Charitable Deduction Income Limits and The Standard Deduction - A Note of Caution

There’s lots of changes in the new tax law (Tax Cut and Jobs Act of 2017 or TCJA) that will reduce the incentives for charitable giving (such as raising the standard deduction, meaning that fewer taxpayers will itemize).  One break which will help donors, however, is an increase in the charitable deduction income limitation.

The deduction for charitable giving is limited to a certain percentage of income, based on the nature of the gift made and the type of organization receiving the gift.  The new TCJA law raises the income limitation for cash gifts from 50% of adjusted gross income to 60%.   The new 60% charitable deduction limit applies only to cash gifts — not real property, not appreciated assets, just cash. (The deduction limits remain the same for gifting other assets, such as stock, real estate, and tangible goods.)   Any gifts above the income limitation can be carried over for five years. 

The increased standard deduction in TCJA means far fewer donor will itemized their charitble deductions.  Some have advocated “bunching” charitable contributions in a single year (by, say, a donation to a donor advised fund).  This would allow the donor to itemized deductions in the year of the “bunching”, and then using the standard deduction in subsequent years.

But in some circumstances this strategy may not be effective – and the problem can be illustrated with an example.  Suppose Bill and Melinda Getz are both 70-year-old retirees.  In 2017 they deposited $50,000 into their donor advised fund but, due to 2017 income limitations, they could only recognize $35,000 of that gift for their 2017 taxes.  They carried forward $15,000 to be used in 2018.

Bill and Melinda have $8,000 in itemized deductions for 2018.  Taking into account the $15,000 in charitable contributions carried forward from 2017, they would have $23,000 in itemized deductions.  They choose instead to use the standard deduction for a married couple for 2018, which is $24,000.  Since they have not used their charitable deduction carry-forward from 2017 to 2018 it carries forward another year to 2019, right?  WRONG!

Under current IRS regulations, the $15,000 carryover is treated as if it were claimed, even though Bill and Melinda choose the standard deduction. IRS rules say that when a taxpayer uses the standard deduction, any charitable deduction carry-forward is reduced as if you took the maximum possible charitable deduction.  Despite the fact that they did not itemize, the $15,000 of the carryover is treated as if it were reported and deducted. Bill and Melinda essentially forfeit their $15,000 charitable contribution deduction carry-forward.

For taxpayers who can “bunch” their charitable contributions without carrying a deduction forward due to the income limitation, this rule does not apply and accumulating charitable gifts in a single year can still be a good strategy.  But if “bunching” results in a charitable deduction carry-forward, the effectiveness of this strategy will be severely limited.