After a rocky first three months of the year, U.S. stocks rebounded in the second quarter with both large and small company indices posting material gains. Foreign shares did not fare as well, possibly due to the U.S. adopting a more aggressive stance on trade policy, including new tariffs on major trading partners (e.g., China, Europe, Mexico, and Canada). Continued strength in the domestic economy allowed the Federal Reserve to raise short-term interest rates in June for the second time this year. The 10-Year Treasury bond yield, a benchmark for longer-term interest rates, has risen significantly from the beginning of the year, but finished the quarter at 2.85%, below its high of 3.11% reached on May 11th.
Asset class returns for the quarter and year-to-date were as follows:
|Index||Asset Class||Second Quarter 2018||Year-To-Date 2018|
|Barclays U.S. Govt./Credit—Int.||Fixed Income||0.0%||-1.0%|
|S&P 500||Large U.S. Stock||3.4%||2.7%|
|Russell 2000||Small U.S. Stock||7.8%||7.7%|
|MSCI ACWI ex‐USA||Foreign Stock||‐2.6%||‐3.8%|
|S&P Global REIT||Real Estate Securities||6.1%||-0.1%|
With the 2017 tax season behind us, we have been scrutinizing the provisions of the 2018 tax reform legislation (formally, the “Tax Cuts and Jobs Act”) to help clients plan for this year and beyond. In this letter, we focus on charitable giving and how investors can most efficiently make gifts to their favorite charities.
One critical aspect of the new tax law is the sizeable increase in the standard deduction, combined with limitations on allowable itemized deductions. The new standard deduction is $24,000 per couple plus an additional $1,300 per person (or $1,600 for unmarried taxpayers) for those age 65 or over. Additionally, for those who itemize deductions, the deduction for state and property taxes is limited to $10,000. If taxpayers do not have significant mortgage interest or medical expenses to deduct, they will likely utilize the standard deduction, potentially negating any marginal tax benefit of charitable donations. Consequently, prior to making any significant charitable gifts in 2018 and beyond, charitably-inclined investors should forecast whether they will itemize deductions and which charitable giving strategy may be most advantageous for them.
Below are four of the most common methods of charitable giving:
The first two methods, gifting cash or securities directly to a charity, may not provide a marginal tax benefit if the donor no longer itemizes deductions. If the donor is younger than 70 and will not itemize deductions, he or she may be better off “bunching” several years of charitable donations into a single tax year to exceed the new standard deduction and itemizing deductions every other year. The best way to implement this “bunching” strategy is by funding a Donor Advised Fund (DAF) or a charitable trust. We typically recommend DAFs because they are simple to establish, and the minimum opening balance is relatively low (e.g., $5,000 at Schwab). By utilizing a DAF and making a high enough contribution, the donor can take a charitable deduction in the year the contribution is made, and subsequently direct smaller gifts to charities over time. DAFs are most advantageous when highly-appreciated securities held for more than one year are used for funding, rather than cash. By gifting highly-appreciated securities from taxable investment accounts, a charitably-inclined investor receives a tax deduction for the market value of the gifted securities and eliminates the future tax liability on the securities’ unrealized gains.
For those over age 70½ with a traditional IRA, a Qualified Charitable Distribution (QCD) may now be the optimal method of charitable giving, regardless of whether he/she plans to itemize deductions. When a taxpayer makes a direct charitable gift from an IRA, the donated amount is excluded from Adjusted Gross Income (AGI). AGI is an important number used in various tax calculations, so reducing AGI by making QCDs can produce significant tax savings. QCDs are only available for IRAs (401(k)s and 403(b)s are not eligible), cannot exceed $100,000 per year, and must go directly to the charity.
QCDs may also be a superior strategy for taxpayers with children who will eventually inherit a significant IRA account. The children’s annual required distributions from the inherited IRA will be fully taxable as ordinary income, while the appreciated stock will receive a step-up in cost basis to fair market value at death, so neither the taxpayer nor his/her heirs will pay income tax on the current unrealized gains.
IRA custodians (e.g., Schwab) have recognized the increasing attractiveness of QCDs from IRAs and have streamlined their processes. The account custodian will issue a check in the amount of the desired donation from the donor’s IRA account, made payable directly to the charity. The check is then mailed to the donor’s address for him/her to forward on to the designated charity. It is important to ensure that your tax professional knows what portion of your IRA withdrawals for the year went to charity and what portion was an ordinary taxable distribution. The IRA custodian will issue a 1099-R to the IRS without specifying the amount related to a QCD, so your tax professional must define this specific amount within your tax return. We can assist in the coordination of this process with your tax professional.
As a guiding principle for philanthropy, lifetime charitable giving typically provides greater tax benefits than making a bequest through a will or trust. The compounding “multiplier” effect on federal and state income tax savings helps you avoid “stealth” taxes based on variable income year-over-year and is truly impactful on your bottom line. If you have an estate below the current estate tax exemption amount of $22.4 million for a married couple that will not be subject to estate taxes, lifetime giving for the immediate tax benefit makes even more sense. Besides, it is just a great feeling to witness your generosity in action. For additional information regarding charitable giving strategies, visit our website at www.dywealth.com/charitable-giving. If you have any questions about charitable giving and how to best achieve your giving goals, we would be happy to discuss this with you in concert with your tax and estate planning professionals.
We encourage you to contact our team with any questions or concerns regarding your finances.