New tax law impacts deductions – and your strategies
Continuing our study of changes to the federal tax laws with the Tax Cuts and Jobs Act, we take a deeper look at the new law’s impact on deductions for personal taxpayers. This article discusses a few ways taxpayers can optimize medical expenses and charitable donations for the maximum tax benefit.
The Tax Cuts and Jobs Act significantly increased the standard deduction amount, and as a result many taxpayers will no longer benefit from itemizing deductions on their federal tax returns. In 2019 the standard deduction is $12,200 for taxpayers filing as single or married filing separately; $18,350 for those filing as head of household; and $24,400 for those filing as married filing jointly. This increase in the standard deduction jeopardizes the deductible benefit of itemized deductions, including medical expenses and charitable donations.
Because the standard deduction for 2019 is now nearly double of what it was in previous years and with the floor for deducting medical expenses increasing to 10% of your adjusted gross income, many taxpayers potentially can benefit from “bunching” their itemized deductions. Using this strategy, a taxpayer “bunches” deductions together into a single year in order to surpass the itemization threshold (and gain a larger deduction benefit) and then takes the standard deduction in the next year. This approach may work well for those who have costly medical expenses or are charitable-minded.
For example, if you’ve been putting off an elective but not cosmetic medical procedure or need to make an expensive prescription drug purchase, you may want to consider paying those medical expenses in a year you already have substantial medical expenses. It is important to note that medical expenses are deductible in the year they are paid, not in the year the medical expense was incurred. The timing of payments can benefit taxpayers bunching expenses.
Charitable giving is another area where bunching can be advantageous. Depending on your specific situation, you may want to consider contributing multiple years’ worth of charitable donations all in one year to surpass the standard deduction threshold and benefit from a larger deduction.
You also could maximize the bunching effect by bunching both major charitable donations and medical expenses in the same year.
Other charitable giving strategies
Bunching is not the only way taxpayers can use charitable giving for potential tax savings. Donating long-term appreciated property, such as stocks or securities, can potentially provide a double benefit: you deduct the fair market value of the stock as a charitable contribution and the gain on the stock is excluded from your taxable income. By contrast, if you own an investment or business property that has declined in value you may want to consider selling the investment and donating the proceeds of the sale; this allows the loss upon the sale to be included in taxable income and allows a charitable deduction for the fair market value.
Another option is to donate publicly traded stock in which you want to continue to invest instead of the equivalent amount of cash. If you donate to charity an appreciated stock and then purchase the same for yourself as “replacement stock,” you receive the fair market value of the stock as a charitable deduction and a stepped-up basis in the replacement stock. This increase in basis can reduce the taxable gain on the replacement stock should it be sold in the future.
IRAs also provide a vehicle for making a charitable donation that may provide tax savings for taxpayers receiving required minimum distributions. Funds can be directly transferred from an IRA to a qualified charity in what’s called a qualified charitable distribution. Donations made with a QCD do not qualify for a charitable deduction; however, the donated amount is not taxable as an IRA distribution and thus is not included in taxable income. Making a QCD can satisfy your IRA’s required minimum distributions for the year provided that certain conditions are met. While QCDs are available to many IRAs [Traditional, Rollover, Inherited, SEP (inactive plans only), and SIMPLE (inactive plans only)], there are requirements to meet for the distribution to qualify as QCD:
- The taxpayer must be 70½ years or older.
- The QCD cannot exceed $100,000, or $100,000 per spouse ($200,000 total) if married filing jointly.
- The funds must be withdrawn from the IRA by the taxpayer’s required minimum distribution deadline (generally December 31) to count toward the distribution requirement.
- The funds must be distributed directly to the qualified charity. Funds distributed to the IRA owner even when subsequently donated to the charity do not qualify.
A donor-advised fund provides another strategy for tax savings using charitable donations – and it can turn your currently high tax bracket into an advantage. If your tax bracket is higher now than what is expected in retirement, you may want to consider frontloading charitable giving by making one large contribution now, rather than several smaller gifts spread throughout retirement. A donor-advised fund is a charitable giving tool established at a public charity that allows donors to make a charitable contribution, receive an immediate tax deduction and then recommend donations from the fund over time as they see fit. The donation is placed into a donor-advised fund account where it can be invested and grow tax-free, and over time during retirement you can direct donations from the account to qualified charities.
These strategies are just a few methods that could improve your tax situation. Tax planning is a complex and ever-evolving area and needs to be tailored to your personal situation. Not every strategy will be beneficial for every taxpayer. Talk to one of our professional CPAs about these strategies and other ideas they have to develop a tax plan that’s right for you.