Anyone who has an IRA and will be at least age 70½ in 2018 will need to carefully consider how he or she makes charitable gifts in 2018 and the years ahead. The Tax Cuts and Jobs Act of 2017 (TCJA) raised the standard deduction to $12,000 for individuals and $24,000 for married couples. The act also eliminated some deductions and cut back on others.
While charitable deductions were not directly affected, the potential tax benefits will be eliminated for many people because of the higher standard deduction. Analysts have estimated that less than 10% of taxpayers will be able to itemize deductions under TCJA.
Maximize Tax Benefits of Charitable Gifts
There are several strategies that could be used to maximize the tax benefit of charitable gifts. One of the easiest to use that doesn’t drastically alter a taxpayer’s normal giving is only available to those who have IRAs and are subject to taking a required minimum distribution (RMD) this year. The Protecting Americans from Tax Hikes (PATH) Act of 2015 reinstated the ability to make a Qualified IRA Charitable Distribution (QCD) permanently. A QCD allows individuals over age 70½ to directly transfer up to $100,000 from an IRA account to one or more charities. This transfer counts towards their RMD, but it doesn’t add to the taxpayer’s adjusted gross income (AGI).
Gifting directly from an IRA is significantly MORE effective than a charitable deduction for taxpayers now that TCJA has increased the standard deduction. Taxpayers using the standard deduction receive no benefit from charitable deductions. Making a QCD provides the tax benefit of writing off the gift while still taking the standard deduction.
Make Qualified Charitable Distribution from IRA
Seniors with higher incomes may be able to save even more taxes by using the QCD provision to make their charitable gifts. The Medicare surtax of 3.8% was not eliminated in TCJA. This additional tax applies to the lesser of net investment income (NII) or the excess of modified adjusted gross income (MAGI) over the income threshold. Threshold levels are $200,000 for single taxpayers and $250,000 for joint filers. Making a QCD lowers MAGI and AGI which in turn will reduce the amount of income subject to the Medicare Surtax.
Lower income taxes are not the only benefit of gifting through a QCD. The gift may help lower Medicare premiums. The standard monthly premium for Medicare Part B is $134 per month in 2018. However, a surcharge applies to seniors with higher income. The surcharge starts at MAGI of $85,000 (singles) and $170,000 (marrieds) and can be as large as $428.60 a month for each person in the household on Medicare! The calculation adds income from tax-free bonds to AGI to determine your income level. Making a QCD could lower MAGI enough to keep a senior out of the Medicare surcharge range.
Careful planning could be the key to a lower tax bill in 2018 and lower Medicare premiums next year. Normal RMDs increase AGI (and MAGI), which may cause you to lose some tax benefits, such as the medical deduction which is tied to gross income. AGI is also used to measure the amount of Social Security benefits that are taxable. Seniors with income above the base amounts of $25,000 (single filer) and $32,000 (joint filer) are subject to federal income tax on their Social Security benefits. For joint filers with incomes above an “adjusted base amount” of $44,000, up to 85% of benefits can be taxed. The trigger point for taxing benefits is based on MAGI.
A major benefit of using the QCD strategy to make charitable gifts is that it lowers MAGI and could potentially lower or eliminate the taxation of Social Security. This can be significant. A couple with $30,000 of Social Security income, $15,000 of other income and a $25,000 RMD would have $15,000 of Social Security subject to tax. Making a $10,000 QCD with some of their RMD would drop the amount of taxable Social Security to $6,850. Their tax bill would be cut dramatically.
Making charitable gifts just to save taxes is not advised. I always tell clients not to give for tax reasons, but instead give to be charitable. That said, once you’ve decided to be charitable, it makes sense to do so in a “tax smart” way. Tax benefits from charitable giving will be harder to receive under TCJA. However, for those with IRAs that are subject to RMDs, a little planning can help maximize tax benefits using the QCD strategy.
- The Tax Cuts and Jobs Act of 2017 raised the standard deduction so fewer taxpayers will be able to itemize deductions.
- A Qualified IRA Charitable Distribution allows taxpayers to save taxes on charitable donations without the need to itemize deductions.
- Medicare premiums are based on a taxpayer’s adjusted gross income.