Giving & the OBBBA
Photo by Katt Yukawa on Unsplash
If you've been reading the news at all this year, or this blog, you're probably sick of hearing about the One Big Beautiful Bill Act that passed earlier this year. The bill is stuffed with more items than a turkey on Thanksgiving, or me after eating said turkey on Thanksgiving.
My clients and I are in the middle of Tax Planning season right now and one aspect we are looking at this year is checking how each client's tax bill might be affected by the OBBBA. There are things that will both help and hinder most clients.
What's changing?
Well a lot of things. Like a lot a lot. From energy credits, to tips being deductible, to the addition of Trump accounts, to -- on and on. If you're super interested in all this stuff, check out my blog post about the OBBBA for more information.
But one of the specific items that will be changing for taxes next year has to do with charitable deductions. Let me explain, no there is too much, let me sum up:
Historically, you've only been able to get a tax benefit from a charitable donation if you itemize deductions.
That's changing next year, as people can deduct $1,000 (for Single/Head-of-Household filers) or $2,000 (for Married Filing Jointly filers) if you take the standard deduction. That's good!
But if you itemize deductions, a hurdle is being added, as the first 0.5% of your MAGI (modified adjusted gross income) given in charitable donations won't be able to be deducted. For example, if someone's MAGI is $300,000, the first $1,500 of charitable donations won't be deductible starting next year. That's not good!
Also, if you're in the 37% tax bracket, all itemized deductions (including charitable donations) can only be deducted at 35% starting next year.
So what should I do about this?
Whether you like these changes or not, they are happening. But there are a few ways to optimize your tax bill in spite of the changes:
If you itemize deductions, there's an incentive to give THIS year instead of next year, before those changes go into effect.
A Donor-Advised Fund (DAF) can be a helpful tool for that, as you can contribute this year and get the full deduction, and then take your time in giving to charitable causes over the next year and beyond.
You can even accelerate this further by giving multiple years' worth to the DAF.
This can be especially helpful if you are "bunching" donations in order to get over the hurdle to itemize deductions for one year, then take the standard deduction for several years after that.
Instead of cash, you can consider giving appreciated stock you've held for more than 1 year to your DAF, which wipes out any embedded capital gains.
I'm going to need an example, Keith
Sure, no worries, an example it is. In fact, I'm going to draw from the details of several real-life client scenarios.
Let's say Jill & Bob live in California. Their MAGI (basically their income) for the year is $500,000, putting them in the 32% marginal Federal tax bracket. Their annual charitable giving budget is $10,000. They normally itemize their deductions.
Starting next year, the first $2,500 (0.5% of $500,000) of their charitable donations won't be deductible. Since they are in the 32% tax bracket, their tax bill will be $800 higher than it would be otherwise.
But Jill & Bob are thinking ahead. Instead of giving $10,000 this year and $10,000 next year, they think, "Hey, we can give $20,000 this year and $0 next year, which will allow us to deduct that 'lost' $2,500." That would lead to $800 in tax savings between the two years.
But Jill & Bob aren't done. They decide to front-load 4 years of giving into this year, or $40,000. This allows them to reclaim the "lost" $10,000 of deductions, effectively saving them $3,200 in taxes over the 4 years.
They decide to use a Donor-Advised Fund for the donation, so that they can get the full $40K deduction this year, then give to their chosen charities over the next 4 years as normal, donating money from their DAF.
Wait a second, Jill & Bob still aren't done. They realize they have a taxable brokerage account with some funds/stocks that have doubled in value over the years. If they sold those stocks, they would pay capital gains tax. But instead they donate $40,000 of those stocks to their DAF (instead of cash), effectively wiping out $20,000 of capital gains, saving around $4,800 in future Federal & California income tax.
Total tax savings: $3,200 + $4,800 = $8,000. Not too shabby.
On the other hand...
What if you take the standard deduction, give around $2,000 per year, and aren't even close to itemizing deductions?
Well, for you, the equation changes.
There's actually a tax incentive to give next year instead of this year. Like if you were planning on giving your annual $2,000 gift in December, you might consider waiting until January.
Why? It's because you won't get a tax benefit if you give it this year, but you will if you do next year (due to the $1,000/$2,000 charitable deduction for those claiming the standard deduction).
Let's take a step back
Of course, the main point of giving is NOT the tax benefits. We should be helping those in need regardless of whether we get tax savings.
Another way to say it: Never let the tax "tail" wag the giving "dog". The giving is more important. Period.
But if we can benefit monetarily too, then we may as well be intentional about the timing of our giving while we’re at it.
If you'd like a few other ideas of how to give in a tax-efficient manner, check out my recent blog post here.