding factor for a much smaller Medicare insurance cost.

    In part two of this blog, Marsha and I discuss tax-beneficial giving strategies for those not yet 70 ½.

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