2020 tax season officially ended with the extended May 17 tax filing date so it is now time to turn our attention to 2021 taxes that will be due on or around April 15, 2022. One way that people frequently do income tax planning is through charitable contributions. In addition to tax benefits, people recently came face-to-face with their mortality risk due to COVID-19, resulting in interest by many in increased philanthropy according to development professionals.
Only about 10% of taxpayers benefit from itemizing income tax deductions such as medical expenses, property taxes, and charitable contributions. For the other ~ 90%, taking the standard deduction saves more on taxes than itemizing. In 2021, the standard deduction is $12,550 for single tax filers and $25,100 for married couples filing jointly. Coupled with the $10,000 cap on state (income) and local (property) taxes (a.k.a., SALT) under the 2017 Tax Cuts and Jobs Act (TCJA), these are “high hurdles” to exceed, especially the standard deduction amount for couples.
So who still benefits from itemizing deductions?
o People with high unreimbursed medical and dental expenses that exceed 7.5% of adjusted gross income (AGI)
o Victims of a federally-declared disaster with an adjusted unreimbursed loss greater than 10% of AGI
o Homeowners with high mortgage interest payments and/or home equity loan debt to buy/build/improve a home
o Donors who make high charitable contributions, often in combination with their SALT tax write-offs
Of these four itemized deduction opportunities, the first two are associated with health issues and property losses and the third is likely associated with high property tax bills that cannot be fully deducted under the TCJA and/or high home maintenance costs. Charitable contributions, on the other hand, have been found in research studies, to be associated with positive things including lower blood pressure, less depression, lower stress levels, and increased self-esteem.
Tax benefits for charitable contributions exist both for donors who take the standard deduction and those who benefit from itemizing. For those who do not itemize, there is an “above-the-line” deduction (i.e., a deduction from gross income before calculating AGI) of $300 for single taxpayers and $600 for married couples filing jointly as a result of the second COVID-19 relief law (a.k.a., the “second stimulus”) signed into law in December 2020.
It is important to note that the $300/$600 tax write-offs apply to cash donations only and not to property donations such as items donated to a thrift shop. Since tax write-offs are limited, it may be useful to prioritize, budget for, and keep track of 2021 charitable donations using this Charitable Giving Budget Worksheet from Rutgers Cooperative Extension.
For those who benefit from itemizing, there is a special rule in place for 2021 to spur COVID-related contributions: a temporary suspension of the normal 60% of AGI cap on charitable deductions. In 2021, donors can deduct up to 100% of their AGI in contributions to qualified charities. However, the penalty for fraudulent overstatement of deductible donations also increased from 20% to 50% of the underpayment. Excess donations above 100% of AGI can be carried forward for 5 years, but the enhanced 100% of AGI annual deduction limit goes away after 2021.
People can make charitable gifts while they are alive or upon their death through bequests in a will or trust and beneficiary designations in life insurance policies and retirement savings accounts. There are five primary ways that people make tax-advantaged charitable gifts during their lifetime:
o “Bunch up” several years of itemized deductions, including expenses for elective medical procedures, SALT taxes, and charitable donations, into one tax year to exceed the standard deduction amount and benefit from itemizing.
o Make qualified charitable contributions (QCDs) directly from a traditional IRA to a charity after age 70 ½ to satisfy required minimum distribution (RMD) rules and remove the withdrawn amount from taxable income in later life.
o Donate appreciated securities (e.g., stock or mutual fund shares) to a charity to avoid capital gains tax and to deduct the fair market value of the donated asset up to the IRS annual limit.
o Set up a donor advised fund (DAF) with an investment company custodian, contribute tax-deductible cash or investments to the DAF, set up an asset allocation, and recommend grants to qualified U.S. charities as desired.
o Set up a charitable trust with the advice and assistance of an attorney and retitle assets in the trust name. The tax deduction is based on the value of the stream of income to the charity. Two common types of trusts for charitable donations that vary as to when charities receive funds are charitable lead trusts and charitable remainder trusts.
What to do? Some financial experts advise making large contributions in 2021 to take advantage of the 100% of AGI limit. Others recommend waiting to see if higher tax rates go into effect in the future, especially for high net worth taxpayers. As always, consider your personal financial situation and reach out to a financial or legal advisor, if needed.