Although the 2017 revisions to the Internal Revenue Code known as the Tax Cut and Jobs Act (TCJA) preserved individuals' itemized income tax charitable deduction, other changes made the standard deduction the best option for most individual taxpayers. If experience is a good indicator, individuals will continue to give to charity whether or not they receive a tax benefit, but they may give less than in prior years. Because charitable giving offers a tax benefit to those who will itemize their deductions, and most itemizers will be high-net-worth taxpayers, charitable giving continues to be an important component of the overall income tax plan for many high-net-worth individuals. With the significant reduction of other deductible expenses under the TCJA, charitable donations may play an even more important role in tax planning for high-income taxpayers. Anecdotally, many charities are reporting that their wealthier patrons are increasing their giving to cover the expected gap resulting from the increased standard deduction.  Although statistics are not yet available, we predict the 2018 data will show that wealthier taxpayers increased their charitable giving.

To maximize the tax advantage of charitable gifts, donors must consider what to give, when to give it, and to what type of charity the gift should be made.

What to Give

Cash. The TCJA's increase to the cap on the deductible amount for cash contributions from 50 percent of the taxpayer's adjusted gross income (AGI) to 60 percent of AGI has been well publicized. But it is often overlooked that taxpayers will qualify for the 60 percent limitation only if all of their gifts are made in cash. As discussed below, the benefits of donating appreciated assets will nearly always outweigh the benefit of paying cash to increase the total deductible amount.

Long Term Appreciated Assets. Taxpayers may recognize more benefit by contributing long term gain assets to charity, rather than cash, because the donor may deduct the fair market value of the asset as of the date of the contribution without having to recognize the taxable gain upon transfer. Notably, gifts of long term gain, real property and intangible assets to a public charity, including a donor advised fund (DAF), are deductible at their fair market value up to 30 percent of the taxpayer's AGI. If the gift is made to a private foundation, it will be deductible at fair market value only if the long term appreciated asset is a publicly traded security, and even then, the total deductibility is limited to 20 percent of AGI. Although taxpayers have been taking advantage of their ability to contribute long term gain assets for decades, it is particularly relevant today due to the stock market's historic rise, which has created significant unrealized gain in many taxpayers' portfolios. Note that any deductible amount disallowed by the AGI cap may be carried forward into the following five years.

This technique may be especially attractive for taxpayers with heavy stock concentrations, such as the founder of a company or a corporate executive. A corporate executive has significant exposure to their employer's stock, not only through the company stock they own, but through equity linked compensation, salary, bonuses, benefits, pension and professional reputation, the combination of which ties their fortune very tightly to that of their employer. Oftentimes this exposure can exceed 90 percent or more of the executive's net worth. For these taxpayers, charitable giving of long term, appreciated employer stock represents an important component of a comprehensive, integrated program to diversify their concentrated position in a tax efficient manner while achieving their charitable goals.

Net Unrealized Appreciation (NUA) Election. A particularly powerful use of donating long term appreciated assets is in combination with the election to withdraw employer stock from a qualified retirement plan, like a 401(k) plan, and treat only their basis in the stock as deferred compensation taxable at ordinary income rates. When the recipient later sells the distributed stock, the “net unrealized appreciation” or “NUA” would be taxed, and then it will be taxed at the capital gains rate. Although the NUA election can significantly reduce the total tax bill for an employee whose employer stock in a retirement plan has greatly appreciated, it also leaves the employee with a concentration of highly appreciated stock in their taxable account. Thus, employer stock received as part of an NUA election can be especially attractive for charitable donation.

Qualified Charitable Distribution (QCD) from IRAs. Many taxpayers make qualified charitable distributions from their IRAs to avoid recognizing ordinary income on required distributions from the IRA. Any traditional IRA owner or beneficiary may exclude up to $100,000 from their income in distributions annually, as long as they have reached age 70½ and the distribution goes directly from the IRA to a qualified public charity. Note that a private foundation is not a public charity and, although a DAF is a public charity, it is not a qualified QCD recipient. A QCD can satisfy the taxpayer's required minimum distribution (RMD), and it will be excluded from income even if it exceeds the taxpayer's RMD.

