How a Charitable Deduction Translates Into Tax Savings
Why do donors care about the charitable deduction?
The charitable deduction is valuable to many donors because it enables them to save taxes. The amount of taxes the donor can save with a given charitable deduction depends on several factors. Let’s consider a simple case first.
Imagine a married couple, the Smiths, with income of $200,000 who make cash donations totaling $25,000 for the year. Assuming they have no other deductions, their charitable gifts will reduce their taxable income from $200,000 to $175,000. The federal income tax schedule for a married couples filing jointly in 2019 is:
|Taxable Income||Tax||% on Excess|
The tax on $200,000 of income would be $28,765 + (200,000 – 168,400) x 24% = $36,349.
The tax on $175,000 of income would be $28,765 + (175,000 – 168,400) x 24% = $30,349.
Their $25,000 in charitable deductions saves the Smiths $6,000 in taxes. The Smith’s highest tax bracket is 24%, which is known as their “marginal tax rate.” Their tax savings from their deductions is at their marginal tax rate. In other words, their tax savings of $6,000 equals $25,000 x 24%.
Factors That May Affect the Value of a Donor's Tax Savings
Several factors can affect the amount of tax savings a donor enjoys from a given charitable deduction. While it is unlikely that you, the gift planner, will have enough information to assess whether any of these factors apply to a specific donor – and, regardless, your role is not to give tax advice – you should be aware of these factors. Your donors will appreciate you making them aware of these considerations.
Donor’s marginal tax bracket: As noted already, a donor who itemizes her deductions saves tax with her charitable deductions based on her marginal income tax bracket. This means that the higher a donor’s marginal income tax bracket, the more tax she can save by itemizing her charitable deductions. A married couple in the 37% federal income tax bracket saves $0.37 on every $1 of charitable contribution they deduct on their federal income tax return. In contrast, a married couple in the 22% federal income tax bracket saves only $0.22 on every $1 of charitable contribution they deduct.
For residents of states that have an income tax and allow a deduction for gifts to public charities, their tax savings from itemizing charitable gifts are somewhat greater than just their federal income tax savings.
Standard deduction: The standard deduction is the amount that taxpayers can choose to deduct when figuring out their taxable income without itemizing all their specific deductions. It makes sense for taxpayers to take their standard deduction rather than itemize their deductions if their total itemized deductions, such as charitable contributions, mortgage interest, and state and local taxes, would be less than their standard deduction.
The 2017 Tax Act roughly doubled the standard deduction to $12,000 for single filers and to $24,000 for married filing jointly filers. These amounts are indexed for inflation;
|Single Filers||Married Filing Jointly Filers|
Of importance to planned gift donors, single filers age 65 or older may increase their standard deduction by $1,650 and married filing jointly filers may increase their standard deduction by $1,300 for each spouse age 65 or older. For these taxpayers, the standard deductions are:
|Single Filers, 65+||Married Filing Jointly Filers, Both 65+|
The 2017 Tax Act also eliminated some itemized deductions and capped the deduction for state and local taxes (sometimes called the SALT deduction) at $10,000.
The combination of dramatically increasing the standard deduction and eliminating or capping some itemized deductions has caused the percentage of taxpayers who itemize their deductions to decline from about 30% in 2017 to about 10% in 2018.
Here’s the important point: taxpayers who take the standard deduction rather than itemize save no taxes because of their charitable contributions.
A planned gift donor who makes a gift that earns a large enough deduction will still want to itemize and will enjoy a tax benefit from the deduction as a result, but many donors who make a modest planned gift, such as a $10,000 gift annuity that produces a charitable deduction of, say, $5,000 - $7,000, may be better off taking the standard deduction and therefore receive no tax benefit from their charitable deduction.
30%/50%/60% Deduction Limitations: The deduction that a donor is allowed to claim in one year for gifts to a public charity is limited by the donor's adjusted gross income (AGI), as follows.
- Cash gifts: 60% of AGI (increased from 50% in the 2017 Tax Act)
- Long term appreciated property gifts: 30% of AGI
- Gifts of other property, such as short term appreciated property or ordinary income property: 50% of AGI
The donor may carry forward excess deductions of each type on up to five additional tax returns. The way the 60%, 50%, and 30% AGI limitations interact is complicated, even more so than you might expect. Here goes.
Cash contributions reduce, dollar for dollar, the limit on 50% deductions taken in the same tax year, whether current gifts or carryforward. Cash contributions also reduce the 50% limit when considering the 30% limit on deductions for gifts of long term appreciated property. The result is that the only way a donor can deduct more than 50% of her AGI in charitable contributions is if the contributions deducted have been made entirely with cash.
Example: If a donor has an AGI of $100,000 and makes $40,000 of cash contributions and $20,000 of long term appreciated property contributions, the donor can deduct all $40,000 of her cash contributions, but only $10,000 of her long term appreciated property contributions. Her deduction for long term appreciated property contributions is limited to $10,000 because the 50% of AGI limit within which the 30% of AGI limit is applied has been reduced to $10,000 by her $40,000 in cash contributions ($50,000 - $40,000 = $10,000). Her total deductions will be $50,000 and she will carry forward $10,000 of 30% long term gain contribution.
Several factors affect the amount of tax savings a donor can derive from a charitable deduction. Most fundamentally, a donor must itemize deductions to enjoy any tax savings at all. As a result of changes brought on by the 2017 Tax Act, only about 10% of taxpayers now itemize rather than take the standard deduction. Although it is likely that well over 10% of planned gift donors still itemize, donors of modest size planned gifts very well may not. And even if they do itemize, they may not have a high enough adjusted gross income to take all their charitable deductions at once. Your donors will appreciate you making them aware of the rules that could constrain the tax benefit from their charitable deduction. Regardless, always encourage your donors to discuss their tax situation with their tax advisors.