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Why You Should Pay Your Charitable Gifts in One Year

For those of you who may make significant charitable gifts each year, the following may help you get more out of those gifts for income tax purposes.

Let’s say you are married and you are in the 24% income tax bracket. In recent years past, you and your spouse could either itemize your deductions on schedule A of your 1040, or together you and your spouse could use the $13,000 standard deduction, which anyone can take, even if they have no itemized deductions. So each year you would calculate your Schedule A deductions and if those were more than the standard deduction, then you would itemize, and if less you would use the $13,000 standard deduction.

For 2018, the standard deduction is now $24,000 between husband and wife. That’s a lot and many people who previously itemized will no longer itemize but will use this standard deduction. Also, certain former itemized deductions cannot be taken now or are limited.

You can still take the medical expense deduction, but this applies only to the extent these exceed 10% of your adjusted gross income, so very people have expenses that high.

The State and Local Tax deduction was on the chopping block, but stayed in, but is limited to $10,000 maximum for married filing jointly, $5,000 for singles. So let’s say you will normally receive a $5,000 annual deduction for these taxes, which generally must be taken each year, although you may be able to pay some property taxes in advance.

There are some changes to the home mortgage interest deduction. These changes and new laws are kind of complex and I don’t wish to fully explain these now, but let’s assume for our analysis here that your home mortgage interest deduction will continue to apply for each year. Your mortgage gets paid down each year, so generally the itemized deduction for the home mortgage will drop a little each year due to your reduced outstanding principal. If you are paying interest of more than $20,000 per year on your mortgage if you are married filing jointly, or paying more than $10,000 per year on mortgage interest if you are single, then the planning technique I am describing below probably won’t work for you right now, but it may when that mortgage becomes much less and your total annual interest paid is reduced accordingly.

For purposes of the explanation, let’s say you are fortunate enough to have no mortgage on your home, so there is no mortgage interest deduction to lose.

So let’s now say the following facts apply for year 1:

  • Adjusted gross income:  $250,000, so marginal tax rate applicable is 24%
  • SALT (state and local taxes) deduction annually:  $5,000
  • Average annual charitable deductions: $25,000

Based on this set of facts, it appears it is always best to itemize because you as a married couple filing jointly will have $30,000 of itemized deductions and since the standard deduction will reduce your taxable income by only $24,000, you are better off itemizing.

But let’s say that you can time your charitable deductions to be lumped together in one year instead of paying the charitable gifts over two years.

If you repeat the above income and deductions for year two, you will have a total deductions for those two years of $60,000. Can you do better? Yes, and here’s how.

Let’s say the SALT deductions cannot be lumped into one year, which is likely, but that instead of paying your charitable payments in two years, you pay them all in one year, totaling $50,000 in year one and $0 charitable deductions in year 2. So in year 1 you get a total itemized deduction of $55,000, consisting of the $50k paid to the charities and $5,000 in SALT deductions. Then in year two, you will make no charitable gifts, but you will still have the $5,000 SALT to itemize, but this would be your only itemized deduction for year 2, so you would take the standard deduction of $24,000 in year 2. So between years 1 and 2, by timing your charitable gifts to occur in year one, you receive a total itemized and standard deduction of $55,000 + $24,000, totaling $79,000, which, compared to making your charitable gifts equal in years 1 and 2, will result in a total deduction for these two years of only $60,000. So with this approach, you receive $19,000 more in deductions, and at a 24% tax rate, you save $4,560.

If you have the flexibility to pay your charitable gifts in one year and not the next, and if your mortgage interest deductions and SALT deductions are not too high, this technique could be used to save some significant income taxes.

For more information on gift taxes, read our article on the recent changes to the gift taxes.