Importantly, the income exclusion for a QCD is in lieu of a separate income tax deduction. The QCD may be more advantageous than a taxable IRA distribution followed by a charitable donation, because the former is not subject to federal or state income tax, whereas the federal deduction for the charitable donation may not offset all of the taxable income (due to AGI limits and other considerations) and several states, including New Jersey, do not offer a charitable deduction.

Taxpayers considering a QCD need to weigh the tax benefit of income exclusion against the tax and economic benefits of contributing long term appreciated stock. Factors to be considered include the taxpayer's effective income tax rate, state of domicile and state taxes, percentage of unrealized appreciation in the stock, and overall level of exposure to the appreciated stock. Also, as noted above, QCDs cannot be used to fund either a DAF or a private foundation.

When to Give

Many taxpayers are electing to frontload their charitable contributions to vehicles that provide a current income tax deduction while delaying distribution of the funds to charities over several years. For example, a taxpayer may give $150,000 to a DAF or private foundation in 2019 to capture the income tax deduction for this year, but defer making grants of such funds for many years. This strategy has broad appeal across income levels. It works well for taxpayers who are looking to bunch deductions under the new tax regime to clear the higher standard deduction hurdle. It may also be useful for a high-net-worth taxpayer to offset a large income recognition event in the current year. This technique allows taxpayers to lock in the current market value on a gifted asset, thereby minimizing market risk, while avoiding any capital gains tax on the appreciated assets. As an added bonus for appreciating assets, frontloading the gift allows the future appreciation to benefit the recipient charity tax free (for a public charity) or nearly so (for a private foundation).

Where to Give

Public Charities. The majority of donations are made to public charities, a class of tax-exempt entities that provide the greatest tax benefit. Public charities include churches (and their equivalents within any established religion), non-profit schools, and non-profit hospitals and scientific research institutions, as well as any other charity which is supported by broad based donations from the general public. Donations to a public charity are deductible up to 50 percent of the taxpayer's AGI, increased to 60 percent for a taxpayer who makes only cash contributions, and decreased to 30 percent for gifts of appreciated ordinary income assets and certain tangible personal property. As noted above, a DAF is a public charity.

 DAF vs. Private Foundations. In recent years DAFs have become an increasingly popular alternative to establishing a private foundation. In addition to offering all of the tax benefits of a public charity, DAFs are less expensive and easier to administer. They require no start-up legal fees, annual tax returns, or annual compliance requirements. Also, unlike private foundations, grants from the DAF may be anonymous. In addition, DAFs grow income tax free while private foundations are subject to a 1 to 2 percent annual income tax.

Split Interest Trusts. Charitable lead and charitable remainder trusts are special creations of the Internal Revenue Code, which mix charitable and private interests while allowing donors both income and transfer tax charitable deductions. For both types of trusts, the donor's charitable deduction is limited to the charity's actuarially computed interest in the trust's assets.

Charitable lead trusts are best used when interest rates are low, and are primarily a way to reduce transfer taxes while benefitting charity. In a typical charitable lead trust, payments are made on an annual basis to a designated charity or charities for a period of years, and the remaining value of the trust, at the end of the term, passes to the donor's heirs either outright or in further trust for their benefit. Charitable lead trusts are being used with more frequency in the current low interest rate environment.

Charitable remainder trusts provide maximum benefit in high interest rate environments, and are best used by donors with highly appreciated assets. In a charitable remainder trust, an individual beneficiary receives annual payments and, when the trust terminates, the remaining assets must be distributed to charity. When the trust sells the donated assets, usually immediately following the funding, the proceeds may be reinvested undiminished by income tax due to the trust's tax exempt status. Tax is paid gradually by the individual beneficiaries as they receive the trust's taxable income with each distribution.

In sum, despite changes to the federal tax code, charitable tax planning can still provide benefits for taxpayers and charities as long as careful consideration is given to the timing and type of assets, as well as the most appropriate vehicles for making the gift.

John Voltaggio, Managing Wealth Advisor, and Jackie Garrod, Senior Trust Advisor (and licensed attorney) sit in Northern Trust's Greater New York office, and are both residents of New Jersey.